Solving the Great Recession

After reading a million contradictory economics articles and blog posts about out current financial meltdown, here’s my ignorant attempt at a solution. The economy is like a series of tubes: the Keynesian formula is consumption + investment + government + exports – imports = GDP. All of these values have dropped markedly. Many banks have lost so much money that they are bankrupt but refuse to admit it (zombie banks); therefore, they are sitting on whatever capital they have left and making fewer real loans. Consumers have been hit hard by the fall in real estate and investments, and by growing unemployment. For the first time in years they are saving rather than consuming (paradox of thrift), which reduces demand for goods. In the long run, the government is doomed to bankruptcy because of the steady growth in entitlements, mostly due to health care. Finally, the financial collapse is global, so we can’t depend on exports to tread water like Japan did during the 90s. So the world is royally screwed.

Fortunately, the federal government can now borrow huge sums of money at very low rates (thanks Asia!) because everyone is so risk-averse. Here’s what the feds should do with the money.

  1. Reduce or eliminate the payroll tax for 3-5 years to instantly bump up everyone’s paycheck. Hopefully, people will use most of that money to pay off consumer debt and buy stuff. This will reduce the eminent collapse in debt based on credit cards, auto loans, etc. In addition, it adds capital to those banks that are most vulnerable.
  2. Give money to states and cities so they don’t cut back on people or projects. (the Republican Senate “moderates” might have killed this item) Fund “shovel ready” projects, though it won’t help much and some of it will be wasteful. It’s better than paying unemployment, though. And I like zoos.
  3. Purchase a few hundred billion in mortgage backed securities (MBS) at whatever the bank’s absurd asking price. However, the government will arrange to recoup their losses from those banks after the economy recovers. This will add more capital to the zombie banks, remove toxic assets from their balance sheets (thus attracting private capital), yet make them pay for losses over a longer schedule so they can get over this hump.
  4. The government should force banks to “cram down” some mortgages, i.e. principal reduction. This will require that homeowners declare bankruptcy and give up some profits, so it’s not a giveaway to stupid borrowers (the liar in “liar loans“). This will help stabilize the MBS market and set a better price on the remaining MBS held by every bankrupt bank in the world. This also improves banks’ capital ratios.
  5. Take time to invest in long-term infrastructure projects. The economy will suck for at least 5 years. So build airports and trains and electrical grids. But make them public/private investments to minimize political interference.
  6. To stimulate some demand, offer a tax credit for disposing of any 10-15 year old gas guzzling clunker. This is better than handing the car companies free money. Good for the environment, reduces oil consumption and keeps Detroit afloat.

The government is likely to do 2 & 4. It will probably do 1 (though not payroll taxes) & 5 in a really wasteful way. They might offer tax credits for new cars and houses (stupid). Geithner announced something about (3), but no details. One thing to ignore is pointy-headed academics arguing about the multiplier effect of tax cuts vs. government spending. Just listen to Warren Buffet. This is why he’s a very rich man.

SG: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?
WB: The answer is nobody knows. The economists don’t know. All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are. Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake or to follow Hoover-like policies would be a mistake and we don’t know how effective in the short run we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.

One thing I’ve learned from watching C-SPAN is that Congress is worse than useless. Nevertheless, to paraphrase Churchill, the US government is the worst government except for all those others out there. The rest of the world is in deeper doo doo than we are.

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