As the U.S. Treasury unveils its new $1 trillion plan to buy up the bank’s toxic assets, there is growing public anxiety that it could be dead on arrival, and for good reason:
1. The $1 trillion associated with the new Treasury plan comes on the heels of the Fed’s $1.15 trillion in promised bond purchases plus $11.624 trillion in other government investments, loans, guarantees and commitments to date — Herculean government efforts that have so far borne little fruit.
2. Even before the bulk of these funds reach the doorstep of the American economy, an equivalent amount has already exited through the back door in the form of $12.9 trillion in wealth losses by households through year-end 2008, according to the Fed’s Flow of Funds.
3. Despite some private sector participation, the Treasury’s plan primarily shifts the burden of toxic assets from the private banking sector to the public. This can only (a) bloat an already-ballooning federal deficit, (b) damage the credit of the U.S. government, and (c) raise the risk that borrowing costs will surge for nearly everyone.
4. Higher borrowing costs, in turn, threaten to harm credit markets and the economy as much as, or even more than, a purely market-based solution to the disposal of toxic assets.
For more specific proposals to rebuild a stronger banking system, see my white paper, presented last week at the National Press Club, Dangerous Unintended Consequences: How Banking Bailouts, Buyouts and Nationalization Can Only Prolong America’s Second Great Depression and Weaken Any Subsequent Recovery. Plus, see my additional comments, below …
Urgently Needed: New Goals for a True Recovery
Martin D. Weiss, Ph.D.
Policymakers must back off from the tactical debates about which plan is best suited to bail out institutions or markets and rethink their overarching goals.
Until now, the oft-stated goal has been to prevent a national banking crisis and avoid an economic depression. However, it is now abundantly evident that the true costs of that enterprise — the 13-digit bills and the damage to our nation’s credit — are far too high.
New goals should include:
1. Protect the people before the banks. Currently, banking regulators are stress-testing the nation’s banks, essentially asking the question: In the event of a depression, do the institutions have adequate capital, relative to the risk they’re taking, to withstand the expected adversity?
However, to our knowledge no similar stress-testing is being actively pursued for the nation’s infrastructural systems that could potentially have a more immediate and irreversible impact on the population, including:
- emergency health care,
- support systems for the homeless and hungry,
- shipping and transportation,
- communication,
- agricultural production, and
- homeland security.
The key question should be: Assuming a depression or a banking collapse, to what degree would the for-profit, charitable and governmental institutions become dysfunctional, potentially threatening these key systems?
Our recommendation: Congress must urgently submit this research request to the Government Accountability Office (GAO), while committing to maximum compliance with the GAO’s resulting recommendations for remediation of any deficiencies.
2. A new message to the public: The nation’s leading economists, members of Congress and even respected Federal Reserve officials now harbor growing doubts about the ability of the U.S. Government to tamp down the global debt crisis. It is now up to the administration to recognize and publicly admit that it can no longer prevent the unpreventable.
Our recommendation:Communicate more fully and frankly the limitations of government power, encouraging greater self-reliance. Warn of the possibility of a depression, while stressing the government’s commitment to supporting the nation’s infrastructure.
3. A healthier alignment of short and long-term goals. Currently, our long-term strategies and short-term tactics are in conflict. We try to squelch each crisis and kick it down the road. Then, we do it again with each new crisis. Meanwhile, fiscal reforms are talked up in debates, but pushed out in time. Regulatory changes are mapped out in detail, but undermined in practice. Specifically, the government’s efforts help create:
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Still more bad debts. Individuals and companies are encouraged to borrow, spend and speculate, adding a new layer of burdensome debts to an already-overburdened economy.
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The ultimate moral hazard: Speculators, among the primary culprits of the boom and bust, are rewarded with even more cheap money and credit; while savers, essential to help finance the next recovery, are punished. After deducting inflation, they earn less than nothing for their money. Or worse, the value of their money could be quickly eroded.
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The potential destruction of the dollar. Savings and retirement nest eggs are trashed. People have little incentive to work hard and every incentive to find alternative schemes for making money. The inflation corrupts society and sabotages efforts to bring about an economic recovery.
Our recommendation: The government’s new goals must be to guide and manage the deflation to (a) protect the public from its most adverse consequences, and (b) maximize its silver-lining benefits, as follows:
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A much-needed reduction of burdensome debts. With deflation, debts are paid off or liquidated in bankruptcies. Bad debts are cleansed from the economic body, creating a clean slate for future growth.
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Just rewards: Speculators who took the most risk during the bubble suffer the biggest losses; while those who had the foresight and prudence to save their money benefit from the best real returns. Thus, deflation naturally delivers the most punishment to those who caused the crisis, while giving the greatest rewards to those most capable of ending the crisis.
