Credit Crisis and Big Spending Projects

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Chidem Kurdas on the Fed and the Current Crisis

Current conventional wisdom holds former chairman Alan Greenspan responsible for the Fed’s mistakes— such as keeping interest exceptionally low in 2002-2006 and not tamping down on excessive lending by banks. That staved off the recession in the aftermath of the stock market collapse, but created the twin credit-property bubbles and the current mess. John Taylor’s analysis of Fed’s easy money policy shows the central bank’s pivotal role in causing the crisis. And Gerald O’Driscoll of the Cato Institute makes short shrift of Greenspan’s responses to Taylor’s critique...

No question, Wall Street drank deeply and to its detriment. But that’s what financial people do, they make money from whatever opportunity that offers. It’s the Fed that created the opportunity, watched the party get out of hand and now will run a rehab center, further extending its reach. Great for the Fed.

For the rest of us, until we learn to impose limits and controls on government agencies, we will remain at the mercy of wrong-headed interventions, which create the problems that then lead to more interventions, more problems and so on. The Fed’s brief should be limited, not expanded. We appear to be going in the wrong direction.

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Economic Rescue: $10.5 Trillion and Counting

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Peter Schiff on the Current Economy

The Current Crisis: An Asessment

The good news from our historical study of eight centuries of international financial crises is that, so far, they have all ended. And we confidently predict this one will end, too. We are just not quite so sure it will be nearly as soon as the chirpy forecasts coming from policymakers around the globe. The U.S. administration, for example, is now predicting that growth will renew in the latter part of this year and continue at a brisk pace of 4 percent for several years thereafter. Is this a fact-based forecast or wishful thinking?

A careful look at the international evidence on severe banking crises suggests a far more cautious assessment. The recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11–12 percent in 2011...

Financial crises don't last forever. But this one could last a lot longer if policymakers don't start basing their actions on more realistic assessments of where we are and what is likely still to come.

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Credit Crisis and Free Markets

Q. But hasn’t the current crisis discredited “free markets”?

The history of markets is one of periodic crises (especially financial crises) and recoveries, including major episodes of creative destruction, but with steady positive long run growth despite severe fluctuations around the trend. The huge fallibility of human actors makes the case for markets stronger, not weaker. The market itself triggers the corrective actions by both public and private actors when these actors do stupid things, like give too many mortgages to people who were not creditworthy and then try to cover it up with fancy securitization. The collapse of financial markets was a severe wake up call to change this stupid behavior; creative destruction is wiping out firms that made huge mistakes (despite some well-publicized cases of individual CEOs getting bonuses despite their stupid actions). New firms or restructured firms will not make the same mistakes (even if they find new mistakes to cause some new crisis). Since we recovered from all the previous crises of capitalism, it seems likely we will recover from this one. A knee-jerk rejection of markets (especially in poor countries) will likely postpone rather than accelerate the recovery.

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Jim Rogers Interview

Q: What do you think of the government's response to the economic crisis?

Rogers: Terrible. They're making it worse. It's pretty embarrassing for President Obama, who doesn't seem to have a clue what's going on—which would make sense from his background. And he has hired people who are part of the problem. [Treasury Secretary Tim] Geithner was head of the New York Fed, which was supposedly in charge of Wall Street and the banks more than anybody else. And as you remember, [Obama's chief economic adviser, Larry] Summers helped bail out Long-Term Capital Management years ago. These are people who think the only solution is to save their friends on Wall Street rather than to save 300 million Americans.

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Cut Taxes Now

I wholeheartedly agree that it makes much more sense for the government to cut taxes, rather than spend money, in order to improve the economy. But what I have been arguing is that the reason for this superiority is not, "Let taxpayers spend money and create jobs rather than the politicians." But if job creation from spending is a bad argument, what are the valid reasons for supporting tax cuts?

First is the simple moral argument. That money was earned by the taxpayers, and so prima facie it is always a good idea to take (i.e., steal) less from them.

Second there is an incentive argument. Especially if the tax reduction comes in the form of lower marginal rates (rather than lump-sum rebates), then individuals have the incentive to produce more. Notice that this is the exact opposite of the standard Keynesian analysis. In other words, the pragmatic argument for tax cuts isn't to give consumers more money to go buy stuff, but rather it's to give producers the incentive to go make stuff.

