Monday, September 29, 2008
In Which I Admit to Being Really Confused
And a whole bunch of banks, quasi-banks, sorta-banks, and insurance companies are in trouble because, at the root of it all, too many people aren’t able to pay back what they’ve borrowed. (The “no credit, no problem” approach to lending only works when house values are climbing, since anyone who can’t make payments anymore can sell at a profit. With house prices falling, now folks who can’t make payments often owe more than the house is worth, so they can’t get out from under.) The banks used to sell the IOU’s from mortgages on the open market to get new money to lend, but now the buyers of those IOU’s aren’t buying anymore, since they’re afraid of getting stuck with unpaid loans. And the banks don’t want to hold the loans themselves, since they know just how shaky the stuff actually is.
Since the banks aren’t getting infusions of money to lend from selling the IOU’s anymore, and the loans they can’t sell are often going unpaid, they have a lot less to lend (and much worse jitters about lending it). This means that people who want to buy houses or cars often can’t, since they can’t get loans. When houses and cars go unsold, their value drops, and the people who make and/or sell houses and/or cars get laid off. Then the people who are laid off have trouble making their mortgage payments, and it gets uglier.
(On the bright side, the relatively few people who make stuff for export are actually doing better, since the declining dollar makes our stuff more competitive.)
Left to its own devices, the market would jack up interest rates to compensate for perceived increased risk. But the Fed doesn’t want that to happen, for fear of accelerating the downward spiral and turning a popped-bubble recession into a devil-take-the-hindmost depression. So the Fed is pouring money into the financial markets to make sure that banks can still lend. And now the government is considering borrowing another 700 billion or so to buy up the stinky IOU’s, to free the banks (and the people the banks sell the IOU’s to) from the consequences of their mistakes, so they can make more.
Here’s where I get confused.
Obviously, there's the 'moral hazard' problem. If the lenders are freed from the consequences of their actions, won’t they revert to form and keep doing what they were doing before? If they get to keep windfall profits in good times, but get bailed out in bad times, why not bet the house (literally) every time?
But more basically than that, where the hell are we getting 700 billion or so to buy up the stinky IOU’s? Aren’t we already running a huge national debt? The only way I can figure it is that either we snooker the Chinese real good and convince them that we’re much better risks than we actually are – which seems unlikely to work – or we just print more money. But the ‘print more money’ approach doesn’t do much to build trust with our lenders, who find that the substantial IOU’s they hold from us are suddenly worth less, since dollars are suddenly worth less. Won’t they compensate by either jacking up interest rates or just refusing to lend?
And if they do that, aren’t we just re-creating the same problem, but on a much larger scale? If the government bails out the banks, who bails out the government?
This has a ‘banana republic’ feel to it. If the cost of borrowing from foreigners becomes prohibitive, the way around that is to either stop borrowing and get our stuff together – probably a wrenching process in the best of times – or to just roll the presses even faster. That’s what a lot of third world countries do. It seems to work for a little while, but usually leads to hyperinflation and economic collapse. You can’t keep flooding the market with money and not expect prices to go up, since the supply of money would increase so much faster than the supply of stuff.
Wouldn’t it make a lot more sense to stop borrowing money for, say, wars of choice, and instead direct infusions of cash to, say, the people who can’t make their mortgage payments? If they can make their payments, then the IOU’s suddenly become non-stinky, and the financial institutions will have the money to start lending again. If people can actually get loans, they’ll buy stuff – we Americans are good at that – which leads to jobs making stuff, so then those folks buy more stuff, and so on. If you direct a bailout to the IOU holders directly, you aren’t addressing the root of the problem – just because old IOU’s got paid off doesn’t make new ones any more solvent. The root of the problem is that people can’t make their payments. Address that through, say, rediscovering the principle of progressive taxation, and taking a serious look at the distribution of income. A prosperous middle class will consume more than enough to keep everything humming along nicely. We’re good at consuming. It’s what we do. We just need the money to do it.
In other words, wouldn’t it make a lot more sense to avoid the ‘borrow and print’ strategy, and instead to tax the uber-wealthy to help the middle class make good on its mortgages? Yes, they’d bitch, but they always bitch. That’s what they do. And as annoying as, say, the income tax can be, depressions are much more so. Instead of borrowing money from abroad and hastening a catastrophic collapse, we could tap the huge private reserves of money already here and actually right the ship. Among other benefits, this would demonstrate to our creditors that we’re a good risk, which would keep the overall system nice and stable. It would also have a nice moral cast to it, since many of those private reserves of wealth are essentially ill-gotten. Make the folks who profited from irresponsibility pay for it. Fair is fair.
Instead, some very experienced, very smart people are saying that we have no choice but to borrow hundreds of billions right now, not bother connecting the dots, and trust that the same very smart people who caused the mess will fix it if we just leave them alone with all that money. They’re good for it, right?
We're supposed to believe all that. And that's why I'm confused.