public is both stymied and angry about a series of bailouts that
constitute the biggest transfer of public funds to a handful of the
superrich in American history. The problem is that these handouts have
not decreased the burden on households victimized by the financial
misdeeds of the recipients of the transfer.
The alarm might well increase as some of the most disturbing elements of Ben Bernanke’s $1 trillion Term Asset-Backed Loan Facility (TALF), scheduled to begin operations on Thursday, become evident. The plan would work in conjunction with Treasury Secretary Tim Geithner’s public-private partnership (ppp), also budgeted at $1 trillion. Together, the two schemes christen some of the worst features of the financial system that has broken down.
Key Features of TALF and the PPP: Back To Mischief As Usual
The ground rules of ppp are byzantine. But this much is clear. The principal aims of the plan, to be implemented along with TALF, are threefold: to protect the big banks from failure by injecting them with yet more government funds, to keep these banks in private hands, and to restart the same kind of trading between banks and investors that contributed mightily to the present meltdown.
TALF restores exactly those features of the so-called shadow banking system that lead to financial instability. Investors will purchase, with the help of low-interest government loans, mortgage securities and a variety of other distressed assets from the banks. Since the plan is termed “Asset-Backed,” the banks will claim that the junk they are selling is collateralized by an array of (notoriously troubled) obligations such as credit card debt, student loans and car loans. The traded assets will continue to be marked-to-model, i.e. valued at the bloated prices set by incomprehensible models created to produce wildly inflated valuations. Thus, Treasury gives its blessing to the continued mispricing of risk. Complex, opaque and unregulated derivatives would remain in circulation.
TALF will also enlist the Federal Reserve to further protect financial institutions from the consequences of their misbehavior. This feature of TALF has received little comment. Most press attention has been directed at the Fed’s new function of providing one trillion dollars to hoped-for consumer and business borrowers. But overindebted and cash-strapped individuals and businesses have been wisely reluctant to get themselves further into debt. This does not faze Treasury or the Fed.
The most important element of the Fed’s role in TALF is its guarantee of any losses the banks might incur as they resume what is essentially business as usual. Losses are inevitable, since certain types of security are disqualified from the program. Since it is virtually certain that very many of these ineligible instruments, underwritten by the Fed, will be unloaded onto TALF, and the Fed is legally prohibited from buying assets worth less than triple A, the tab will be picked up by working people, otherwise known as “the taxpayer.”
The Fed has established additional limitations on investors, the purchasers in this game. And this translates into corresponding restrictions on banks’ freedom to sell/dump their junk. Since banks despise restrictions and regulations, they have responded to this limitation by resorting to the labyrinthine procedures concocted to enable them to evade regulation and transparency during their pre-meltdown heydey years. The Structured Investment Vehicle has been revived both to enable banks to hide their virtual insolvency from investors, and to allow investors to escape the restrictions laid down by the Fed. Both the Fed and Treasury have given their blessing to this bald effort to evade transparency.
This new round of cash-for-trash swaps works like its predecessors to move red ink from the books of the banksters to what is supposed to be the balance sheet of the people, the U.S. Treasury. This is the only recourse available to Geithner and Bernanke given their commitment to “making the banks whole” or “saving the banking system,” offering no direct aid to working people and keeping the banks in private hands. It is as if the debt burdens of the working population don’t exist – the insolvency of the biggest banks is treated as THE debt problem.
Is There Really a Freeze On Credit?
Prioritizing the problems of the banks seems to be axiomatic for the Obama administration. On March 12 president Obama spoke before the Business Roundtable, an assemblage of leading corporate CEOs. He summed up nicely his administration’s economic obsession: “[T]he only way we can truly unlock credit and heal our financial system for good is to address the state of our banking system,… And I know that this crisis is at the top of your list of immediate concerns – and I promise you, it is at the top of mine, as well.”
George W. Bush made the same claim in his defense of then Treasury Secretary Paulson’s TARP scheme, warning that unless huge sums were given to the banksters “Even if you have a good credit history, it [will] be more difficult for you to get the loans you need to buy a car or send your children to college.”
These claims are the main justification of present policy, but they are indefensible. They start from an irrefutable premise, that the number of new loans issued to households has indeed fallen sharply. But is this due to banks’ unwillingness to lend to qualified borrowers? Economist Dean Baker has tested the hypothesis that credit-worthy applicants are being denied loans by banks unwilling or unable to lend. If the hypothesis is true, we should expect to observe mortgage applications increasing much more rapidly than home sales, since qualified applicants would be applying to multiple banks for a loan. But Baker found no significant increase in the ratio of mortgage applications to home sales. The dramatic decline in new loan applications is more plausibly explained by the dire straits of consumers, who have lost $6 trillion of housing wealth and $8 trillion of stock and retirement wealth. They are therefore hunkering down, saving and servicing debts instead of putting themselves deeper in debt. The problem is not that “the financial system” is badly strapped, but that working people have no money.
