Category Archives: financial crisis

Senator Fischer, if You Vote for the Awful Tax Bill, There Will Be Political Consequences!

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Congressional Republicans have agreed on a compromise tax bill, details to be released soon. After scoring by the Joint Committee on Taxation, it will be voted on separately by the House and Senate, sometime next week.  It is likely to reach the President, and be signed into law, before Christmas.


As I have previously discussed at great length, this is a very bad bill for the following reasons:

  • Lowering the corporate tax rate to 21% is actually a good idea because it will encourage U.S. multinational companies to bring their foreign profits back home for reinvestment as well as encouraging foreign companies to set up shop in the U.S.
  • Adding $1 trillion to the debt over ten years, as previously scored by JCT and likely on rescoring, is what is so awful about the tax plan. It is also sad because this could be avoided.  Our debt (the public part on which we pay interest) is already, at 77% of GDP, the highest it has been since right after WWII, and is predicted by the Congressional Budget Office to keep getting worse without major changes in current policy.
  • As interest rates rise, interest payments on the debt will grow dramatically (right now our debt is almost “free” money). Eventually this will lead to a new financial crisis, much worse than in 2008.
  • Overheating the economy, now growing at 3% per year for the last two quarters, makes the tax bill even worse. The last thing our economy needs right now is a trillion dollars of artificial stimulation. This will force the Federal Reserve to raise interest rates faster than it would otherwise.
  • Nebraska Senator Deb Fischer, who is up for reelection in 2018, voted for the Senate version of the tax plan. She should reconsider for the final combined bill and vote no.

Conclusion. If Senator Fischer votes for the final version of this bill, and if it passes and is signed into law by the President, then she is personally responsible for the devastation it will wreak on our economy. What can I as an individual Nebraskan do about this?  It should not be hard to figure out.  Stay tuned!

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Another Reason for Tax Reform to Be Revenue Neutral

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My last post noted that with our unemployment rate down to 4.2% and with median household income having increased by 3.2% in 2016, the emphasis now should be totally directed to addressing our number one long term problem:

  • Massive national debt. With a deficit of $668 billion for Fiscal Year 2017, our debt now stands at 77% of GDP (for the public part on which we pay interest), the highest it has been since the end of WWII. It is predicted by the Congressional Budget Office to go much higher without significant changes in current policy.

Obviously our annual deficits are way too large and we need to shrink them dramatically. One way to start doing this is to speed up economic growth which will increase tax revenue especially by creating more jobs and better paying jobs.  Faster economic growth is quite feasible and this is one of the main goals of tax reform, now being considered by Congress.  But it needs to increase growth without increasing the deficit which is entirely doable.

But there is another big reason for revenue neutral tax reform as well. The dollar has depreciated by 10% in 2017 while the stock market has increased by 13%.  The S&P price-earnings ratio has risen to 30 at present which is way above average.  All of this means that we are in a loose money financial bubble.  For Congress to make our annual deficits worse than they already are, with deficit increasing tax reform, would make this bubble even bigger and therefore be highly irresponsible.

Conclusion. When interest rates return to much higher normal levels, as they inevitably will, interest payments on our debt will grow dramatically and cause a huge budget crunch. If ignored, this situation will eventually lead to a new fiscal crisis, much worse than the Financial Crisis of 2008.

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The Right Way to Deregulate Wall Street

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The economy has been chugging along at about 2% annual GDP growth ever since the end of the Great Recession in June 2009. Unemployment has been steadily dropping and is now a fairly low 4.4%.  Low wage earners are now even beginning to see bigger gains in pay.
Most people would like to speed up economic growth even more.  Tax reform will help in this regard but so will sensible deregulation.  Barron’s has an excellent article this week about deregulating Wall Street by William D. Cohan.


