Dean Baker's new book, Plunder and Blunder: The Rise and Fall of The Bubble Economy, explores the stock and housing bubbles at the heart of our current economic crisis. This week, we're hosting a two-part discussion of the book, moderated by Ezra Klein. Read part one here.
On Tuesday, I concluded our discussion,
As such, I think it's time to dismiss worn bonds of "seriousness." The situation is burning through consensus offerings so fast that it's hard to say what will, or will not be, radical next week. We've already identified various culprits: The housing bubble, global financial flows, the political system's lazy and late reaction to problems for the working class. So for Thursday, let me ask this: In 500 words or less, what should be done? Not what can be done, not what we think will be done, but what should be done? In some ways, the problem was obvious, just inconvenient. Is that true for the solutions, too?
Many of the solutions are obvious, but the deciders are no more willing now to step outside the conventional wisdom and think for themselves than when they were busy ignoring an $8 trillion housing bubble two years ago.
In terms of immediacy, the first item should be helping distressed homeowners. The obvious way to do this is "right to rent," which means giving homeowners facing foreclosure the right to remain in their home as renters paying the market rent for a substantial period of time (10 years, for example). This would immediately give homeowners security in their home, and it would also give banks real incentive to negotiate terms on mortgages that allow homeowners to remain in their home as owners, since the banks do not want to become landlords.
This plan requires no tax dollars and no bureaucracy and could start protecting all homeowners facing foreclosure the day it is signed into law. In other words, it makes far too much sense to be seriously considered in Washington.
The second issue is restoring the banking system to solvency. It is clear that many, if not most, banks are or will be insolvent. The obvious answer for this situation is to take over the insolvent banks. The government will then separate out the bad assets into a Resolution Trust-type entity (following the model of how we dealt with the failed savings and loan associations in the 1980s). These will be auctioned back to the private sector over time. The banks will then be restructured and sold back to the private sector. Current shareholders will be out of luck (that's what happens when you own stock in a bankrupt company), and the current crew of highly paid executives that wrecked the banks will be sent packing.
Longer term, we have to rein in the financial sector to keep it from growing to the point where it can again wreak havoc on the economy. The best way to limit the size of the financial sector is to tax it. A modest set of financial transactions taxes (0.25 percent on a stock trade, for example) will have almost no impact on long-term investors, but they will make short-term speculation and financial engineering much less profitable and far more risky. In addition, even a modest tax can easily raise more than $100 billion a year in revenue.
It is important to remember that finance is an intermediate good like trucking, rather than a final good that directly provides benefits, like health care or housing. An efficient financial sector is a small financial sector. Furthermore, a large financial sector will be a politically powerful financial sector. It will be more likely to be able to use its political power to prevent effective regulation, as was quite obviously the case over the last 15 years.
Finally, we need to have a Federal Reserve Board that takes a broader view of the economy. There is nothing more important that the Fed can do than to deflate bubbles before they grow to the dangerous size of the stock and housing bubbles. The Fed must also pay attention to the value of the dollar. The overvaluation of the dollar over the last dozen years has been one of the major causes of the economy's imbalances.
To ensure that the Fed does its job, Congress will have to take a more active role in overseeing its conduct. We may not want Congress to be setting interest rates, but we do want Congress to ensure that the Fed has a good reason for setting the interest rate where it does. Congress has been incredibly derelict in exercising this responsibility in the last three decades.
The Republicans have placed their bet: The country faces a massive decline in aggregate demand, and they are betting that the spending proposed by the Democrats won't be sufficient to get us out of the hole we're in. By opposing President Obama's proposals, they think they have positioned themselves for a comeback in the midterm elections. If they are wrong, nothing lost -- no one will care that they held up passage of the economic recovery package. But if they are right, they will run again in 2010 on "big government is not the answer" and "deficits are a burden on future generations."
Democrats must be bolder. Health care is the obvious place to start -- it's 17 percent of the economy. An immediate 5 percent expansion of this sector -- say, by bringing the unemployed and parents of children eligible for S-CHIP into Medicare -- would add almost 1 percent of gross domestic product to the stimulus. And it would be a down payment on the promise of universal health care.
At his confirmation hearing for secretary of the treasury, Timothy Geithner won kudos for getting tough on China's manipulation (or, as the Chinese would say, management) of its currency. He wants the Chinese to let their currency rise against the dollar. This is admirable policy -- but we don't need to wait for the Chinese to take action. The U.S. also has the ability to manage its currency, and the Obama economic team could engineer a decline in the dollar against the Chinese renminbi on day one. What are they waiting for?
A decline in the exchange rate of the dollar against the currencies of countries like China is essential to a revival of U.S. manufacturing and to the long-term health of the economy. But it comes at a cost. Goods imported from China will rise in price in the U.S., undermining the purchasing power of American families. The Obama administration needs to take steps to protect the living standards of these families. It's easy to see where they should start -- see the health-care proposal above.
