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?
As we are just getting started on what so far is a confusing presidential election campaign, it would be easy to forget how incredibly lucky we are in America. Our country is very strong and we are isolated from many of the world’s problems. The terrorist attacks in Paris over the weekend are a grim reminder of this fact. But we still have responsibility for much of what is happening around the world.
George W. Bush’s biggest failing is not the Iraq War, draining Medicare funds with a new drug benefit or ramping up deficits with tax cuts that lose revenue. His biggest failing is not foreseeing the financial crisis and at least mitigating it if not heading it off entirely. His financial advisors (Greenspan, Bernanke, Geithner, Paulson) were asleep at the switch. As the Economist makes clear in its latest issue, “First America, then Europe. Now the debt crisis has reached the emerging markets.”
Barack Obama’s biggest failing is not the stagnant economy or massive debt buildup which occurred on his watch, although he could have eased their burden with smarter policies. His biggest failing is his unwillingness to assert sufficient power in the Middle East to head off the chaos we observe today. The enormous European refugee crisis with all of its attendant horrors is largely the result of his inadequate intervention in Iraq, Libya and Syria.
The main concerns of this website are the internal fiscal and economic problems faced by the U.S. We have to figure out amongst ourselves how to address these very serious issues. But, like it or not, what we do affects the whole world. If we fail to meet our responsibilities, the whole world, including us, will suffer with the consequences.
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. The 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”!
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.
Here 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.
“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. Dodd-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 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. Not 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 Department of Housing and Urban Development gradually increased the requirement that loans acquired by Fannie Mae and Freddie Mac be made to low- and moderate-income borrowers from 30% in 1992 to 56% in 2008.
As a result of these policies, by the middle of 2008 there were 31 million Nontraditional (low down payment and/or poor credit) Mortgages (NTMs) in the U.S. Financial system, more than half of all mortgages outstanding, with an aggregate value of more than $5 trillion. At least 76% of these were on the books of government agencies such as Fannie, Freddie and the FHA or banks and S&L institutions, holding loans which they were required to make by the Community Reinvestment Act.
The 24 million NTMs acquired or guaranteed by government agencies were major contributors to the growth of the housing bubble and its lengthy extension in time.
The growth of the bubble suppressed the losses that would ordinarily have brought NTM type Private Mortgage-Backed Securities (PMBS) to a halt but rather made these instruments look like good investments.
When the bubble finally burst, the unprecedented number of delinquencies and defaults among NTMs drove down housing prices.
Falling home prices produced losses on mortgages, whether they were government backed or PMBS.
Losses on mortgages caused investors to flee the PMBS market, reducing the liquidity of the financial institutions that held the PMBS.
Once the housing bubble burst, four major errors were made by our top government financial officials: The first and major error was the rescue of Bear Stearns. The moral hazard created by this action reduced the incentive for other firms to restore their capital positions. Once Bear had been rescued it was essential to rescue Lehman Brothers. Treasury Secretary Paulson and Fed Chairman Bernanke’s arguing that they did not have legal authority to rescue Lehman provided an excuse for Congress to pass the destructive Dodd-Frank Act. Finally, TARP accomplished little but caused much popular resentment against the banks which supposedly got bailed out.
Conclusion: as long as the American people don’t understand that government housing policies were the main cause of the financial crisis, we are likely to repeat the same mistakes over again.