Fed Watch: Regardless of Bailout, US Economy Decelerating

Tim Duy:

Regardless of Bailout, US Economy Decelerating, by Tim Duy: The US economy is limping through the second half of the year as the impact of this summer’s stimulus checks fades. The continued weakness, I suspect, will come as a shock to the public, who have now been essentially promised that their problems will be solved with a bailout package they really don’t understand to begin with for the financial sector they view as arrogant aggregators of wealth. But any bailout will only prevent a financial meltdown that threatens to deepen the credit crunch and worsen the ongoing slowdown, not reverse the current weakness. I doubt, however, the general public sees that distinction. And they are not likely to be convinced; this Administration sacrificed its credibility long ago. Instead, the public will see billions channeled into Wall Street as the unemployment rate climbs. And climb it will.

The flow of data this week, for those paying attention, is decidedly negative in tone. The housing market continues to deteriorate, with a precipitous decline in new home sales reported today. By definition, we must be closer to a bottom on new construction – but, to say the least, that bottom remains elusive. Initial unemployment claims, reached nearly 500,000 last week, although the Department of Labor attributes roughly 50k to the impact of recent hurricanes. Still, initial claims hovering around 450k foreshadows another weak employment report next week. Perhaps the most discouraging report this week was the advance durable goods release, which revealed a 2% decline in new orders for nondefence, nonaircraft capital goods. As Spencer at Angry Bear notes, the report is a negative for third quarter GDP.

In my opinion, the stimulus package revealed the staggering importance of US households on debt supported spending. Cash funneled to households via the mortgage markets fueled the recovery from the 2001 recession, but at the cost of driving housing prices to unsustainable levels. This financing channel broke down when it became evident the household income was fundamentally incapable of supporting the debt loads necessary to sustain elevated housing prices. Credit markets contracted as underwriting conditions returned to traditional standards. I see this as permanent shift to a more sustainable equilibrium; credit needs to be extended on the basis of ability to pay, which ultimately reflects household cash flow (income). Housing prices need to adjust accordingly. Hoping for a rebound in housing prices to reverse current trends is, in my opinion, naïve.

To compensate for reduced access to capital markets, policymakers initiated a fiscal stimulus package to put cash in the hands of households. The debt necessary to support the package was floated onto financial markets and absorbed by foreign central banks. Households traded one debt-financed cash infusion for another. Because, as should have been expected, housing markets did not recover over the summer, the government stimulus provided only temporary relief. Households need a steady source of cash beyond their incomes to support their consumptive proclivities; without some artificial support, consumer spending will contract as a percentage of overall economic activity. I tend to believe this process is inexorable. Economic growth needs to become less dependent on consumer spending to be sustainable in the long run. Policymakers can cushion the blow, but policy should avoid entirely resisting the adjustment.

The fall in housing prices, and outright mortgage defaults, crumbled the base of Wall Street’s financial pyramid. A collapse of that pyramid threatens to spread and deepen the credit contraction beyond that already seen in housing. To be sure, a certain amount of additional contraction is almost certain as financial firms deleverage to more sustainable balance sheets. But this process threatens to turn disorderly quickly, which would generate a more significant credit crunch than is either necessary or desirable. The implications for Main Street are severe. Consequently, some sort of bailout for the financial sector is justified, in my opinion. I think the collapse of credit markets is something to be avoided if possible. I remember emerging Asia. We are not that different.

Congressional leaders were pulling together the final details of a bailout package to stem the bloodletting on Wall Street. The details may have been less than desirable. Indeed, it remains an extremely difficult sell to the public, especially when those who benefit are impolitic enough to suggest the following:

There also is the human cost to the financial floods, the collective psychological breakdown that occurs when Greenwich’s billionaires become mere millionaires.

“It’s the human toll that is frightening,” said State Rep. Livvy Floren, a friend of Mr. Fuld. “Dick Fuld has spent 39 years of his life doing this. It’s more than just money. They’re not going to be in the streets starving….I think the man worked 24/7. His family and Lehman are his life.”

A deeper analysis was offered by local Democrat Ned Lamont, who in one fell swoop compared Greenwich’s money woes to the Japan malaise, Asian tsunami and the New Orleans flood.

“It really is a financial tsunami, and it could go either way,” said the multimillionaire telecommunications mogul who ran for the U.S. Senate in 2006. “It took Japan 20 years to recover from their buying binge. How long does it take us to work through excessive leverage? That could take years not months. This is our Katrina.”

I have yet to meet a soul on the street who accepts that it is necessary to move forward on a fix to the nation’s financial underpinnings. With comments like these, is it any wonder?