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A strong dollar: The U.S. dollar gains in purchasing power, giving every American a bedrock of value to strive for, to save and to invest prudently. This lays the foundation for shared sacrifice by families, local communities and the country as a whole.
4. Recognize that deflation is the lesser of the evils. At this stage of the crisis, there’s abundant evidence that deflation is prevailing: In 2008, U.S. commodity prices, wholesale prices and consumer prices plunged; mortgage debts, corporate debts and other forms of debt were liquidated at the fastest pace since the 1930s; and the U.S. dollar enjoyed the most rapid surge overseas since the mid-1980s.
But it’s thanks to this deflation that government officials think they have the leeway to bail out failing companies without restraint, cut interest rates to zero, print money to their heart’s content and pump up the economy with the largest stimulus packages of all time. “Who cares how much inflation that might create?” they reason. “Right now, as long as we have deflation, we can afford some inflationary consequences.”
Recent history shows, however, that this rationale is gravely shortsighted. The government’s efforts to end the tech bust of 2000-2002 produced the housing bubble of 2003-2005; its efforts to end the subsequent housing bust produced the energy and commodity bubble of 2006-2007; and its current, desperate struggle to end the resulting price bust (deflation) may harbor even greater dangers.
Indeed, looking back at these bubbles and busts in the first decade of the 21st century, it’s clear that, despite some near-term successes, nearly everyone has lost: millions of Americans were denied access to affordable homes, lured into unpayable debts, and then thrown out on the street with foreclosures. They were squeezed by surging fuel prices, squeezed again by vanishing credit, and then punched below the belt by job losses.
In the final tally, even the initial beneficiaries of the booms—the technology industry, the housing industry and commodity producers—were smashed. Americans have lost $12.9 trillion. And the federal government itself has been severely weakened as its debt and deficits have exploded in size.
Each time, just as soon as consumers resumed buying and business resumed expanding, most of the extra money and credit pumped into the economy merely reignited more borrowing and speculation. With each new cycle, America’s finances, competitive ability, and recuperative power were weakened further. Instead of real, growth, we got more bouts of inflation. Instead of lasting recoveries, we got more bubbles, more busts, and, ultimately, more depression.
Here’s the fundamental fallacy of the theories prevailing in our government today: Contrary to their view, inflation does not cure deflation; and deflation in itself does not cure inflation. Rather, inflationary forces are akin to the human diseases that produce high blood pressure. A weak heart or clogged arteries do not magically disappear just because the patient’s pressure has fallen to dangerously low levels. Likewise, the fundamental causes of inflation do not disappear just because prices have recently plunged to new lows.
The causes of inflation are rooted in technological and cultural aspects of the economy that do not change quickly—sinking productivity, bad work ethics, excessive greed, weak management, burdensome taxation, and more. Like the causes of high blood pressure, they remain embedded in the economic body, lurking behind the scenes, ready to wreak havoc. Even in the midst of an economic decline, even after an initial bout of deflation, they do not go away.
Our recommendation: Allow deflation to take its course, managing the process proactively.
{ 6 comments… read them below or add one }
Well put.
Too bad that politicians only listen to the same forces that are decimating our country because they fund their re-election campaigns.
Martin,
All we’ve been hearing are numbers that frankly, is hard to relate to. One million, I understand. Even $250 million I can comprehend considering A-Rod makes that much with his Yankee contract. But when Obama, politicians and economic bloggers throw out numbers into the trillions, I wonder, when does it become real money? How can trillions of dollars be managed? Budgeted? Accounted for? How does a regular hard working American process these astronomical numbers so he can make prudent investment choices?
In recent recommendations you suggested GLD. Is this investment recognized as a “collectable” by the IRS catching us in a higher bracket with any gains?
I just read your white paper, and it was the clearest, most compelling research I have yet to encounter about the state of our economy. I learned more from it than I ever have the wall street journal, which I read cover-to-cover every day, or networks like cbnc, whose coverage I watch at least 10 hours of each week. Thank you for your work. It is a wonderful public service to anyone interested in getting to the heart of this crisis. Thanks again.
Martin,
Please read the article of Jeaffrey Sachs in the FT.com dated March 25th. It explains how the this is a dress-up. An asset previously worth 360K would now be worth 714K under this new plan because of the non recource loans of the FDIC.
No wonder the banks are surging. The gvt just gave the half a trillion.
The Ultimate Moral Hazard is very nicely said. As a saver, I have no incentive to invest in a crooked country where contracts can be voided in a heartbeat, and where imprudent lenders and borrowers are rewarded at the expense of prudent savers. No true recovery can begin until this upside-down style of justice is turned right-side-up.