A solution for the economic crisis?
February 5, 2009 11:02 AM Subscribe
An article in today's Huffington Post claims that the way to solve the economic crisis is to cut the cost of ALL debt. Is it that simple?
Anne Pettifor in today's Huffington Post claims that the way to solve the economic crisis is to cut the cost of all debt. It would seem to be a great solution. But I'm not an economist. So my question is would it work? If not, why not? And if so, is it as simple as goverment intervention to put a cap on all interest rates? Or is this a viable solution but much more difficult to implement than she claims?
If this is a viable solution, I'd like to let my congressman, senators and the President know as well as everyone I know. If not, I'd like to avoid wasting my time.
Anne Pettifor in today's Huffington Post claims that the way to solve the economic crisis is to cut the cost of all debt. It would seem to be a great solution. But I'm not an economist. So my question is would it work? If not, why not? And if so, is it as simple as goverment intervention to put a cap on all interest rates? Or is this a viable solution but much more difficult to implement than she claims?
If this is a viable solution, I'd like to let my congressman, senators and the President know as well as everyone I know. If not, I'd like to avoid wasting my time.
Sorry, no answer, but I'm wondering if this similar to the idea that Jon Stewart's been saying on his show for the last couple of weeks? He brought it up again a couple of days ago when his guest was some sort of financial guy (sorry I know, I'm useless) who didn't seem to have a plausible argument against it. Not that it was a ringing endorsement either, he sounded like he was humoring Stewart.
I know it can't be that simple, but it seems that the idea of giving billions to banks and cutting interest rates are also working on pretty simplistic theories and they're not working.
posted by like_neon at 11:15 AM on February 5, 2009
I know it can't be that simple, but it seems that the idea of giving billions to banks and cutting interest rates are also working on pretty simplistic theories and they're not working.
posted by like_neon at 11:15 AM on February 5, 2009
Debt is cheap. Mortgage rates in the past couple of months have been crazy low. Heck, its easy credit that got us in this mess to begin with. The lack of 'cheap debt' isnt keeping me from buying a new condo or making any large purchases, its the fear of being laid off. I doubt Im the only one.
posted by damn dirty ape at 11:18 AM on February 5, 2009
posted by damn dirty ape at 11:18 AM on February 5, 2009
Mod note: please stick to the question and don't just include your "I don't like huffpo" remarks
posted by jessamyn (staff) at 11:19 AM on February 5, 2009
posted by jessamyn (staff) at 11:19 AM on February 5, 2009
Well, I'm sure Wall Street would have a piss fit if this happened. But, then again, Wall Street seems to dislike any idea that doesn't include paying them to take free government money.
I've notice a general across-the-board humored dismissal, by all the pontificating heads, of any proposal that would divert bailout funds to consumers in order to retire/reduce their enormous debt loads. Personally, despite all the hammering about how consumers must control their debt, I think the last thing the financial industry really wants is to have consumers actually pay-off that debt. Heck, the current plans seems to be designed to make money available so consumers and businesses can take-on more debt.
posted by Thorzdad at 11:22 AM on February 5, 2009 [2 favorites]
I've notice a general across-the-board humored dismissal, by all the pontificating heads, of any proposal that would divert bailout funds to consumers in order to retire/reduce their enormous debt loads. Personally, despite all the hammering about how consumers must control their debt, I think the last thing the financial industry really wants is to have consumers actually pay-off that debt. Heck, the current plans seems to be designed to make money available so consumers and businesses can take-on more debt.
posted by Thorzdad at 11:22 AM on February 5, 2009 [2 favorites]
like_neon: The argument against Stewart's (jokey) plan is the same as the big problem with this "experiment" which was recently spread via email: the amounts just don't really work out:
If you divide $1T by 250M Americans, you get ~$4,000 per person. That would be nice, I agree, but it wouldn't really solve anything; most people who are in trouble are in A LOT more trouble than that. And, because this is deficit spending (which is necessary at this point), essentially, all you're doing is forcing everyone to take a loan they will eventually have to repay, whether they need that loan or not.