Tonight we learned, however, that Republicans sabotaged a pivotal meeting today at the White House; the details are very distressing – see MarketWatch, Paul Krugman and Brad DeLong. The Republicans are playing with fire; the lack of leadership is on this issue is mind numbing. While I disagreed with certain elements of the initial proposal – nonexistent oversight is not a privilege this administration has earned – I believe there is a clear need for a comprehensive solution. And it is naïve to believe that the solution will come without a cost to taxpayers. No bailout is ever a free lunch. It is equally naïve, however, to believe that failure to act will be costless.

My hope is that a bailout is coming. But it will not change the path the economy is already on, it will only prevent activity from shifting to a new, less desirable path. I don’t quite see how the billions of dollars plowed into this program will be funneled to households. I see instead it will only cushion the process of deleveraging, and thus minimize the quantity of resources stripped from the economy. This is important and necessary, but will not provide a miracle cure for the economy’s travails.

Assuming a bailout comes to fruition, my attention will turn to the following:

1. What is the course of monetary policy? Increasingly, expectations are building for additional rate cuts, as much as 50bp as early as Monday. Federal Reserve Chairman Ben Bernanke’s shift to a more dovish tone from Tuesday to Wednesday appears to open the door to additional rate cuts. I think, however, that was not Bernanke’s intention. Instead, he felt it necessary to more forcefully press his case to Congress. That said, economic activity is decelerating, which, combined with the recent credit tightening, would typically prompt a rate cut – if the Fed had not already cut interest rates well ahead of their usual timing. And I suspect that Bernanke & Co. are more disposed to turn their attention to fixing the financial system, seeing that, rather than additional rate cuts, as the key to reinvigorating (or at least stabilizing) economic growth. Overall, I doubt they are interested in an intermeeting cut, and would prefer to wait until the December meeting.

If you are a cynic, however, and you believe there was a quid pro quo between Bernanke and Congressional leaders, then the Fed will cut rates next week. If so, the Fed would be openly abandoning its independence. Maybe it has come to that point. Nothing surprises me anymore when it comes to rate policy.

2. Will Congress step up to support Main Street? After the billions for billionaires bailout, it will be almost impossible to justified not taking further action to support Main Street, especially as labor markets deteriorate. It is not “if,” but “when,” with only the nature and size of stimulus to be decided.

3. How will the bailout and fiscal stimulus be financed? If it is not deficit spending, it will not be stimulative. My preference is for policy to focus on restructuring, not stimulus. Accept that we cannot deficit spend out way to prosperity, and support the bailout and additional stimulus via a tax increase on top income earners, those who have benefited most from Wall Street’s orgy of debt. I recognize, however, that it would be silly of me to actually expect that Americans would stand for self-financing their problems, and instead foreign central banks will be called upon to finance the bailout and future stimulus.

4. What will be the consequences of flooding global financial markets with more US Treasury debt? We will get another lesson in the world’s tolerance for absorbing low-yielding US assets. As long as foreign central banks continue to buy US debt no question asked, the lesson of the Reagan years hold true – deficits don’t matter (unless of course, we set off another burst of global liquidity that fuels commodity prices). If global financiers balk at acquiring the debt, then deficit will matter, and domestic interest rates would rise quickly. Place your bets, but realize that betting against the Bank of China has been a losers bet.

With the bailout package currently in doubt, however, my worry is that credit markets will collapse Friday morning. Under these circumstances, the Fed would likely be forced into cutting interest rates in an intermeeting move. With Congress nipping at their heels over their handling of the crisis to date, and Republicans undermining the bailout package, monetary policymakers may simply be out of other tricks.

Good luck Friday…these are treacherous times.

Comments

[bob mcmanus]

If it is not deficit spending, it will not be stimulative.

So government spending financed by increased taxes can never be stimulative? We are in such trouble.

[bakho]

There was a housing bubble. Prices will drop for the near future. There is also a finance bubble. There are too many players chasing too few good investment opportunities. Big Finance must shrink. The trick is to prop up the economy as housing prices continue to decline, housing starts wait for demand to fill the over-building and BigOil sucks the couch change out of the economy.

Our situation does not have a monetary fix. We need new fiscal, regulatory and institutional policies. We will not get this from an administration run by Laissez Fairies.

[ken melvin]

"Economic growth needs to become less dependent on consumer spending to be sustainable in the long run.

All consequence of the selling out of the working class, methinks.

[Graham]

I think we have reached too many peaks all at the same time.

Peak Oil,
Peak Credit,
Peak derivatives,
Peak Leverage,
Peak home ownership,
Peak Automobile manufacture,
Peak Mall rental,
Peak Corporate Officer Remuneration
Peak foreign investment,
Peak Employment,
Peak wage stagnation,
Peak Fed and Treasury manipulation,
Peak Presidential incompetence,

From the Peak of Mount Everest there is only one direction for the avalanche to go.

[Robinia]

My preference is for policy to focus on restructuring

Yep. Past time for it.

[spencer]

Very good wrap-up.

Like you, I do not much like the Paulson plan. It has many problems.

