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Stimulate This! Sustaining Life in the Slow Lane

Thanks to Tim O’Reilly, my attention has been captured by the lengthy cautionary analysis of James Galbraith, “This Crisis Is Way Bigger Than Dead Banks and Wall Street Bailouts.” 

This is a lengthy analysis with much to consider.  Here is the worrisome bit about the current approach [with all emphasis mine]:

“That chance [of bad assets recovering value] can be assessed, of course, only by doing what any reasonable private investor would do: due diligence, meaning a close inspection of the loan tapes. On the face of it, such inspections will reveal a very high proportion of missing documentation, inflated appraisals, and other evidence of fraud. (In late 2007 the ratings agency Fitch conducted this exercise on a small sample of loan files, and found indications of misrepresentation or fraud present in practically every one.) The reasonable inference would be that many more of the loans will default. Geithner's plan to guarantee these so-called assets, therefore, is almost sure to overstate their value; it is only a way of delaying the ultimate public recognition of loss, while keeping the perpetrators afloat.

“Delay is not innocuous. When a bank's insolvency is ignored, the incentives for normal prudent banking collapse. Management has nothing to lose. It may take big new risks, in volatile markets like commodities, in the hope of salvation before the regulators close in. Or it may loot the institution -- nomenklatura privatization, as the Russians would say -- through unjustified bonuses, dividends, and options. It will never fully disclose the extent of insolvency on its own.

“The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. … ”

There is a part that reflects my own experience, begun in early 2008 well before the year-end crash but not sufficient to endure it unscathed:

“A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.”

I don’t know what you are doing but I am looking at ways to save.  If I am looking for credit, it is for something that is secured, inexpensive, and protects me from having to dig into my nest egg.  And the use of credit is essentially for a bridge that allows my continued saving to create a cushion against unexpected expenses such as automobile maintenance, health problems, and rising costs of insurance, utilities, and current rents.  I am not keen to spend cash on anything inessential.  If I have discretionary funds, they are to be saved.

For this next worrisome part, some disclosure: We are working at living entirely on Social Security benefits, the payments from an annuity, and the limited earnings of our two small businesses.  Those earnings, along with seriously-curtailed spending, are indispensible in improving and building a financial cushion outside of my 401k which is too devalued to touch, especially because withdrawals are taxed and subject to withholding (the appropriate payback for allowing the contributions and their appreciation to be untaxed, but economically terrible if touched now).  Here is my worst nightmare, since any reduction in benefits (Medicare or Social Security) would put us on the street.  And, hey, do you really want me competing for your job, which I would do cheaper and smarter although certainly not faster?

“ … We should offset the violent drop in the wealth of the elderly population as a whole. The squeeze on the elderly has been little noted so far, but it hits in three separate ways: through the fall in the stock market; through the collapse of home values; and through the drop in interest rates, which reduces interest income on accumulated cash. For an increasing number of the elderly, Social Security and Medicare wealth are all they have.

“That means that the entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale. Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. Increasing benefits is a simple, direct, progressive, and highly efficient way to prevent poverty and sustain purchasing power for this vulnerable population. I would also argue for lowering the age of eligibility for Medicare to (say) fifty-five, to permit workers to retire earlier and to free firms from the burden of managing health plans for older workers.”

It is interesting that the European Union resistance to stimulus of financial institutions is reported to be because their social-welfare systems are actually providing softer responses and security for the public and workers during the economic retrenchment.  In particular, instead of lay-offs, there are work reduction strategies in which the social system compensates for the wage reductions.  Galbraith continues,

“This suggestion is meant, in part, to call attention to the madness of talk about Social Security and Medicare cuts. The prospect of future cuts in this modest but vital source of retirement security can only prompt worried prime-age workers to spend less and save more today. And that will make the present economic crisis deeper. In reality, there is no Social Security "financing problem" at all. There is a health care problem, but that can be dealt with only by deciding what health services to provide, and how to pay for them, for the whole population. It cannot be dealt with, responsibly or ethically, by cutting care for the old.”

I obviously have a self-interest that finds reassurance in these statements.  There is much more to the analysis and I encourage thoughtful reading of the entire piece.  It may be necessary to read it more than once to overcome ones initial rejecting reactions, to the extent those are aroused.

Meanwhile, two bits from the concluding passages:

“ … The government must take control of insolvent banks, however large, and get on with the business of reorganizing, re-regulating, decapitating, and recapitalizing them. Depositors should be insured fully to prevent runs, and private risk capital (common and preferred equity and subordinated debt) should take the first loss. Effective compensation limits should be enforced -- it is a good thing that they will encourage those at the top to retire. As Senator Christopher Dodd of Connecticut correctly stated in the brouhaha following the discovery that Senate Democrats had put tough limits into the recovery bill, there are many competent replacements for those who leave.

“Ultimately the big banks can be resold as smaller private institutions, run on a scale that permits prudent credit assessment and risk management by people close enough to their client communities to foster an effective revival, among other things, of household credit and of independent small business -- another lost hallmark of the 1950s. No one should imagine that the swaggering, bank-driven world of high finance and credit bubbles should be made to reappear. Big banks should be run largely by men and women with the long-term perspective, outlook, and temperament of middle managers, and not by the transient, self-regarding plutocrats who run them now.

“… What is required are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers -- and no alternative to taking the long view.

“A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.”


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