We don't need to stop with health care. We can raise living standards for working- and middle-class households by facing up to the 21st-century reality that mothers as well as fathers are in the paid work force. Workers need paid time off to care for children and elderly parents -- paid vacations, paid sick days, paid leave to bond with a newborn or care for a seriously ill family member. It's past time for Congress to make this a reality.
Just to be clear, when I said that the last year was radicalizing, I was really just describing my own thoughts. I wish it were a more universal response, especially on the part of my profession, but I'm not sure it is.
Dean and Eileen have thrown a bunch of relatively specific policy ideas onto the table, and I can't find a single one I would quibble with. Let me draw out a couple of more and add a hazy thought to this all.
The Obama administration has been granted authority over the second half of TARP funds. Just in time, the idea of buying up troubled assets off bank balance sheets has returned. Presumably this will be packaged with "help for homeowners." Which is, of course, often just another name for buying bad assets off bank balance sheets. It should be (but somehow isn't) needless to say at this point that this is a terrible idea. Banking functions are necessary for the economy to move forward, but today's actually existing banks and their managers and shareholders aren't.
There has been some talk lately even by non-deranged economic observers about the need to avoid a "rush" to nationalize failed banks. What "rush"? Credit markets began slowly tearing at the seams in August 2007. This became an eruption in September 2008, almost half a year ago now. In financial/economic-crisis terms, we have so far displayed a disastrous surplus of patience.
Regarding congressional oversight of the Fed, it's time that progressives took appointments to the Federal Reserve Board even 1 percent as seriously as they take judicial appointments. The Fed has more power over the day-to-day life of working Americans (and those seeking work) than judges, yet appointments to the Fed are almost completely off everybody's radar screen. More Fed governors like Edward Gramlich, who lobbied essentially alone among his peers to rein in the irrational lending feeding the housing bubble, might have helped avoid much of the mess we're currently in.
It's also time to realize that the (true) progressive saw about reconnecting households' living standards and overall economic growth has an often-ignored application. It's usually presented as raising low- and moderate-income growth to match overall growth rates. The flip side of that project is that it would lower the incomes of the rich such that their raises only track overall growth as well. That would be a good thing.
There are two reasons for this, and neither is just spite. First is simple arithmetic: one person's income is another's cost -- all else being equal, faster growth at the bottom requires slower growth at the top. Second (more germane to our current conversation), so long as the privileged few think there's a path to riches besides participating in broad economic growth, then the constituency for sound macroeconomic policy is running on (at best) one engine.
Worse, this alternate path to riches often conflicts with sound macroeconomic management, say when it involves speculating in an asset market bubble while gambling that you can sell at the top. Dean's call to shrink the financial sector is right-on, but I do worry that its most salutary effect (penalizing incredibly lucrative but not particularly socially productive behavior) may evanesce as the super-rich find some other sector to serve as the conduit for their rent-seeking. Keeping this from happening will require constant vigilance.
What should be done? As Josh says the proposals so far are excellent. Yes we need to beat an orderly retreat on home prices (own-to-rent and bankruptcy cram-downs have been discussed) and the dollar. Going forward, we need an independent central bank or perhaps just a few more independent bank governors and an independent government voice. But it is Eileen's thoughts around health care for the unemployed and S-CHIP parents that really start to get at what is needed.
We must be brave enough to move the rhetoric and the focus of the recovery away from the "middle class" to those whom the market and the institutions of this country have never served well.
The reason I say this is not that I have it in for people earning between $40,000 and $75,000 -- or even $100,000 in many areas. In part it is because most middle-class people will stay housed and fed during this downturn. Most will keep their home. But more important, policies given the middle-class label, policies that can be sold to the middle class tend to benefit most those who make a lot more. Income-tax cuts, suburban highways, and home-improvement tax credits all help the middle class a little, but they also serve those with more money, and they do not help low-income people much.
Moreover, it is well known that lower-income people are more likely to spend in a windfall. Whether it comes as a job, a direct payment, or more indirectly from the reduced costs and increased opportunities from programs to assist them, this multiplier will trickle up through retail stores, rents, and mortgage and credit payments to stimulate the entire economy and eventually put even Wall Street back on its feet.
This goes at Josh's point, I think. If we focus on improving the lives of the most vulnerable populations most rapidly, focusing on long-term investments like supportive and extremely low-income housing, health centers, and youth employment (all things states are already quickly cutting back on), government policy can create economic activity where there would otherwise be none, address genuine long-term structural deficits, and make our economy more productive without subsidizing private investment that would happen anyway in a recovery. That's much better stimulus than a home-improvement tax credit. And, in the process, we would have demonstrated that the fate of the least of us is inextricably tied to the fate of all of us.
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