But it is still better than nothing.

[Smaller is Better]

"This financing channel broke down when it became evident the household income was fundamentally incapable of supporting the debt loads necessary to sustain elevated housing prices."

The solution to propping up the economy is housing prices that people can afford. Build smaller, less expensive homes and the economy will pick up. Builders will build, furniture makers will sell chairs and couches for the new homes. There is no good reason US homes/lots must be significantly larger than European homes. We just can't afford McMansions, or high lot prices that subsidize pricey projects. NINJA loans are not coming back anytime soon, so McMansions on pricey lots won't sell. The economy is toast without affordable housing (low prices). Smaller homes also use less fuel to heat, helping to solve another problem.

[Foreign Loans]

"A collapse of that pyramid threatens to spread and deepen the credit contraction beyond that already seen in housing."

The credit the rest of the world was generously willing to extend was wasted on bubbles, instead of building up productive efficiency. Now there may not even be enough credit extended by foreigners to keep our businesses functioning as is. If you borrow money, you must invest it in such a way that you will be able to produce enough extra product to pay it back. Building a highly productive business to export products to the lenders fits the description. Borrowing to consume doesn't.

Yet the dual mandate is currently interpreted as requiring promoting ever more consumption via borrowing. This has led to consumption via borrowing far in excess of national productive capacity, and policy is still trying to increase consumption via borrowing even more. Dual mandates are not used anywhere else, because they don't work. They hopelessly unbalance domestic supply/demand for credit. Look at the result.

[roger]

"But it is still better than nothing."

That is perhaps the worst reason ever for spending 700 billion dollars. Floyd Norris has an excellent column this morning that slices and dices the inherent contradictions in the plan, which, if it is fair - as per the Dodd proposals - will probably not work.

"One lesson of the last 18 months is that when the government promises aid to a financial institution, if needed, the pledge does more harm than good. What the public hears is that an institution needs help, which means it is not a good place to put your own money. Speculators sell the stock, and they buy credit-default swaps.

When the price of the swaps goes up, others get worried.

Mr. Paulson decided that problem could be solved by funneling hundreds of billions of dollars to banks, whether they needed it or not.

Since his criteria for getting the money did not involve any actual need for it, the hope was that none of us would think badly of the banks that get the cash.

The concessions demanded by legislators could change that in important ways, giving healthy banks possible reasons to turn down the plan — and perhaps raising suspicions about the others.

It has been a year since Mr. Paulson started trying to find a way out of this mess. The latest plan is not all that different from his first idea, announced last October. Then he wanted the banks to set up what became known as a super-SIV to buy dicey assets from the regular SIVs, or structured investment vehicles."

Because ideology has blocked what would work - a government run bank or a government supported modality through commercial banks that would actually help indebted consumers and producers lower their debt load to more supportable levels - we are debating a proposal that would make almost a trillion dollars disappear just so economists and policy makers could feel good about "trying something." That this problem was a grassroots problem has been evident for more than a year, and the only thing that was done to address it was the comic income tax refund scheme.

The problem is, of course, sheer class interest. The millionaire class can no longer think outside of its bubble or understand its dependence on the non-millionaire populace, except insofar as they serve as easy marks.

[bakho]

What Graham says.

Add to that
Peak GOP pique at the bailout.

Smaller is better says

is a good idea that may have worked 5 years ago, but that horse has already left the barn. What to do now that the bigger is not affordable has already been built. House sharing?

[anon]

"4. What will be the consequences of flooding global financial markets with more US Treasury debt?"

The bail out is a domestic asset transaction - an asset swap in substance. It's not a budgetary expenditure, doesn't contribute to the deficit, and doesn't require flooding global markets with more debt.

[Smaller is Better]

"What to do now that the bigger is not affordable has already been built. House sharing?"

When you are in a hole, stop digging. That is, don't build any more McMansions. Start building affordable homes to keep the economy going. There are more than enough McMansions extant to meet the need for many years. The market will gradually absorb them.

[Noni Mausa]

Whether or not housing prices are kept "affordable", are there enough people in a position to buy them?

The US has sat at record levels of bankruptcies over the past few years or a decade (I don't have the numbers here, sorry) so what percentage of adults with some sort of income still qualify for a mortgage -- especially if they just got *****'d by a subprime loan?

An interesting story here: http://www.sacbee.com/finance/story/1216054.htmlBankruptcy filings soar for seniors
By Cynthia Hubert - chubert@sacbee.com

September 7, 2008

No one, Placerville lawyer John Roberts insists, wants to raise the white flag of personal bankruptcy.

For the young and strong, wiping out suffocating debt can offer a fresh start, but for seniors on fixed incomes, it can signal a lower standard of living.

"The impact on them is far worse," said Roberts. "Their health is declining. Their options for earning income in the future has narrowed. They are in a very vulnerable situation."

