September 29, 2008

CRASH TALK SEPTEMBER 29

Center for Budget & Policies Priorities - New gaps have opened up in the budgets of at least 15 states plus the District of Columbia just two months after they struggled to close the largest budget shortfalls seen since the recession of 2001. These 15 states include more than half of the 29 states that have already moved to cut spending, use reserves, or raise revenues in order to adopt a balanced budget for the current fiscal year - which started July 1 in most states. Now, their budgets have fallen out of balance again.

The 15 states facing additional shortfalls are Arizona, Connecticut, Florida, Georgia, Hawaii, Illinois, Maryland, Massachusetts, Nevada, New Hampshire, New York, Ohio, South Carolina, Vermont, and Virginia. In addition, the District of Columbia faces a budget shortfall.

Dean Baker, TPM Cafe - There is no plausible scenario under which the no bailout scenario gives us a Great Depression. There is a more plausible scenario (but highly unlikely) that the bailout will give us a Great Depression. There is no way that the failure to do a bailout will lead to more than a very brief failure of the financial system. We will not lose our modern system of payments. . .

The basic argument for the bailout is that the banks are filled with so much bad debt that the banks can't trust each other to repay loans. This creates a situation in which the system of payments breaks down. That would mean that we cannot use our ATMs or credit cards or cash checks.

That is a very frightening scenario, but this is not where things end. The Federal Reserve Board would surely step in and take over the major money center banks so that the system of payments would begin functioning again. The Fed was prepared to take over the major banks back in the 80s when bad debt to developing countries threatened to make them insolvent. It is inconceivable that it has not made similar preparations in the current crisis.

In other words, the worst case scenario is that we have an extremely scary day in which the markets freeze for a few hours. Then the Fed steps in and takes over the major banks. The system of payments continues to operate exactly as before, but the bank executives are out of their jobs and the bank shareholders have likely lost most of their money. In other words, the banks have a gun pointed to their heads and are threatening to pull the trigger unless we hand them $700 billion. . .

Given the loss of housing equity, I have actually been surprised that the downturn has not been sharper. Homeowners had been consuming based on their home equity. Much of that equity has now disappeared with the collapse of the bubble. We would expect that their consumption would fall. We also would expect that banks would be reluctant to lend to people who no longer have any collateral.

This is the story of the downturn and of course the bailout does almost nothing to counter this drop in demand. At best, it will make capital available to some marginal lenders who would not otherwise receive loans. . .

Finally, the bailout absolutely can make things worse. We are going to be in a serious recession because of the collapse of the housing bubble. We will need effective stimulus measures to boost the economy and keep the recession from getting worse. However, the $700 billion outlay on the bailout is likely to be used as an argument against effective stimulus. We have already seen voices like the Washington Post and the Wall Street funded Peterson Foundation arguing that the government will have to make serious cutbacks because of the bailout.

Abraham Lincoln, January 11, 1837 - It is an old maxim and a very sound one, that he that dances should always pay the fiddler. Now, sir, in the present case, if any gentlemen, whose money is a burden to them, choose to lead off a dance, I am decidedly opposed to the people's money being used to pay the fiddler. . . all this to settle a question in which the people have no interest, and about which they care nothing. These capitalists generally act harmoniously, and in concert, to fleece the people, and now, that they have got into a quarrel with themselves, we are called upon to appropriate the people's money to settle the quarrel.

Peter Willans, Tasmanian Times - The current crisis had its nemesis in the policy decisions taken in the United States in the aftermath of the World Trade Centre disaster in 2001. Then head of the Federal Reserve, Alan Greenspan endeavored to stimulate the economy further in 2003 by lowering short term interest rates to one percent. An unprecedented influx of capital from Asia including high levels from China swamped credit markets. . .