According to Mr. Cohan:

  • GDP growth is highly correlated with bank lending.
  • The Dodd-Frank Act, passed by Congress in 2010, has disproportionately burdened community banks, despite their having no role in the financial crisis.
  • More than 1700 U.S. banks have disappeared since Dodd-Frank was passed.
  • Senator John Kennedy (R, LA) has introduced a bill which would exempt community banks and credit unions with assets of less than $10 billion from the Dodd-Frank Act.
  • As a result of Dodd-Frank, big banks are now required to have more capital and less leverage. Today a bank’s assets would have to fall about 7% before a bank’s capital would be wiped out, as opposed to only 2% in 2008.  This makes them safer.
  • Prior to 1970 the Wall Street partnership structure ensured that bankers had plenty of skin in the game – essentially their full net worth was on the line every day.
  • Today bankers and traders are rewarded for taking risks with other people’s money. Mr. Cohan recommends that the top 500 traders and executives at every big bank have a significant portion of their net worth on the line.

Conclusion. Mr. Cohan’s program would not only give a big boost to the economy by enabling community banks to lend more freely but would also make our financial system safer by requiring top financiers to have skin in the game.

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The Dangers of Complacency

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My last post, “What Ails America? I. Complacency,” lays out the thesis of the economist Tyler Cowen that American society has become much too complacent, i.e. self-satisfied, in recent years.  In particular:

  • Fewer Americans are moving.
  • Segregation (by income, education, social class and race) is increasing.
  • Americans have stopped creating. New business creation is down and monopolies are getting stronger.
  • Matching (i.e. assortative mating) is on the upswing.
  • Calm and safety above all is the predominant attitude.

These societal trends are normal and even desirable in many respects. But they can lead to stagnation.  Eventually needed social change will boil over in uncontrollable ways and America will undergo a “Great Reset.”


This will likely involve major events such as:

  • A major fiscal and budgetary crisis. Currently our public debt (on which we pay interest) is 77% of GDP, the highest since just after WWII. It will keep rising steadily without a major change in public policy. When interest rates return to more normal higher levels, interest payments on our debt will be a huge drain, without letup, on our tax revenue.
  • The inability of government to adjust to the next global emergency which comes along. When the financial crisis came along in 2008, debt was at the much smaller level of 38% of GDP. This allowed for temporary fiscal stimulus and larger deficits to ride out the resulting recession. With our currently high debt level, we’ll have far less flexibility when the next recession comes along.
  • A rebellion of many less-skilled men. The median male wage (adjusted for inflation) was higher in 1969 than it is today. In fact, the take-home pay for typical American workers has been falling since the end of the Great Recession in June 2009. To a large extent this explains the rise of Donald Trump.
  • A resurgence of crime. A new crime wave will probably be internet related. There are now tens of millions of identity thefts, phishing attacks and successful but fraudulent pleas for cash every year. Internet crime is calmer than traditional crime and less visible. But the next crime wave could badly damage internet commerce.

 

Conclusion.  Mr. Cowen paints a depressing picture for the future of American society.  Of course, it is possible to turn some or all of these negative developments around.  But will a complacent American populace have the political will to do it?

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Bush Failures Led to Obama and Obama Failures Led to Trump

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As I have previously stated, I voted for Hillary Clinton because Donald Trump is so crude and sleazy even though our country will now greatly benefit from the change which Mr. Trump represents.  This is the way the political process often works.

capture79 Consider that after eight years of George Bush we had:

  • Ongoing war in Iraq and Afghanistan, of which the Iraq war was an unnecessary mistake.
  • $2.5 trillion of additional debt, even after Mr. Bush started out with a budget surplus, compliments of Bill Clinton.
  • An expensive new Medicare Part D prescription drug plan which just makes overall Medicare even less affordable than it already is.
  • The Financial Crisis of 2007-2008 which the Bush Administration could have seen coming if they had been more vigilant.