Across the country, older people are showing up in huge numbers in the offices of bankruptcy attorneys like Roberts.

A recent study by university researchers shows that, between 1991 and 2007, the rate of bankruptcy filings more than doubled among Americans age 65 and older. The filing rate per thousand people between 55 and 64 was up 40 percent. Among those 65 to 74, it jumped 125 percent.

The trend appears to be continuing in 2008, and the problem may be far worse than the numbers reflect, said Harvard law professor Elizabeth Warren, one of three researchers who conducted the study as part of AARP's Consumer Bankruptcy Project.

"Many older people who need to file bankruptcy don't do it because they simply cannot bear the shame," Warren said. "It is humiliating to make a public declaration that you can't pay your bills. But for older people, it can be devastating."

...many older people are being pushed toward bankruptcy because of illness or unplanned medical costs...

[...]

"The first thing out of their mouths is, 'I never thought I would be in this position,' " said Sacramento bankruptcy attorney Stephen Koonce. "They're ashamed, humiliated, angry with themselves. They can't believe that this has happened to them."

Bankruptcy filings are soaring among all age groups. In the Eastern District of California, which includes Sacramento, Modesto and Fresno counties, they have jumped 85 percent during the past year, records show.

[...]

The national study shows that while most bankruptcy filers are in their 30s and 40s, the financial landscape for younger and older Americans has changed dramatically during the past two decades.

In 2007, people 55 and older made up 22 percent of all filers, compared to 8 percent in 1991. While they make up only a small percentage of all filers, Americans 75 and older were the age group with the highest jump in bankruptcies

[...]

Like people of all ages, Roberts added, some seniors also are falling prey to real estate scams that have drained their finances.

"They get talked into refinancing their houses or buying up," using adjustable rate loans that suddenly "blow up" and suck their bank accounts dry, he said.The full report is here: http://assets.aarp.org/rgcenter/consume/2008_11_debt.pdf

One hidden effect of the bankruptcies of seniors will be no inheritances for their children.

It looks like on one side of the street are houses on the market but sitting empty, while on the other side of the street are people who don't have the credit rating to buy them.

What solution? Maybe banks (or their owners, the feds?) becoming de facto rental agencies? I'm sure they would love that.

Noni

still has her picket fence ... for now...

[gsw]

why is raising taxes on one group to support another self-financing? Perhaps I am being too naive, but to be self-financing, people should pay their own way. In fact, if we had more people paying their own way instead of trying to live off the backs of others, we would have far smaller government, far less reliance on persuading the government to provide benefits to a certain political group and far less need for these poorly thought out bailouts.

JP Morgan's purchase of Wamu demonstrates that there are buyers for these assets at the right price. There are better solutions to this problem that can be effected with regulatory changes and private capital.

It is possible that the credit markets are not functioning due to banks sitting back and refusing to lend to each other in order to make the situation worse in order to put additional pressure on the gov't in a giant game of chicken. As usual, the gov't will be the first to blink since they have no skin in the game and will just throw more of my money at the problem - as they always do. I wonder if they would be so liberal if they had to put up a portion of their own net worth for this and all of the other wonderful spending plans that they come up with.

[King Whitey the Man]

I think we need to accept that we can't borrow our way to prosperity and no amount of government assurance that credit will flow like oil is going to change the collapsing consumer base is really at the heart of the meltdown.

Maybe if we parked some guillotines down on Wall Street and Capitol Hill, the plutocrats might take heed that sometimes you need to place a higher value on everyone. A subtle reminder that the over valuation of the few has a very immediate and concrete cost to said few.

How about a trade with the ruling class. We give you the bailout financing in return for which we put a moratorium on off-shoring work, health care premium increases and a bonus and raise program. Any takers?

[Smaller is Better]

"Whether or not housing prices are kept "affordable", are there enough people in a position to buy them?"

There are plenty of youngsters who want an affordable home, and have a decent credit rating. They just don't want to be trapped into working 2 or more jobs just to feed the money pit McMansion. Let them build homes they can afford, and the economy will recover as they buy homes/furnishings.

As a separate issue, many older people are declaring bankruptcy. A large part of this is soaring medical bills, and general CPI inflation eroding their meager pensions/savings. Have mercy on them also. Get rid of CPI inflation to maintain their pensions/meager savings, and fix our medical system so costs are not twice as high per capita as other nations.

[rufus]

anon says...
"4. What will be the consequences of flooding global financial markets with more US Treasury debt?"

The bail out is a domestic asset transaction - an asset swap in substance. It's not a budgetary expenditure, doesn't contribute to the deficit, and doesn't require flooding global markets with more debt.

