DRAFT 1-22-08 Greenspan Did It But What Now?

1-22-08 Greenspan Did It But What Now?

The story of how the failures of the Fed got us into this fix is short and well understood. The fault belongs to the 18 year tenure of Alan Greenspan as chair of the Federal Reserve. Greenspan, the premier disciple of Ayn Rand and her libertarian economics, watched approvingly as financial markets were freed of regulation and inevitably spun out of control.

The economic and financial powers-that-be panicked yesterday -- and for good reason.. Blame Greenspan and hold onto your job, your house and your family because nothing anyone is proposing is going to cure the problem. But, with the expected shift in the political landscape, we might, in the long run, have an opportunity to re-start the economy in the right direction

The White House just asked Congress for a fiscal stimulus of $150 billion -- and sooner rather than later. The Federal Reserve moved almost precipitously for a monetary stimulus, lowering the federal funds rate by an almost unheard-of three-quarters of a percent between meetings.

None of this short-term stuff will do any good to help the suffering middle-class, correct the mis-incentives or reestablish the regulation that would give the markets some certainty.

The Fed failed to control the trade deficit. Every year billions of US dollars flowed out to China and the rest of the world. Those dollars flowed back into US banks and securities where they were loaned out to blow the housing bubble ever bigger. Every homeowner thought he was living in his retirement nest egg -- or he was borrowing on it to keep up a standard of living.

The Fed failed to control that housing bubble or the predatory lending that followed. Instead the Fed praised the securitization and "financial innovations" that allowed banks to make bad (sub-prime) loans to sometimes innocent, sometimes greedy, middle-class homebuyers. The banks then bundled and sold those subprime loans as AAA securities to unsuspecting investors. Those "securities" were anything but as they flowed out like a contagion through the financial system.

Finally, the Fed did not object to the deregulation of the financial industry and the repeal of the Glass-Steagall Act In the consolidations that followed, banks became securities firms, became insurers, became hedge funds, became private equity firms, etc. The conflicts of interest and misguided incentives that this created had to lead to a meltdown.

The Fed had the tools and the oversight authority to have stopped this in any number of places. Greenspan's free-market ideology denied markets the controls and the certainty they need.

So the bubble popped. Consumers ran out of housing value to borrow against and having maxed out their credit cards, began to slow their purchases. They stopped paying the mortgage, the interest did not flow to the investors and the investors stopped buying loans from the banks. The banks stopped lending to homeowners or firms. No one pretends that the consequent freezing up in financial markets has run its course and so we have a recession of undetermined depth and duration.

Knowing what caused the problem is one thing, getting out of it is something else.

The fundamental problem is a lack of savings in America. Those dollars flowing to China permitted us to consume beyond what we were producing. We have to stop that. And that means cutting down consumption. No one wants to do that in our amoral society.

The dramatic Fed action along with the administration's willingness to craft a stimulus package seems to have steadied the stock and bond markets for the moment. It is not, of course, intended to nor will it do anything to fix the underlying problem.

In the short run, the monetary stimulus of lower interest rates, and that means putting billions of dollars into the economy, should begin to have an impact in about six months. Similarly, the stimulus package will take probably two to three months to pass and another two to three months before checks will arrive in your mailbox. In the meantime, the recession will be endured with the hope that those two stimuli will eventually have the hoped-for effect.

A real solution does exist. The fiscal and monetary authorities have to set America on a course that will sharply increase productivity. Productivity means a bigger pie from which we can pay down our debts and have enough to pay the taxes we need to rebuild our economy.

The presidential candidates should be talking about those new programs that will rebuild our infrastructure, refinance our middle class, stop the leveraged buyout of America, start up innovative, alternative energies, get serious about our educational system, our prisons and, yes, our housing. Finally, a national health-care program will grow our economy. But all that is another column.

The story of how the failures of the Fed got us into this fix is short and well understood. The fault belongs to the 18 year tenure of Alan Greenspan as chair of the Federal Reserve. Greenspan, the premier disciple of Ayn Rand and her libertarian economics, watched approvingly as financial markets were freed of regulation and inevitably spun out of control.

The economic and financial powers-that-be panicked yesterday -- and for good reason.. Blame Greenspan and hold onto your job, your house and your family because nothing anyone is proposing is going to cure the problem. But, with the expected shift in the political landscape, we might, in the long run, have an opportunity to re-start the economy in the right direction

The White House just asked Congress for a fiscal stimulus of $150 billion -- and sooner rather than later. The Federal Reserve moved almost precipitously for a monetary stimulus, lowering the federal funds rate by an almost unheard-of three-quarters of a percent between meetings.

None of this short-term stuff will do any good to help the suffering middle-class, correct the mis-incentives or reestablish the regulation that would give the markets some certainty.

The Fed failed to control the trade deficit. Every year billions of US dollars flowed out to China and the rest of the world. Those dollars flowed back into US banks and securities where they were loaned out to blow the housing bubble ever bigger. Every homeowner thought he was living in his retirement nest egg -- or he was borrowing on it to keep up a standard of living.

The Fed failed to control that housing bubble or the predatory lending that followed. Instead the Fed praised the securitization and "financial innovations" that allowed banks to make bad (sub-prime) loans to sometimes innocent, sometimes greedy, middle-class homebuyers. The banks then bundled and sold those subprime loans as AAA securities to unsuspecting investors. Those "securities" were anything but as they flowed out like a contagion through the financial system.

Finally, the Fed did not object to the deregulation of the financial industry and the repeal of the Glass-Steagall Act In the consolidations that followed, banks became securities firms, became insurers, became hedge funds, became private equity firms, etc. The conflicts of interest and misguided incentives that this created had to lead to a meltdown.

The Fed had the tools and the oversight authority to have stopped this in any number of places. Greenspan's free-market ideology denied markets the controls and the certainty they need.

So the bubble popped. Consumers ran out of housing value to borrow against and having maxed out their credit cards, began to slow their purchases. They stopped paying the mortgage, the interest did not flow to the investors and the investors stopped buying loans from the banks. The banks stopped lending to homeowners or firms. No one pretends that the consequent freezing up in financial markets has run its course and so we have a recession of undetermined depth and duration.

Knowing what caused the problem is one thing, getting out of it is something else.

The fundamental problem is a lack of savings in America. Those dollars flowing to China permitted us to consume beyond what we were producing. We have to stop that. And that means cutting down consumption. No one wants to do that in our amoral society.

The dramatic Fed action along with the administration's willingness to craft a stimulus package seems to have steadied the stock and bond markets for the moment. It is not, of course, intended to nor will it do anything to fix the underlying problem.

In the short run, the monetary stimulus of lower interest rates, and that means putting billions of dollars into the economy, should begin to have an impact in about six months. Similarly, the stimulus package will take probably two to three months to pass and another two to three months before checks will arrive in your mailbox. In the meantime, the recession will be endured with the hope that those two stimuli will eventually have the hoped-for effect.

A real solution does exist. The fiscal and monetary authorities have to set America on a course that will sharply increase productivity. Productivity means a bigger pie from which we can pay down our debts and have enough to pay the taxes we need to rebuild our economy.

The presidential candidates should be talking about those new programs that will rebuild our infrastructure, refinance our middle class, stop the leveraged buyout of America, start up innovative, alternative energies, get serious about our educational system, our prisons and, yes, our housing. Finally, a national health-care program will grow our economy. But all that is another column.