In conclusion, the critics of the nearly trillion-dollar "stimulus" plan are certainly correct to call for tax cuts rather than more government spending. However, many of these critics couch their justifications in ways that actually prove the superiority of government spending. A correct analysis shows that it is better to let taxpayers keep more of their money, even if they use 100% of the savings to pay down debt. There is nothing magical about consumption spending, and in fact it was overconsumption that got us into the present mess.

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TARP Return: -1096%

Even without doing the math, you probably get that the government's financial-rescue effort is failing.

But do the math, and you can begin to understand how really botched this bailout has been. Since October, the government has deposited $165 billion into the accounts of the nation's eight largest banks. Yet those same financial firms are now worth $418 billion less than they were four months ago, and the Congressional Budget Office estimates that the government's preferred shares are worth at least $20 billion less. In Wall Street terms, that's throwing good money after bad. All told, the government's annualized rate of return on its investment in the nation's largest banks is -1,096%.

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My thoughts: Remember when you were told that the TARP was an investment that could make money for taxpayers? Congress actually had a straight face when they said it.

More Peter Schiff

Peter Schiff on the Current Crisis

"They don't understand that what is happening right now is the consequence of the phony economy that they thought was so great."

My comments: Schiff is among the best commentators around.

Peter Schiff on the Crisis its Causes and Solutions

With faith in the free markets now taking a back seat to fear and expediency, nearly the entire political spectrum agrees that the federal government must spend whatever amount is necessary to stabilize the housing market, bail out financial firms, liquefy the credit markets, create jobs and make the recession as shallow and brief as possible. The few who maintain free-market views have been largely marginalized...

Governments cannot create but merely redirect. When the government spends, the money has to come from somewhere. If the government doesn't have a surplus, then it must come from taxes. If taxes don't go up, then it must come from increased borrowing. If lenders won't lend, then it must come from the printing press, which is where all these bailouts are headed. But each additional dollar printed diminishes the value those already in circulation. Something cannot be effortlessly created from nothing.

Similarly, any jobs or other economic activity created by public-sector expansion merely comes at the expense of jobs lost in the private sector. And if the government chooses to save inefficient jobs in select private industries, more efficient jobs will be lost in others. As more factors of production come under government control, the more inefficient our entire economy becomes. Inefficiency lowers productivity, stifles competitiveness and lowers living standards...

The good news is that economics is not all that complicated. The bad news is that our economy is broken and there is nothing the government can do to fix it. However, the free market does have a cure: it's called a recession, and it's not fun, easy or quick. But if we put our faith in the power of government to make the pain go away, we will live with the consequences for generations.

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My thoughts: Schiff is one of the best economic commentators around.

Crisis of 2008: A Summary

In summary, the essence of the subprime crisis is that money was lent (often through the agency of questionable mortgage brokers) at very low interest rates (courtesy of the Fed) to hundreds of thousands of people (all they needed was a credit score and a pulse) who could not afford to pay it back; and it was backed by collateral (a house) that was not properly valued. Such assets, accurately described as "liar loans," were then packaged into opaque securities, known as structured-investment vehicles (sponsored but not guaranteed by a respected and well-known name), which very few people understood. They were sold on to pension funds, banks, and others whose gullible investment managers also did not understand them and failed to carry out the rigorous analysis that their clients had a right to expect.

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My thoughts: One of the best explanations of the crisis that I have seen.

Greenspan to Blame

With no one denying the obvious fact that America is in a deep slump anymore, the discussion has instead shifted to why it happened. The Austrians (including me) who predicted these problems based on Greenspan’s low interest rate policy know of course that the main cause was that low interest rate policy, with his numerous bailouts of failed financial institutions also creating a moral hazard that encouraged risky behavior...

In conclusion, there can be no doubt that Greenspan, primarily through his low interest rate policy but also through the negative effects of his various bailouts, was responsible for the housing bubble and therefore the current slump.

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My thoughts: Greenspan has been discredited.

How to Spot a Keynesian

One of the best tests for determining whether a financial columnist or a professional economist is a Keynesian is to examine his views on personal spending. If he favors an increase of personal spending as a means to stimulate the economy, he is a Keynesian. He may not call himself a Keynesian, but he is a Keynesian...