 

Under such political circumstances, the 2008 election of the Democratic nominee, Barack Obama, over the Republican nominee, John McCain, was almost inevitable. But then in the next eight years we have experienced:

  • Slow economic growth averaging only 2% per year, ever since the end of the Great Recession in June 2009. The unemployment rate has fallen to 4.9% but there is still a lot of slack in the labor market which holds wages down. This is the main reason for the huge support Mr. Trump had from white blue-collar workers in the election.
  • Massive debt, now 76% of GDP (for the public debt on which we pay interest), the highest since right after WWII and double the debt in January 2009 when Mr. Obama entered office. Such a high debt level means greatly increased interest payments as soon as interest rates go up which they are likely to do anytime. The high annual deficits contributing to the debt mean little budget flexibility for new programs.

Conclusion. Democrats like to say that slow economic growth is “the new normal” which can only be overturned with budget busting new fiscal stimulus. This is a pessimistic point of view which refuses to consider other alternatives.  This is what led to Ms. Clinton’s defeat on November 8.

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Can the U.S. Economy Grow Faster?

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The U.S. economy has grown at the rate of only 2.2% since the end of the Great Recession in June 2009.  This is much slower than the average rate of growth of 3% for the past fifty years.
CaptureThe economists Glenn Hubbard and Kevin Warsh, writing in the Wall Street Journal, “How the U.S. Can Return to 4% Growth,” point out that:

  • After the severe recession of 1973-1975, the economy grew at a 3.6% annual real rate during the 23 quarters that followed.
  • After the deep recession of 1981-1982, real GDP growth averaged 4.8% in the next 23 quarters.
  • Recent research has shown that steep recoveries typically follow financial crises.

The economist John Taylor, also writing in the WSJ, “A Recovery Waiting to Be Liberated,” explains that the growth of the economy, i.e. growth of GDP, equals employment growth plus productivity growth.  He then points out that:

  • Population is growing about 1% per year. However the labor-force participation rate has fallen every year of the recovery, from 66% in 2008 to 62.9% in 2014. Even turning this around slightly would increase employment growth above the 1% figure coming from population growth alone.
  • Although productivity growth has hovered around 1% for the past five years, this is less than half of the 2.5% average over the past 20 years.

Given the strong headwinds of globalization and ever new technology affecting the U.S. economy, we especially need new policies such as:

  • Fundamental tax reform directed at increasing the incentives for work and driving investment in productive assets.
  • Regulatory reform that balances economic benefits and costs (e.g. lightening the burdens of Obamacare and Dodd-Frank).
  • Trade agreements to break down barriers to open global markets.
  • Education policies to prepare all young people for productive careers.

In other words, rather than accepting our current situation as “the new normal” or as unalterable “secular stagnation,” we need to “give growth a chance”!

Fixing the Debt: Creating a Greater Sense of Urgency II. An Example

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My last post, ”Fixing the Debt: Creating a Greater Sense of Urgency,” expresses my dismay that our huge debt problem does not receive enough serious attention from the American people.  Yes, most Americans deplore the national debt and the deficit spending that leads to it, but it only too seldom affects how they vote for candidates for federal office, thus giving a pass to the big spenders in Congress.
CaptureHere is a good example of this refusal to take the debt seriously.  The advocacy group FAIR (Fairness and Accuracy in Reporting) ridicules NPR for addressing this problem, “Look a Deficit: How NPR Distracts You From Issues That Will Actually Affect Your Life.”  Here is what FAIR is saying:

  • Interest on the national debt is projected to be only 2% of GDP in 2016 and 3% of GDP in 2024, which is tiny. (But this is because the interest rate for the debt is now abnormally low, approximately 1.7%).
  • If the Fed keeps interest rates low, then interest on the debt will continue to stay low indefinitely and so the debt will continue to be a trivial problem. And the President appoints 7 of the 12 voting members of the Fed Open Market Committee which sets interest rates.
  • The reason the Fed raises interest rates is to slow the economy and keep people from getting jobs.  (Actually the real reason is not to keep people from getting jobs but to keep inflation under control. Once inflation takes off, it is very difficult to bring it back down as we painfully discovered in the late 70s and early 80s).
  • Anyhow, if the Fed raises interest rates to keep the labor market from tightening, as it did in the late 1990s, this would effectively be depriving workers of the 1.0 – 1.5 percentage points in real wage growth they could expect if they were getting their share of productivity growth. (A rise in interest rates need not choke off economic growth which is primarily affected by supply and demand. Fiscal policy (tax rates and spending), established by Congress, has a far greater effect on the rate of economic growth than does monetary policy).

