Bankster Bailouts Did NOT Save Us from the Second Great Depression
Did our brilliant politicians and the cool heads at the Federal Reserve save the world? Popular public opinion says yes. Me and many other astute observors say no. The only thing our collective actions has accomplished is to stop a group of greedy and ignorant fools from experiencing the consequences of their actions. Instead, the consequences have been passed on to us in the form of huge government bailouts and locally inflated house prices.
Politicians and the media continue to refer to the economic downturn as being the result of a financial crisis. This is wrong. We have 15 million people out of work because the housing bubble that drove the economy since the last recession finally burst. The financial crisis may have been good entertainment for those who like to see huge banks collapse, but it was a sidebar. The real story was the rise and demise of the housing bubble.
Those who claim that the real problem was the financial system and its faulty regulation can be disproved with a single word: Spain. Spain is noteworthy because it now has an unemployment rate of more than 19%, the highest rate in any of the wealthy countries. Spain did not have a financial crisis. In fact, its well-regulated financial system is often held up as model for the United States.
Spain did have a horrific housing bubble. As a result, the share of construction in the economy rose from less than 8% of GDP at the end of the 90s to 12.3% in 2007. By comparison, it is typically less than 6% of GDP in non-bubble years in the United States. This rapid rate of construction led to enormous overbuilding, which meant that a collapse was inevitable with construction falling to far below normal levels.
The run-up in house prices also had the predictable effect on consumption. Because people believe that the run-up in house prices is based on fundamentals, homeowners assume that their newly created housing wealth is real and they spend accordingly. Spain’s saving rate fell from just under 6% in 2000 to 3% in 2007. When the housing wealth created by the bubble disappeared people naturally cut back their consumption.
This is Spain’s crisis. According to the IMF, housing starts in Spain fell by 80% from the peak of the boom. While total construction has not fallen as much (repairs and non-residential construction did not decline nearly as much), if construction in Spain fell by 50%, this would imply a loss in annual demand of more than 6% of GDP. That would translate into a drop in demand of more than $800bn in the United States.
Similarly the loss of housing wealth reverses the housing wealth effect. If consumption fell enough to return the savings rate to its pre-bubble level, then this would imply a loss in annual consumption demand of more than three percentage points of disposable income. In the US this would amount to more than $300bn in lost annual consumption.
There is no easy mechanism to replace more than $1tn in lost demand. This is why Spain’s economy is in a severe slump right now. Note that just about all analysts agree, Spain’s financial system was well regulated and it had none of the loony loans and outright corruption that pervades Wall Street and the US financial system. Yet, it is suffering from this economic downturn even more than the United States.
The moral of this story is that the problem is not first and foremost a financial crisis. It might be fun to watch the Wall Street and government boys sweat as they stay up late trying to keep the big banks from drowning in the cesspools they created. But this is all a sideshow. No one saved us from a “second Great Depression,” they just saved the jobs and wealth of the Wall Street crew.
The economy’s real problem is simply the loss of demand created by collapse of the bubble. Throwing even more money at the banks is a way to ensure that they don’t suffer from the consequence of their own greed and stupidity. It is not a way to restore the economy to health.
Restoring the economy to health is about finding a replacement for the demand lost as a result of the collapse of the bubble. In the short-term, this means increased government spending and tax cuts. Deficits put money in the economy, and using the old-fashioned view that people work for money, we can determine how much money we need to spend for the government to get the economy back towards full employment levels of output.
In the longer term, we need to move towards more balanced trade, with higher exports and fewer imports making up for the demand lost due to collapse of the housing bubble. This will require a lower-valued dollar – everything else in the trade picture is just for show.
We do need financial reform. We have an incredibly wasteful and reckless financial industry. But bad financial regulation by itself did not give us 10% unemployment, nor would good regulation have been sufficient to prevent it. Just ask the workers in Spain.
I have profiled hundreds of cases of HELOC abuse (or use depending on your point of view). This was an enormous economic stimulus that is now gone, and it isn’t coming back. Our current economic woes are largely caused by the loss of HELOC demand and the unemployment caused by laying off most of the building industry and much of the finance industry. We still don’t know how to replace that demand. We probably won’t.