On the surface it might appear this way...

http://www.usnews.com/usnews/politics/
bulletin/bulletin_080924.htm

Wednesday, September 24, 2008
WASHINGTON NEWS
Financial Bailout Plan Meets Resistance

Plan Unlikely To Add $700 Billion To Deficit The Wall Street Journal reports the Bush Administration "might be seeking $700 billion for its financial rescue plan, but that amount isn't likely to show up in the budget deficit." Federal Reserve Chairman Ben Bernanke told senators, "This is not an expenditure of $700 billion. This is a purchase of assets, and if auctions are done properly...the American taxpayer will get a good value for his or her money. And as the economy recovers, most, all, or perhaps more than all of the value will be recovered over time."

The 'hook' will be whether or not the Treasury will be able and economic conditions will be favorable to unwind these holdings in positive NPV result. Bernanke's comment assumes a positive NPV result.

The problem will be that these will be the most 'toxic' current assets/marketable securities of the bailee companies, carrying highest default risk and worst liquidity.

So other questions hopefully being asked are,
What price will be paid for these low/declining quality assets?

Will the quality of these assets appreciate/depreciate, and at what rate (i.e. when will the housing market recover)?

How long will the US Treasury have to finance potentially $700 billion and at what rates (nominal and real) to acquire these low quality assets?

Which makes this,
4. What will be the consequences of flooding global financial markets with more US Treasury debt?
a legitimate question.

[rufus]

...And if Bernanke and Paulson's bet on a positive NPV result is incorrect to a large degree, the last question to be asked will be who all gets swept up with the vaudevillian 'hook'.

[AvlDao]

"Smaller is Better writes:
'....when it became evident the household income was fundamentally incapable of supporting the debt loads necessary to sustain elevated housing prices....' The solution...is...Build smaller, less expensive homes and the economy will pick up. Builders will build, furniture makers will sell chairs and..."

I agree in spirit, but that level of building wont be feasible within any known timeframe. Let's look at 2008 to 2024. Presently there are 18 million empty houses & condos in the US. No one is going to (get commercial loans to) be undertaking any significant residential building to impact national numbers until that excessive stock of 18 mil gets sold via auctions, short-sales, or foreclosures, or get rented at a rate high enough to stay current on mortgage, insurance & taxes. And that has to occur during a recession that is deepening and generates job losses that reduce workers’ combined incomes which are also shrinking via price inflation for food & energy.
Immigration and net household formation will not dent that 18 million inventory much either, there’s almost no job growth to attract many immigrants or spur bursts of HH-formation. So ‘Smaller’, ur looking at say, 2014?
But wait; that's only IF the recession is not deep & long and IF the credit contraction is indeed slowed by Paulson’s Bailout v2, and IF workers with declining incomes can meet tighten mortgage rqmts where 20% down = $50k for a $250k house, but note that our pre-recession savings rate in the US was –zero-. So Smaller, maybe 2019?
But wait, there’s more....David Rosenfeld, a noted economist, feels the current deleveraging/’debt unwind’ and credit crisis wont end until US households collectively IMPROVE their ‘balance sheets’ by $2 Trillion (equates to $15,000 in reduced debt per household) AND also get their savings rate up to 8% - all during a recession!
So maybe 2024??
Nah, truth is there wont be much new construction. More likely, from 2008 to 2024, we will have methodically shifted into green & sustainable Adaptive ReUse/Rehabbing and Retrofitting of the existing mis-built & overbuilt real estate of vacant sub-division and urban condo towers, vacant strip malls and shopping centers, and those vacant ‘see-thru’ office towers and suburban office complexes, as time slowly passes. Converting it into denser housing & workspace as financing and credit-worthiness and demand allows. Think of Japan's Malaise, the 15-year version.

[AvlDao]

I can forward links to the data on 18 million empty homes. The 16 years from 2008-2024 is the length of the 3 over-lapping market bubbles from 1992 to 2007 that got us into this mess: the 'irrational exuberance' stock market bubble, the dot-com bubble and the housing price bubble.
I believe clinging to ‘false empty hope’ is a waste of human talent, so if our policymakers wont give us uncomfortable 'big picture' truths, we will analytically discover them for ourselves so we can plan & realistically manage our expectations.

[Patricia Shannon]

In my county, zoning laws have blocked the building of affordable homes. There are two factors. (1) The county government wants higher-priced homes so they can get more property taxes. (2) If a builder plans to build affordable housing, people in nearby expensive neighborhoods crowd the meetings of the zoning commission and protest that it would hurt their property values.

I expect that the fact that the people running the government are part of the upper-class, also contributes to their wanting to keep others out, but they usually don't acknowledge that publicly.

I have to admit I have no sympathy at all for those in category (2) who are losing value in their own homes because of the current crisis.

[Smaller is Better]

"I can forward links to the data on 18 million empty homes."

Unfortunately, they are mostly McMansions. If the price drops from $350,000 to $320,000 due to the credit crunch, this is still unaffordable. Small homes in the $100,000 range are needed to fill the demand, not McMansions. McMansions will never be affordable. They are just too expensive to buy, heat, and maintain.