 

If our debt is not soon placed on a sustainable downward path, we will soon have another financial crisis, much worse than the Great Recession of 2008.  This will affect everyone’s life in a substantial and very unpleasant way.

The Financial Crisis IV. Where Do We Go From Here?

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“It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.                                                                    former Congressman Barney Frank, 2010

“Only by understanding the factors that led to and amplified the crisis can we hope to guard against a repetition.”
                                                   former Federal Reserve Chair, Ben Bernanke, 2010

As I explained in my last post, my views on the financial crisis are most heavily influenced by John Allison, President of the CATO Institute; Sheila Bair, former Chair of the FDIC; and Peter Wallison, a financial policy analyst at the AEI, as follows:

  • The primary cause of the crisis was the affordable housing policy, created by Congress and administered by HUD, under which higher and higher percentages of mortgages acquired by the GSEs Fannie Mae and Freddie Mac had to be made to low and moderate income borrowers. This policy, aided by the very low interest rates maintained by the FED from 2002-2004, created the housing bubble which burst in 2007 leading to an unprecedented number of delinquencies and defaults.
  • Subprime lending abuses could have been avoided if the FED had used the authority it had under the Home Ownership Equity Protection Act of 1994 to require appropriate mortgage lending standards. In other words, lax regulation, but not deregulation, was a major contributor to the crisis.
  • Investment Banks, such as Bear Stearns and Lehman Brothers, magnified the misallocation of credit to the housing market with financial products such as CDOs and derivatives.

Clearly congressional action was needed to address the financial abuses leading up to the crisis.  But the Dodd-Frank Act is an overreaction.  It requires 398 new regulations which are taking a big toll on the economy as shown by the chart below from the American Action Forum.
CaptureDodd-Frank should be scaled back so that its provisions apply only to the very largest financial institutions where the abuses were the greatest.  This can be accomplished with capital requirements which increase proportionally with the size of the institution so that smaller banks are better able to compete with the giants.
Faster economic growth is critical for our future.  It will not only create more jobs and higher paying jobs but will also alleviate our deficit problem by bringing in more tax revenue.  Paring back and streamlining Dodd-Frank would be a big step in the right direction.

The Financial Crisis III. How Do We Sort Out What Happened?

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The Financial Crisis in 2008 was one of the most disruptive events in U.S. history.  It is crucial that we understand what caused it so that we can recover from it more fully and avoid a recurrence.  My favorite books about the crisis are: The Financial Crisis and the Free Market Cure by John Allison, President of the CATO Institute and former CEO of the large financial services company, BB&T;  Bull By the Horns by Sheila Bair, Chair of the FDIC from 2006-2011; and Hidden in Plain Sight by Peter Wallison, an economics policy scholar at AEI and former member of the FCIC.
CaptureNot surprisingly, these three very well informed individuals have somewhat different points of view.
Mr. Wallison says that the government’s affordable housing policies caused the financial crisis by essentially requiring the GSEs Fannie Mae and Freddie Mac to acquire increasingly large numbers of subprime mortgages.  The financial power of the GSEs forced private lenders to lower their own lending standards in order to compete (this last assertion is in dispute). When the resulting housing bubble burst, large numbers of subprime mortgages defaulted causing huge losses for both GSEs and private financial institutions alike.
Ms. Bair says that “the subprime lending abuses could have been avoided if the Federal Reserve Board had simply used the authority it had since 1994 under the Home Ownership Equity Protection Act to promulgate mortgage lending standards across the board.”  In March 2007 she testified strongly in favor of the Fed issuing an anti-predatory lending regulation under HOEPA and was rebuffed by the Fed.  As FDIC Chair she constantly urged, largely without success, that other federal agencies use their regulatory powers to curtail the abuses of private lenders.
Mr. Allison agrees with Mr. Wallison that “the whole origination market relaxed its standards to compete with Freddie and Fannie.”  However he goes on to say that “the investment banks (including Bear Stearns and Lehman Brothers) magnified the misallocation of credit to the housing market.  They created a series of financial innovations (CDOs, derivatives, etc.) that leveraged an already overleveraged product. … Investment bankers unquestionably made irrational decisions based on pragmatic, short-term thinking. … Those who made these mistakes should have been fired and their companies allowed to fail.”
Can these disparate points of view be melded into a coherent framework for the financial crisis which suggests a way forward from where we are today?  I will attempt to do this in my next post.