Why did we bail out the banks? We could have wiped out all the equity and bond holders, recapitalized with taxpayer funds, then sold the public interest later. Sweden did this in the mid 90s, and it worked well. The only reason we did not do this is because the equity and bond holders like Goldman Sachs control our government and knew they could pass the losses off to us.
Mike Whitney: [email protected]
Housing is still on the rocks and prices are headed lower. Master illusionist Ben Bernanke has managed to engineer a modest 7-month uptick in sales, but the fairydust is set to wear off later this month when the Fed stops purchasing mortgage-backed securities (MBS). When the program ends, long-term interest rates will creep higher and sales will begin to flag. The objective of Bernanke’s $1.25 trillion quantitative easing program was to transfer the banks’ toxic assets onto the Fed’s balance sheet. Having achieved that goal, Bernanke will now have to find a way to unload those same assets onto the public. Freddie and Fannie, which have already been used as a government-backed off-balance-sheet dumping ground, appear to be the most likely candidates.
Bernanke’s liquidity injections have helped to buoy stock prices and stabilize housing, but the economy is still weak. There’s just too much inventory and too few buyers. Now that the Fed is withdrawing its support, matters will only get worse.
Of course, that hasn’t stopped the folks at Bloomberg News from cheerleading the “nascent” housing rebound. Here’s a clip from Monday’s column:
“The U.S. housing market is poised to withstand the removal of government and Federal Reserve stimulus programs and rebound later in the year, contributing to annual economic growth for the first time since 2006. Increases in jobs, credit and affordable homes will help offset the end of the Fed’s purchases of mortgage-backed securities this month and the expiration of a federal homebuyer tax credit in April. ‘The underlying trend is turning positive,’ said Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York.”
Just for the record; there have been no “increases in jobs”. Unemployment is stuck at 9.7 percent with underemployment checking in at 16.8 percent. There’s no chance of housing rebound until payrolls start to rise. Jobless people cannot afford to buy homes.
Also, while it is true that the federal homebuyer tax credit did cause a spike in home purchases its effect has been short-lived and sales are gradually returning to normal. It’s generally believed that “cash for clunker-type” programs (like the homebuyer tax credit) merely move demand forward and have no meaningful long-term impact.
So, it’s likely that housing prices — particularly on the higher end — will continue to fall until they return to their historic trend. (probably 10 to 15 per cent lower) That means more trouble for the banks which are already using all kinds of accounting flim-flam (“mark-to-fiction”) to conceal the wretched condition of their balance sheets. Despite the surge in stock prices, the banks are drowning in the losses from their non-performing loans and toxic assets. At the same time, they’re about to get hit by the next wave of Option ARMs and Alt-As resets which will require another $1 trillion in financing.
I enjoy writers with a clear grasp of the situation.
So, let’s summarize:
1–Bank bailout #1–$700 billion TARP which allowed the banks to continue operations after the repo and secondary markets froze-over from the putrid loans the banks were peddling to credulous investors.
2–Bank bailout #2–$1.25 trillion Quantitative Easing program which transferred banks toxic assets onto Fed’s balance sheet (soon to be dumped on Fannie and Freddie) while rewarding the perpetrators of the biggest financial crackup in history.
3–Bank bailout #3–$1 trillion (or more) to cover all mortgage cramdowns, second liens, as well as any future liabilities including gym fees, energy drinks, double-tall nonfat mocha’s, parking meters etc. ad infinitum. Basically, carte blanche for the banksters.
And as far as the banks taking “haircuts”? Forget about it! Banks don’t take “haircuts”. It looks bad on their quarterly reports and cuts into their bonuses. Taxpayers take haircuts, not banksters. Besides, that’s what Geithner gets paid for–to make sure bigshot tycoons don’t have to pay for their mistakes or bother with the niggling details of fleecing the little people.
It is hard to argue with the author’s conclusions about the behavior of our government and the banksters. We have bailed them out and in the process provided them with the money to lobby and fight any real financial reform that might cut into their profits.
We have created moral hazard. Lenders know they can take unlimited risks an we will absorb the losses.
We are pwned. Our leaders have failed us.
“Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves.” — Andrew Jackson