Build smaller homes that are affordable, and forget about the McMansions. McMansions can't be made affordable, so they won't solve the problem. Don't insist that all McMansions be sold before anything smaller can be built. No one can afford them, so the economy will stagnate.

[pater_tenebrarum]

you are in complete error. the government has no resources of its own. there is no magic store of wealth it can draw from. this is to say, every bail-out needs to be paid for by someone else. the pool of real resources in the economy is limited. what the government proposes can be financed by either taxation, borrowing or running the printing press. in the first two cases money is moved from A to B. it will have to be taken from those who produce wealth to prop up those who quite obviously consume it. an inflation of the money supply via the printing press meanwhile has exactly the same effect, if in a more roundabout way. supporting wealth consumers by robbing wealth producers means the very economic actors who would carry the next economic upswing will be weakened. the 'bail-out road' is a well traveled one. it was tried in the 1930s on a grand scale, and again in 1990's Japan. the result was a catastrophe every time. by contrast, economic recessions that were not bedeviled by government intervention, quickly gave way to vigorous upswings again (see US 1921, and even Russia 1998). if the bail-out plan succeeds, we are almost guaranteed to be on the road to a depression, especially as it is to be expected that after it fails, more of the same will be demanded and tried. markets need to clear - the bail-out plan will delay this necessary market clearing. we had the biggest credit bubble in all of history - in all likelihood the process of reordering of the economy's structure of production to conform to actual demand patterns (as opposed to the artificial ones the credit expansion has produced) will be a painful one, but it is necessary and the only way to keep it as short as possible is to keep the government out of it and let the market do its work.

[Patricia Shannon]

When I bought a house in 1978, it cost about a year's salary. I had a tight squeeze for several years until my salary increased. I would say that $100,000 is still way to much for a house for many people. I heard on NPR this morning or yesterday morning that almost 15% of Americans pay more than 50% of their income on housing!

[Smaller is Better]

"I would say that $100,000 is still way to much for a house for many people."

You are right, of course. The 100k would only be for traditional site built homes. Manufactured homes are now very sturdy (some made by Warren Buffett), and can inexpensively house people.

[BJ Feng]

I think one of the most harmful parts of the proposed legislation is requiring foreclosure modifications to "allow" people to stay in their homes. This will just prolong the housing slump if it works at all. Think about it, these homes are 30-50% underwater! There is almost no way the homeowner can get back what they paid for the house unless they are willing to wait 20 years or so. Why would people volunteer to keep on paying a mortgage on a house that they might never be able to get their money back on? walking away would be a better option for a great many. Save your money for a new downpayment on a house that's now much more affordable. Only if the mortgage payments were lowered to below that of similar rental costs would it be worthwhile for someone to stay in a house that they vastly overpaid for.

In Riverside County near Los Angeles, we've seen median home prices drop by about 40-50%! Houses that were purchased for $400,000 are now being auctioned off for $150,000! How long will it take for someone who purchased a house for $400,000 to break even again? And they're expected to keep on paying reduced mortgage without any hope of breaking even? What's the motivation? Why not walk away, rent an apartment, and save some money for a new downpayment in a few years so that you can buy a house for $200,000? And mortgages have limits. What happens, if after 15 years or 30 years, the house still isn't worth $400,000? Why they wouldn't be able to refinance for the total amount, they'd have to come up with more money or be foreclosed on again. This is a bad proposal.

[James Kroeger]

If it is not deficit spending, it will not be stimulative.So government spending financed by increased taxes can never be stimulative? We are in such trouble.Actually, Bob, increasing taxes always results in an increase in GDP IF the levy is on rich people. It's difficult to find even a non-Republican economist who will acknowledge this fact, in spite of the fact that most of them teach their students about the effect.

The balanced budget multiplier is based, ultimately, on the marginal propensity to consume of those paying the tax. In other words, it depends on how much of disposable income is saved. Saved money is money taken out of the economy. When some of the money that would have been saved by taxpayers is spent, instead, by the government, there is a net increase in aggregate spending---all else equal.

Good luck in getting Mark Thoma to either confirm or deny that this is true. My guess is that he will never voice an opinion on the topic unless and until The Herd starts to move in that direction.

[Regressive]

"...increasing taxes always results in an increase in GDP IF the levy is on rich people."

The problem is, there are far too many regressive taxes. Property taxes, sales taxes, and the super regressive inflation tax. Get rid of all of them, and the standard of living of the bottom 90% will improve.

"Saved money is money taken out of the economy."

Business spending is part of GDP, and savings can be funneled into business spending. To the degree that savings improves productivity via business spending, it increases output over time. Of course, savings put into inflation hedges is useless for this purpose, and thus taken out of the economy as you suggested. Inflation thus promotes wasteful removing of savings from the economy.