Real estate purchases used to require a considerable down payment in order to leverage the balance of the purchase from a lending institution. The proliferation of unregulated lenders has been associated with the rapid decrease in the amount required for a lending transaction to occur. In 1976 in the US the average first time buyer contributed 18% to the purchase matrix. Between mid-2005 and mid-2006 half of all first time buyers contributed nothing at all. The median contribution was only 2%. All of this was not so serious in a rising market but by the final quarter of 2007 US housing values fell across the board. Fifteen million homeowners in the US now owe more on mortgages than their homes are worth. . .

Recent reports indicate that 2.2 million households in the United States are in some stage of mortgage distress or default. Foreclosure warnings rose 75% from the previous year. . .

Dean Baker, co-director of US based Centre for Economic and Policy Research, says that average housing prices have fallen by ten percent in the United States during 2007 which is something that has not occurred since World War 2. At this rate American households are getting poorer at a rate of $2 trillion a year. . . .

When Dr Ben Bernanke, chairman of the US Federal Reserve, the most important financial supervisor of all, was quizzed by the US Senate banking committee about whether derivatives - complex financial instruments liberally used by hedge funds - should be regulated, he commented: “Derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and use them properly." This statement came very close to admitting that regulators don’t have a clue what is going on and are therefore powerless to regulate the funds. Given their sheer size and increasing influence of hedge funds, this is stunning - and should scare policy makers who are scrambling to provide responses to a deepening global economic meltdown. . .

Davd Sirota, Alternet - When an individual consumer uses a new credit card to pay off astounding debt from an old credit card, it's akin to check kiting, which is illegal. Apparently, though, when the government does it, it's billed as Serious Public Policy. Because that's what this supposedly prudent bailout bill would do: Force taxpayers to borrow $700 billion from foreign banks to pay off the bad debt of Wall Street banks. During a crisis that is aimed at preventing interest rates from skyrocketing, nobody has been able to explain how adding almost a trillion dollars to the interest rate-exacerbating national debt would do anything other than undermine the plan's underlying objective. . .

The Washington Post reported on Friday, almost 200 academic economists "have signed a petition organized by a University of Chicago professor objecting to the plan on the grounds that it could create perverse incentives, that it is too vague and that its long-run effects are unclear."

NYU's Nouriel Roubini, the visionary who had been predicting this meltdown, says "The Treasury plan (even in its current version agreed with Congress) is very poorly conceived and does not contain many of the key elements of a sound and efficient and fair rescue plan."

Harvard's Ken Rogoff, a Former Federal Rerserve and IMF official, insists that the prospect of this bailout is, unto itself, taking a manageable problem and making it into a more intense crisis. He says that credit is frozen primarily because banks want to avoid dealing with other banks that might drive a hard bargain, and instead would rather wait for free money from the government. Without the prospect of that free money, Rogoff suggests that credit would probably begin moving again, if slowly. . .

The truth is, there are a number of alternatives. Here are just a few:

In the Washington Post last week, Galbraith outlined a multi-pronged plan shoring up and expanding the FDIC, creating a Home Owners Loan Corporation, resurrecting Nixon's federal revenue sharing, and taxing stock transactions (a tax that would fall mostly on speculators) to finance the whole deal.

The Service Employees International Union has drafted a plan based around a massive investment in public services and national health care, and regulatory reforms preventing foreclosures and forcing banks to renegotiate the predatory terms of their bad mortgages. . .

The amount of brazen corruption and conflicts of interest swirling around this deal is odious, even by Washington's standards -- and polls suggest the public inherently understands that. Consider these choice nuggets:

Warren Buffett is simultaneously advising Obama to support the deal, while he himself is investing in the company that stands to make the most off the deal. *McCain's campaign is run by lobbyists from the companies that stand to make a killing off a no-strings government bailout. The New York Times reports that the person advising Paulson and Bernanke on the AIG bailout was the CEO of Goldman Sachs -- a company with a $20 billion stake in AIG. The Obama campaign's top spokesman pushing this deal is none other than Roger Altman, who Bloomberg News reports is simultaneously "advising a group of investors who are trying to prevent their shares from being diluted in the U.S. takeover of American International Group Inc." -- that is, who have a direct financial interest in the current iteration of the bailout. . .

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