This is, of course, the same problem with across-the-board tax cuts which increase deficit spending; we're borrowing that money from our future selves, so we should make damned sure we're using it intelligently.
posted by JMOZ at 11:31 AM on February 5, 2009 [1 favorite]
If you divide $1T by 250M Americans, you get ~$4,000 per person. That would be nice, I agree, but it wouldn't really solve anything; most people who are in trouble are in A LOT more trouble than that. And, because this is deficit spending (which is necessary at this point), essentially, all you're doing is forcing everyone to take a loan they will eventually have to repay, whether they need that loan or not.
This is, of course, the same problem with across-the-board tax cuts which increase deficit spending; we're borrowing that money from our future selves, so we should make damned sure we're using it intelligently.
posted by JMOZ at 11:31 AM on February 5, 2009 [1 favorite]
Response by poster: Thanks everyone, I appreciate the feedback. A couple of points (And please remember, IANAE(conomist):
1. Cheap debt may be part of what caused this recesssion. But wasn't the problem really about giving home loans to people who had no business buying houses or no idea what they were getting into? Particularly in regards to variable rate loans? In effect, that cheap debt became very expensive when the variable rates rose?
2. Debt may be cheap (and I don't know that I'd agree) but it's also very difficult to get a loan at this point. Right?
3. Cutting the cost of debt is not the same as giving bailout money to consumers. It's reducing the cost they have to pay for their debt. This may mean giving more money to banks that will be getting less from consumers but it is not the same as providing cash to consumers. I think that this is a key point. She is not talking about cash bailouts for consumers just lowering the cost of debt across the board.
4. As far as the pontificating heads, if they knew so much, why are we in this mess?
Thanks again. Please carry on.
posted by cjets at 11:42 AM on February 5, 2009
1. Cheap debt may be part of what caused this recesssion. But wasn't the problem really about giving home loans to people who had no business buying houses or no idea what they were getting into? Particularly in regards to variable rate loans? In effect, that cheap debt became very expensive when the variable rates rose?
2. Debt may be cheap (and I don't know that I'd agree) but it's also very difficult to get a loan at this point. Right?
3. Cutting the cost of debt is not the same as giving bailout money to consumers. It's reducing the cost they have to pay for their debt. This may mean giving more money to banks that will be getting less from consumers but it is not the same as providing cash to consumers. I think that this is a key point. She is not talking about cash bailouts for consumers just lowering the cost of debt across the board.
4. As far as the pontificating heads, if they knew so much, why are we in this mess?
Thanks again. Please carry on.
posted by cjets at 11:42 AM on February 5, 2009
From the article: corporate and mortgage interest rates are high and rising
Interest rates are not high in any sort of reasonable historic context. Mortgage rates are in fact about as low as they have every been (the author's link to news that 30-year mortgage rates are up 0.06% is just silly because she fails to mention that 30-year rates hit a historic low only a few weeks ago).
Be clear -- there's no reason why the Fed cannot control interest rates across-the-board.
This isn't at all clear. Is the author suggesting here that the Fed should try to lower interest rates through normal means or is she suggesting that the Fed regulate rates directly? I can't tell from reading the article and it is pretty difficult to say anything about her proposal without knowing what she is suggesting.
posted by ssg at 11:47 AM on February 5, 2009
Interest rates are not high in any sort of reasonable historic context. Mortgage rates are in fact about as low as they have every been (the author's link to news that 30-year mortgage rates are up 0.06% is just silly because she fails to mention that 30-year rates hit a historic low only a few weeks ago).
Be clear -- there's no reason why the Fed cannot control interest rates across-the-board.
This isn't at all clear. Is the author suggesting here that the Fed should try to lower interest rates through normal means or is she suggesting that the Fed regulate rates directly? I can't tell from reading the article and it is pretty difficult to say anything about her proposal without knowing what she is suggesting.
posted by ssg at 11:47 AM on February 5, 2009
Best answer: 1. Cheap debt may be part of what caused this recesssion. But wasn't the problem really about giving home loans to people who had no business buying houses or no idea what they were getting into? Particularly in regards to variable rate loans? In effect, that cheap debt became very expensive when the variable rates rose?