Large businesses tend to reinvest (spend) with retained earnings to a degree, but small businesses need loans. Small businesses create most new jobs.

[anon]

rufus,

You are quite right. But you are right because you have differentiated between what others are erroneously labelling a deficit cost and what you correctly identify as a deficit risk. And it is indisputable that the risk is less than the erroneously labelled cost.

[James Kroeger]

Of course, savings put into inflation hedges is useless for this purpose, and thus taken out of the economy as you suggested. Inflation thus promotes wasteful removing of savings from the economy.I assume that you are talking about asset price inflation. Yes, that is one very good example of a waste of dollar movement. It is also, unfortunately, what happens when you throw money at rich people, as the Republican Party has over the past quarter century....savings can be funneled into business spending.They can be, but not much of it is. Example: between 1998 & 2001 (years that included cyclically high levels of business investment) the combined borrowing of non-financial corporations and all non-corporate businesses varied between 20-34% of total borrowing nationwide (see Fed Flow of Funds).To the degree that savings improves productivity via business spending, it increases output over time.Yes, and to what degree is it? Well, since corporations finance roughly 85% of their investments out of retained earnings or other internally generated funds, that leaves only about 15% of corporate investment requiring the savings of others (or injections of newly created money by the Fed) for loanable funds.

Small businesses may depend more heavily on borrowed money for their investments, but the total of their borrowing and that of non-financial corporations only accounts for about 28% of all borrowing.

What these facts tell us is that there isn't any great shortage of savings. Banks are more than happy to lend money to consumers for consumption purchases, and to ever more risky customers, generally, in their hot pursuit of higher returns.

Thowing more savings dollars at the credit markets (by cutting the taxes of rich people) does not mean that more business investment is going to occur. It does mean wasteful asset price inflation is going to occur and that the chances of cataclysmic failure are enhanced.

There is a hell of a lot of 'savings' we could obtain from the top quintile of income earners [and spend on infrastructure] before the assessments begin to threaten the supply of loanable funds. Even then, there would be options...

[Regressive]

"What these facts tell us is that there isn't any great shortage of savings."

There is no shortage of world savings, but there is a shortage of domestic savings. Importing virtually all savings creates balance of payment problems for our nation. It is not sustainable in the long run.

"Small businesses may depend more heavily on borrowed money for their investments, but the total of their borrowing and that of non-financial corporations only accounts for about 28% of all borrowing."

Yes, most borrowing by this nation does not increase productivity. This is a problem, as we will not easily produce enough additional products/services for export to pay back our foreign lenders. The standard of living will fall as a result. We should discourage excessive borrowing for consumption, while encouraging borrowing to increase productive capacity.

"I assume that you are talking about asset price inflation."

When people move into inflation hedges, this causes asset price inflation. However, general CPI inflation drives people into inflation hedges in the first place. They won't willingly put money in bank savings accounts if they perceive it to be losing value over time. They buy big homes instead as inflation hedges.

"...cutting the taxes of rich people..."

I never advocated this. Progressive taxes are the best way to go. What I advocate is eliminating regressive taxes. Especially the regressive inflation tax, which dries up domestic savings by forcing people into inflation hedges.

[Navy_VET_EOD]

FDR's series of programs between 1933 and 1938 (i.e. during the Great Depression) that successfully restored the US economy to growth and stability was focused on job creation (e.g. the WPA). It also focused on reform of business practices---particularly in the banking industry---that were the primary cause of the depression to begin with (i.e. 1929 stock market crash). None of the New Deal programs provided direct funding to the banks or insurance companies.

It was a bottom-up approach that recognized---not paid mere lip service to---the fact that labor force in any thriving economy is the keystone to its success. The less literate, less educated, less trained, less motivated, less secure that labor force is, the weaker the economy.

If the US government is going to obligate $750,000,000,000 to save the economy, why not use the greatest part of that obligation to create federally funded hydrogen filling stations, for example, at a strategically selected number of conventional filling stations across the country? Such a program would create jobs in a new high-technology applied research, manufacturing and service industries, create demand for training opportunities, and work in a strategic direction to dramatically reduce carbon emissions and dependence on foreign oil.

The same could be said of infrastructure refreshment and expansion programs.

The ultimate effect of such investments on the economy would be:

1. Stabilization and eventual reduction of the unemployment rate

* More people working, earning, buying; eventually the impact on the housing market would be positive because many of these people will be in a better position to qualify for reasonable, regulated mortgages, thus cutting into the current supply glut in the market

2. Increased opportunities for investors and venture capitalists to capitalize businesses created to support these programs (e.g. manufacturers of wind, solar, hydrogen and other "alternative" energy solutions).
3. GDP growth
4. Increased federal revenues

Aside from possibly temporarily unfreezing the credit market, sending $750B to Wall Street won't accomplish any of this. It will just give Wall Street a second chance under slightly different conditions (i.e. technically they are no longer investment banks, but rather bank holding companies or subsidiaries of them).