While a relatively small number of giant banks are in big trouble, many credit unions and smaller local banks are in fact ready, willing and able to lend to qualified borrowers.
Bailing out the Big Boys is a distraction from the more fundamental problem of debt-hobbled households and businesses.
Focusing On the Biggest Contributors to GDP: Households
Consumer spending accounts for over seventy percent of the Gross Domestic Product. In most of the business cycles since the Second World War, economic recoveries were initiated at the household level, by increases in consumer spending stimulated by expansionary fiscal and/or monetary policy. The resulting pickup in consumption expenditures elicited growth in business investment, thereby increasing production, employment, wages, profits and tax revenues required to provide essential public services.
The financial crisis was initiated by defaults on fraudulently inflated mortgage obligations. It is the latter, at the household level, that have made financial instruments troubled. Delinquent mortgages have had an even broader ripple effect, threatening major banks, reducing consumption, stifling production, increasing unemployment, and reducing the tax base, rendering cities and municipalities unable to provide adequate public services.
Addressing the Meltdown at the Household Level, Without Adding Debt
Present administration policy is to induce banks to lend much more, and to a lot of consumers, not merely qualified borrowers. Thus, tightly strapped consumers up to their ears in debt are to increase their already crushing debt burden. The effect of this would be to re-inflate the housing bubble and to resume crisis-inducing business as usual, garnering for the bankers yet another fortune. This seems to have been the goal of Paulson’s short-lived TARP, and it seems to be the objective of TALF. But the fact is that the existing debts, of both households and financial institutions, simply cannot be paid. The administration recognizes this for the banks, but flatly ignores the predicament of households. Government has chosen to give unheard of sums to the banks, with no strings attached, even as it leaves households to twist in the wind.
Standard capitalist procedure is to wipe out unpayable debts and start anew. The only feasible alternative to injecting more public money into broken banks is to destroy their worthless assets and nationalize them, which should include the new government owner issuing loans at lower rates commensurate with prevailing income levels. Variations on this theme have been proposed by an impressive array of distinguished economists.
The corresponding policy regarding households should be to directly engage the problem of negative equity by acknowledging the disparity between the real value of the house and the size of the mortgage. This means writing down the mortgages to correspond to the real value of the house and the ability of the homeowner to pay. These mortgages would then be purchased by government at their depreciated market value and returned to the homeowner when the house is paid for.
This would be far cheaper than the astronomical cost of the current succession of bailouts.
And this plan has a real-world precedent, the Homeowners’ Loan Corporation (HLC), created by FDR as a government credit agency for homeowners hit by the Great Depression. The HLC did exactly what is described in the preceding paragraph, with great success. Roosevelt conceived the HLC as a workable alternative to Herbert Hoover’s failed Reconstruction Finance Company, which, like the Bush-Obama bailout, stuffed the banks’ coffers with public money. Less than three years later, almost all the recipient banks had gone under.
After Nationalization: A Stimulus Program Based on Historical Precedent
Addressing the housing crisis is not enough. It needs to be coupled with a stimulus plan directly aimed at providing employment to working people seeking a living wage in a de-industrialized economy with an employment problem that has been mounting since the late 1960s. Since then the unemployment rate has displayed a gradual but steady upward trend.
An effective stimulus would provide funding directly to working people for education, small business starts and, as noted, housing purchases and starts. There is much to learn from the most extensive social program in American history, the 1944 Servicemen’s Readjustment Act, the “G.I. Bill.” In 1947 40 percent of housing starts were funded by the G.I. Bill’s loan guarantee. The Bill’s fruits were ongoing: between 1945 and 1956 16 million veterans used the Bill’s funding to put themselves through college and trade schools, and for on job training in factories and on farms.
This social program was running when the deficit was four times its 1997 size, exceeding the GDP by 125 percent.
A 1988 U.S. Senate study reviewed the G.I. Bill and estimated that it had provided the greatest return on investment, in both the private and public sectors, in the country’s history.
There is no dearth of public works, public service and infrastructure needs that could be met by a comparable program today. This would be greatly facilitated by the nationalization of the Federal Reserve, making that institution a public utility. Monetary policy, the creation of money, and whatever distribution is effected by government, would be subject to democratic determination, just as fiscal policy has always been. The case for this is made more compelling by repeated calamitous experiences resulting from permitting private, profit-motivated banks to create money solely for the purposes of maximizing private profit.
Needless to say, this outcome will materialize only in the wake of large-scale public agitation, nationally coordinated grass-roots politicizing, in its support. The precedent: it was only the radicalization and “revolt from below” of the 1930s’ burgeoning organized labor movement that compelled FDR to initiate programs that provided direct benefits to working people in the “second New Deal.” At this historical juncture there is a great deal to be gained. In the 1930s, the achievements of political agitation were not to be sneezed at: the Works Progress Administration, the Wagner Act, which gave workers the legal right to organize, unemployment insurance, and Social Security. In these times, comparable accomplishments are an urgent need.