Interest rate resets are a problem, but they are a secondary problem. The primary issue was the bubble in asset valuation. Easy credit can cause the value of collateral (in this case, houses) to increase. People see collateral values increase and assume it's something intrinsic about the asset which is making it more valuable, and thus better collateral for secured lending. George Soros calls this "reflexivity"--easy mortgages and home price appreciation created a vicious circle that generated an asset price bubble.
2. Debt may be cheap (and I don't know that I'd agree) but it's also very difficult to get a loan at this point. Right?
I also don't agree that "debt is cheap" in a broad sense. It's cheap for the US Treasury to borrow money now. And a 30-year fixed rate mortgage is cheap (though arguably not very cheap as a spread to treasury rates). But auto loans, business loans, credit cards and other forms of corporate and consumer borrowing are incredibly expensive and hard to obtain.
3. Cutting the cost of debt is not the same as giving bailout money to consumers. It's reducing the cost they have to pay for their debt. This may mean giving more money to banks that will be getting less from consumers but it is not the same as providing cash to consumers. I think that this is a key point. She is not talking about cash bailouts for consumers just lowering the cost of debt across the board.
The article is very vague on how this would be done. Does she want to lower the contractual rate of the debt? Or have the government subsidize a piece of the interest payments (so the banks would still receive the same amount)? If it's the former, that's the market's worst nightmare--the possibility that the government could come in and alter the terms of a private contract will create uncertainty in the price discovery process and drive prices down further. And it sets a dangerous precedent for the industry going forward.
4. As far as the pontificating heads, if they knew so much, why are we in this mess?
We have never suffered from a lack of insightful analysts, bankers, academics, etc. We suffered from poorly designed incentives by which the most profitable activity was incompatible with the most prudent activity.
Also, I have never heard a thesis about the Japanese crisis that blames "high interest rates." The argument that makes sense to me is that Japan suffered from a similar asset price bubble that occurred here in the US. The banks made all sorts of silly loans to cronies and ponzi-like corporations. When things fell apart, there wasn't the political will to force the banks to take massive right downs and then recapitalize. As a result, the banks took FOREVER to recapitalize and were highly resistant to loan write-downs (thus, becoming zombie banks). And making things worse, the Japanese people (and corporations) increased their savings rate, a normal reaction to a recession. That meant that demand for loans was low. Without those high interest rate loans to consumers and companies, the banks weren't very profitable. Sure, they could build up a ton of zero-percent checking and savings accounts, but the only asset they could buy in bulk was Japanese government bonds paying next to nothing. A bank can recapitalize over time by earning profits--but it will take a long, long time in a zero-interest rate environment coupled with anemic demand for credit.
The lesson that for the US in the Japanese experience is that it's best to get the pain over with quickly. You force banks to write down bad assets, wipe out current equityholders (and possibly subordinated debt holders) and then recapitalize the banks. The new banks are considered trustworthy and sustainable and can do business-as-usual. The Swedes did this by nationalizing banks, putting bad assets in a "bad bank" and then recapitalizing the "good banks", which were quickly sold back into private hands. It seems like Obama is going to suggest the "bad bank" part of this formula and we are sorta recapitalizing through the TARP. Whether we'll have the political will to nationalize the banks is unclear (though I think we should in some form).
Another problem in general with giving money directly to consumers is that they have a tendency to save it during hard economic times. That makes sense for individuals, but it doesn't stimulate the economy right away. That's why the Keynesian want to a) clean up the banking system via write-downs/recapitalizations and then b) stimulate the economy through government spending.
posted by mullacc at 12:25 PM on February 5, 2009 [6 favorites]
Interest rate resets are a problem, but they are a secondary problem. The primary issue was the bubble in asset valuation. Easy credit can cause the value of collateral (in this case, houses) to increase. People see collateral values increase and assume it's something intrinsic about the asset which is making it more valuable, and thus better collateral for secured lending. George Soros calls this "reflexivity"--easy mortgages and home price appreciation created a vicious circle that generated an asset price bubble.