I say "possibly" because no one, neither Paulson nor Bernanke, has yet presented a clear, detailed analysis that describes exactly how this "rescue" is supposed to work. If they have and I happened to miss that, please send me the slides. It will make me feel better about the $750B obligation if I understand how it's going to be spent and why.

Considering Ben Bernanke's history (PhD in Economics from MIT; Milton Friedman school monetarist) I'm guessing (without any evidence to the contrary) he either doesn't know how "the Plan" is supposed to work, or for one reason or another doesn't want to tell us.

Sarah Palin isn't the only one who isn't talking.

[Navy_VET_EOD]

..Don't tell me again, please, as McCain just did, how there will be "grave consequences" if we don't go through with this. Explain those consequences to me, please, in the following terms:

1. The unemployment rate is currently at 6.1%. If we send $750B to Wall Street, what is the projected impact (e.g. show me what it would be in 12 months if we go through with the bailout...and if we don't). If a credible analysis can show me that going through with the bailout will result in an estimated unemployment rate of 5.9% at the end of 2009, while doing nothing would result in a rate of 10%, then I can be persuaded. If the numbers are 5.8% if we do and 7% if we don't, then I don't think it's worth it. Bring on the depression! The "cleansing" will do us all good, especially those with most to lose if we don't approve the $750B obligation: Wall Street.

Show me the cost/benefit analysis---and the logic behind it---in economic terms.

2. Same thing goes for GDP growth and the CPI/inflation rate impacts.

After all, that's what economics is for, isn't it?

As it is, only someone who would buy a used car without checking under the hood and taking a test drive from someone who has already sold them a lemon once before could possibly vote for this thing.

We should all be aware of how our respective senators and representatives in Congress vote on this.

If they vote "yes", then vote them out the next time they're up for election no matter what else they might have done for you...if for no other reason than their sheer stupidity.

[James Kroeger]

Yes, most borrowing by this nation does not increase productivity. This is a problem...It's a problem, but it does not need to be a problem. If you had banking authorities who were actually driven by the public interest, regulations could be imposed on all lending institutions that would set (if need be) an absolute limit on the quantity of money that is lent to non-productivity-enhancing borrowers, including financial corporations.

This would put banks in a position [at some point] where they would have extremely limited loanable reserves available to lend to financial firms and consumption customers (and riskier borrowers in general), but would have copious reserves that they are allowed to led to [non-financial] firms. These kinds of restrictions on lending categories would drive interest rates on business loans down while at the same time driving the interest rates on consumer loans higher.

There are probably better ways to establish hard quantative limits on certain types of lending than trying to guess the absolute limit to set, but the point is that it is possible to ensure that loanable reserves for productivitiy-enhancing enterprises (or in bad times, all productive enterprises) remain plentiful even while you are increasing taxes on the wealthy in a steeply progressive fashion. It is the answer to the argument that we can't tax rich people more because it will deprive the supply side of the economy of the funds in needs for investment.

BTW, such controls over lending categories would also make it quite easy for central banks to squash any threat of hyperinflation. If your banks can only lend out so many dollars, hyperinflation is an absolute impossibility.When people move into inflation hedges, this causes asset price inflation. However, general CPI inflation drives people into inflation hedges in the first place.Actually, I can't agree with this at all. It is simply not true that people need to fear a 'generalized inflation' before they can feel inspired to invest in real [or even paper] assets. It has always been a good idea for people who have a lot of money to save or 'invest' to use much of it to buy real property. Yes, it is 'a variable', but a rather minor one. Asset price inflation will happen if you throw lots of extra dollars at rich people, whether they fear inflation or not.

[Jennifer Burton]

Despite the stats and the market, I see so many high paying jobs posted on employment sites -

www.linkedin.com (networking)
www.indeed.com (aggregated listings)
www.realmatch.com (matches you to jobs)

I see 100K, 150K and 200K jobs. For those that know where to look, they will find great jobs.

[Avl Dao]

Smaller Is Better wrote: "Unfortunately, they are mostly McMansions."

Hmmm, where did you get that idea regarding the 18 million unsold units? Maybe we're not talking on the same subject, Im refering to built but unsold inventory in the USA...all 50 states, not some single suburban sub-division.
A big chunk of that unsold national inventory is condos, not just attached or detached houses in the suburbs, and not urban teardowns. You will have to separate whatever data source you have by type of housing stock (or are you simply making policy statements instead?).
Yes, vacant McMansions are vexing and are the darling scapegoat of the press, but they are outnumbered by unsold condo units.
My larger points stands: no one will be doing any mass building - period - for quite awhile, be it smaller, McMansions, or otherwise.