Keynes and his disciples had a solution to the liquidity trap: increased government spending and monetary inflation. This debases the currency, forcing hoarders to spend. The process by which this was accomplished, worldwide, was World War II. In the name of the war effort, every nation authorized its central bank to inflate.

This is what they are all doing again, in our Keynesian world, in which hardly anyone in the West hoards currency. Central banks are inflating. Governments are running huge deficits...

The Keynesian assumes that in a recession, the world is no longer suffering from scarcity. He believes that there are no remaining opportunities for profit in serving future consumers. The Keynesian believes that the central government must intervene and spend money in order to stimulate the economy. Expected private demand for future goods is insufficient to persuade entrepreneurs to invest money to meet this demand. The expected return on capital is zero. The Keynesian economist believes that the government gets money from lenders, and that by spending this money, the government can increase demand by consumers. This increased demand stimulates the economy. There will be economic growth, and therefore the government will reap a positive rate of return on its investments. This is what politicians are promising. "The government will be repaid." It is a fantasy, but even if it comes true, this will benefit the government, not taxpayers...

If someone believes anything as silly as the Keynesian economic system, he is likely to believe that consumer spending, in and of itself, will create such demand that the economy will be reversed from its recessionary condition. He believes that if he can just persuade enough people to go out and spend money, no matter what they spend it on, the economy will revive...

Stein then cited the source of his seemingly revolutionary idea: John Maynard Keynes.

Look, we're faced with John Maynard Keynes called "the paradox of thrift." If everyone is cheap and thrifty and doesn't spend, the economy slumps and everyone is poorer, not richer.

This really isn't rocket science. It's part of what caused the Great Depression.

No, this was not what caused the Great Depression. Federal Reserve expansionary monetary policy in the 1924–29 period caused it...

The money supply will increase, prices will increase, and we will be back in the clutches of price inflation by the end of 2009. From that point on, price inflation is going to be the major problem in American economic life. The Keynesians will get their wish: spending without investing. There will be more money chasing a restricted supply of goods and services. The supply of goods and services will be restricted precisely because the government has intervened in the credit markets in order to stimulate consumption.

This is why the recession is going to last much longer than normal. It is going to be an inflationary recession. It is going to result in what was once called stagflation. This is what Keynesianism always produces. It is hostile to thrift; it is hostile to investing; and it is favorable to government deficits. The productivity that is needed to get us out of this recession will be restricted by policies of government spending.

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My thoughts: A must read article. Consumers and government cannot spend an economy into prosperity. Inflation concerns should have began in September 2007 when the Fed began slashing interest rates. In 2010-2011, when inflation becomes obvious to everyone, people will regret not listening to North, Schiff, and others.

Cartoon: Corporate Bailouts

Recession: December 2007---???

What Is a Recession?

Common definition: Two consecutive quarterly contractions in gross domestic product, a measure of the output of goods and services.

National Bureau of Economic Research: The semiofficial body that defines the U.S. economic cycle defines a recession as 'a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators.

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My thoughts: We are in a recession according to definition #2, but not definition #1. This tells us take while the this recession is likely to last over 2 years it will not necessarily be as deep as the mid 1970s and early 1980s recessions. However, the unprecedented intervention into Wall Street and the housing market could have serious repercussions in the coming months and years.

Cartoon: Paulson's New Plan

Cartoon: Looting the Treasury

Government Bailout Hits $8.5 Trillion

The federal government committed an additional $800 billion to two new loan programs on Tuesday, bringing its cumulative commitment to financial rescue initiatives to a staggering $8.5 trillion, according to Bloomberg News.

That sum represents almost 60 percent of the nation's estimated gross domestic product.

Given the unprecedented size and complexity of these programs and the fact that many have never been tried before, it's impossible to predict how much they will cost taxpayers. The final cost won't be known for many years...

That sum represents almost 60 percent of the nation's estimated gross domestic product.

Given the unprecedented size and complexity of these programs and the fact that many have never been tried before, it's impossible to predict how much they will cost taxpayers. The final cost won't be known for many years.

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My thoughts: The costs are dwarfing the initial $700 billion bailout (passed in October) that the American people overwhelmingly opposed. It is probably asking too much for ALL of the people in Washington to be held accountable in the 2010 election.