2. Debt may be cheap (and I don't know that I'd agree) but it's also very difficult to get a loan at this point. Right?
I also don't agree that "debt is cheap" in a broad sense. It's cheap for the US Treasury to borrow money now. And a 30-year fixed rate mortgage is cheap (though arguably not very cheap as a spread to treasury rates). But auto loans, business loans, credit cards and other forms of corporate and consumer borrowing are incredibly expensive and hard to obtain.
3. Cutting the cost of debt is not the same as giving bailout money to consumers. It's reducing the cost they have to pay for their debt. This may mean giving more money to banks that will be getting less from consumers but it is not the same as providing cash to consumers. I think that this is a key point. She is not talking about cash bailouts for consumers just lowering the cost of debt across the board.
The article is very vague on how this would be done. Does she want to lower the contractual rate of the debt? Or have the government subsidize a piece of the interest payments (so the banks would still receive the same amount)? If it's the former, that's the market's worst nightmare--the possibility that the government could come in and alter the terms of a private contract will create uncertainty in the price discovery process and drive prices down further. And it sets a dangerous precedent for the industry going forward.
4. As far as the pontificating heads, if they knew so much, why are we in this mess?
We have never suffered from a lack of insightful analysts, bankers, academics, etc. We suffered from poorly designed incentives by which the most profitable activity was incompatible with the most prudent activity.
Also, I have never heard a thesis about the Japanese crisis that blames "high interest rates." The argument that makes sense to me is that Japan suffered from a similar asset price bubble that occurred here in the US. The banks made all sorts of silly loans to cronies and ponzi-like corporations. When things fell apart, there wasn't the political will to force the banks to take massive right downs and then recapitalize. As a result, the banks took FOREVER to recapitalize and were highly resistant to loan write-downs (thus, becoming zombie banks). And making things worse, the Japanese people (and corporations) increased their savings rate, a normal reaction to a recession. That meant that demand for loans was low. Without those high interest rate loans to consumers and companies, the banks weren't very profitable. Sure, they could build up a ton of zero-percent checking and savings accounts, but the only asset they could buy in bulk was Japanese government bonds paying next to nothing. A bank can recapitalize over time by earning profits--but it will take a long, long time in a zero-interest rate environment coupled with anemic demand for credit.
The lesson that for the US in the Japanese experience is that it's best to get the pain over with quickly. You force banks to write down bad assets, wipe out current equityholders (and possibly subordinated debt holders) and then recapitalize the banks. The new banks are considered trustworthy and sustainable and can do business-as-usual. The Swedes did this by nationalizing banks, putting bad assets in a "bad bank" and then recapitalizing the "good banks", which were quickly sold back into private hands. It seems like Obama is going to suggest the "bad bank" part of this formula and we are sorta recapitalizing through the TARP. Whether we'll have the political will to nationalize the banks is unclear (though I think we should in some form).
Another problem in general with giving money directly to consumers is that they have a tendency to save it during hard economic times. That makes sense for individuals, but it doesn't stimulate the economy right away. That's why the Keynesian want to a) clean up the banking system via write-downs/recapitalizations and then b) stimulate the economy through government spending.
posted by mullacc at 12:25 PM on February 5, 2009 [6 favorites]
Cheap debt wasn't the problem -- easy debt was the problem, exacerbated by cheap initial rates that later ballooned way beyond anyone's expectations.