The Financial Crisis II. Is Peter Wallison Credible?

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“It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.
                                                              former Congressman Barney Frank, 2010

“The ferocity of the left in defending Fannie Mae, Freddie Mac, and the government’s housing policies before 2008 is sometimes shocking, especially when even Barney Frank has given up.  It makes you wonder why this is so important to them.  They have no data, no policy arguments, just a virulent denial that anything other than the private financial sector could possibly be responsible for the financial crisis.”
                                                  “Hidden in Plain Sight,” p 42, by Peter Wallison, 2015

My last post, “The Financial Crisis I. The Cause” reported on a new book “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again” by Peter Wallison, a financial policy analyst at the American Enterprise Institute.  He makes a very strong case, with voluminous documentation, that the basic cause of the financial crisis was the HUD policy requiring government agencies like Fannie Mae, Freddie Mac and the FHA to gradually acquire an increasing percentage of subprime mortgages.  When the housing bubble finally burst in 2007, the enormous number of delinquencies and defaults among these nontraditional mortgages, aggregate value over $5 trillion, drove down housing prices and caused the financial crisis.
CaptureAs noted above by Mr. Wallison himself, such an explanation is simply unacceptable to people who insist on blaming the private sector for the crisis.  Rather than dealing with public records and data available, they instead try to discredit Mr. Wallison.  My purpose today is to give two vivid examples of the types of documents which Mr. Wallison uses to make his case:

  • (Fannie Mae 10-K report, 2006). “We have made, and continue to make, significant adjustments to our mortgage loan sourcing and purchase strategies in an effort to meet HUD’s increased hosing goals and new subgoals.  These strategies include entering into some purchase and securitization transactions with lower expected economic returns than our typical transactions.  We have also relaxed some of our underwriting criteria to obtain goals-qualifying mortgage loans and increased our investments in higher-risk mortgage loan products that are more likely to serve the borrowers targeted by HUD’s goals and subgoals, which could increase our credit losses.
  • (statement by Daniel Mudd, former Fannie Mae CEO, April 2010). “Fannie Mae’s mission regulator, HUD, imposed ever-higher housing goals that were very difficult to meet during my tenure as CEO.  The HUD goals greatly impacted Fannie Mae’s business, as a great deal of time, resources, energy and personnel were dedicated to finding ways to meet these goals.  HUD increased the goals aggressively over time to the point where they exceeded the 50% mark, requiring Fannie Mae to place greater emphasis on purchasing loans in underserved areas.  This became particularly problematic when goal requirements grew to far exceed the proportion of eligible mortgages originated in the primary market.”

Mr. Wallison’s book is filled with this type of detailed documentation for the case he is making.  It should be persuasive to anyone with an open mind.  It certainly is to me.  Now that Mr. Wallison’s credibility is established, it is time to discuss the implications of his thesis.  Stay tuned!