Yes, it seems to me that one small part of fixing the whole mess would be to say, "Okay, every mortgage in America is now a 30-year fixed at 4% if the homeowner wants it to be." Banks would be pissed, but because their lack of due diligence created the mess -- and because something is better than nothing -- it could work. Bailout $$ could help ameliorate the lost capital.
posted by coolguymichael at 12:51 PM on February 5, 2009
Yes, it seems to me that one small part of fixing the whole mess would be to say, "Okay, every mortgage in America is now a 30-year fixed at 4% if the homeowner wants it to be." Banks would be pissed, but because their lack of due diligence created the mess -- and because something is better than nothing -- it could work. Bailout $$ could help ameliorate the lost capital.
posted by coolguymichael at 12:51 PM on February 5, 2009
Best answer: I think I kinda got off track in my answer above. Here's why I think her plan is a bad idea:
It is effectively a government-enforced floor on asset prices. Imagine this scenario: I am a subprime borrower in Arizona. I want to buy a house, but with mortgages so cheap the market has taken off. The house I pick costs $300k. By historical standards, the economically sustainable value of that house should be $200k. But I can get a subprime-tastic 5% down, adjustable rate mortgage (with a 2-year reset) without disclosing my true income. Yay. So I put 5% down and take out a $285k mortgage from the bank.
Two years later, the market has tanked and my house is now worth the $200k it should have been worth anyway. My mortgage is massively underwater and my interest rate is going to reset. I can't afford the new interest rate, I can't sell the house for more than what I owe and i can't refinance my mortgage. Normally, I'd default and the bank takes my house. The bank sells it for $200k--I lost my $15k in equity and the bank lost $85k. The bank's loss hits its equity, causing the bank to be under-capitalized. It's in trouble. In comes the government with this "low interest rate plan"--it subsidizes my interest payment and I keep my house. Yay! The bank doesn't have to take the loss. But what if I want to sell my house? That $300k price wasn't realistic, but I need to sell it for that to keep the bank whole. So the government offers the interest rate subsidy to the next buyer. And so on...
It's a never-ending cycle. The $300k house is only worth that much if the government subsidizes the mortgage. As soon as the government fails to provide the subsidy, the house drops in value. The government can keep borrowing and borrowing to finance this, but eventually there's a limit. Our only hope would be if the government kept subsidizing until that $200k house really became worth $300k--with inflation and normal economic growth, it will happen eventually. But with all this government tied up in mortgage subsidies and banks depending on the government for solvency, our economy won't be in very good shape. It would be a zombie economy with zombie banks.
posted by mullacc at 1:12 PM on February 5, 2009 [6 favorites]
It is effectively a government-enforced floor on asset prices. Imagine this scenario: I am a subprime borrower in Arizona. I want to buy a house, but with mortgages so cheap the market has taken off. The house I pick costs $300k. By historical standards, the economically sustainable value of that house should be $200k. But I can get a subprime-tastic 5% down, adjustable rate mortgage (with a 2-year reset) without disclosing my true income. Yay. So I put 5% down and take out a $285k mortgage from the bank.
Two years later, the market has tanked and my house is now worth the $200k it should have been worth anyway. My mortgage is massively underwater and my interest rate is going to reset. I can't afford the new interest rate, I can't sell the house for more than what I owe and i can't refinance my mortgage. Normally, I'd default and the bank takes my house. The bank sells it for $200k--I lost my $15k in equity and the bank lost $85k. The bank's loss hits its equity, causing the bank to be under-capitalized. It's in trouble. In comes the government with this "low interest rate plan"--it subsidizes my interest payment and I keep my house. Yay! The bank doesn't have to take the loss. But what if I want to sell my house? That $300k price wasn't realistic, but I need to sell it for that to keep the bank whole. So the government offers the interest rate subsidy to the next buyer. And so on...
It's a never-ending cycle. The $300k house is only worth that much if the government subsidizes the mortgage. As soon as the government fails to provide the subsidy, the house drops in value. The government can keep borrowing and borrowing to finance this, but eventually there's a limit. Our only hope would be if the government kept subsidizing until that $200k house really became worth $300k--with inflation and normal economic growth, it will happen eventually. But with all this government tied up in mortgage subsidies and banks depending on the government for solvency, our economy won't be in very good shape. It would be a zombie economy with zombie banks.
posted by mullacc at 1:12 PM on February 5, 2009 [6 favorites]
This thread is closed to new comments.
posted by bonaldi at 11:11 AM on February 5, 2009 [1 favorite]