Economic Tough Love? (unemployment, Congress, generations, suspect)

[GhostInTheShell]

I've been thinking about some of the comments myself and others have made recently about our country's economy. While I believe that some of the posts are likely to be true to a degree, few if any of them really struck at the heart of the matter. We've focused more on macro-level, situational cause and effect than on trying to identify and examine the roles of the underlying forces or principles (of which there are probably only a few) that govern those macro-level events. I’m certainly no economist, but I believe that no matter how complex or mathematically complicated the economic phenomena we observe become, those phenomena are most likely all governed by the same basic principles. Do you agree? If so, I have a few questions for you.

While I don’t doubt that greedy bankers and brokers--among other things--played a big role in our current crisis, did we not empower them to do so by straying from basic, common sense guidelines in our own lives?

One of the recurring themes I see among many of the posts is the notion that we need to spend money to keep the economy going. Is this true or false? They say, "The retailers will go out of business if we don't buy their merchandise. This in turn affects the companies that supply the merchandise, the factories that create the merchandise, the people who design the merchandise, etc. The more money we spend, the less likely our economy is to collapse." We've followed this guideline for so long now that, collectively, we've completely depleted our savings, we've overextended ourselves with debt, and we've collected and consumed more than several times the amount of "stuff" per capita than any other nation in the world. At what point does it end? Can it continue to expand forever? Can we continue to consume more than we produce, spend 100% of our income, take on more debt, delay payments, extend loans to unqualified borrowers, consume our equity and sale off our assets without eventually reaching some critical point where our economy comes to a screeching halt? What then is the alternative?

I believe we should save. Would we be in the mess we're in now if we hadn't stopped saving to begin with and instead lived within our means and kept our debt to a minimum? Before answering, consider this: saving doesn't necessarily mean we have to shove Federal Reserve notes under our mattresses. Saving can mean investing in our economy. Investments of capital in banks and companies create jobs. Isn’t this the basic premise behind what our treasury is doing right now with the bailouts? Why then can’t we skip the middle man and simply do it ourselves? Why didn’t we do it before? (As an aside, if we're not consuming as many of the companies’ products and services as before, they might try to market the surplus abroad, partly addressing the problem of our trade deficit.)

I believe the answer to some of those questions isn’t an economical one, but a philosophical one. We spend because we don’t want to delay reward. We feel entitled to too much. We don’t appreciate that the generations before us sometimes worked their entire lives before having a comfortable level of disposable income or before owning nice homes (the ones some of us expect to “own” a few years after graduating college), if at all. They saved for the things they bought, rather than financing them with no money down. They produced as much as they consumed.

Sometimes, people get back on track with their lives through tough love. I do believe that we empowered the wolves to do what they did. We empowered them by not taking responsibility for our lifestyles. Maybe our government should express a little tough love, back off and let us face the consequences of our foolish actions. Hard though they might be, I bet we’d learn a few lessons that way.

We can use what I've written above as a very basic starting point, examine it and go from there. Before posting, I want you to understand that I'm looking for sincere, thought-provoking comments, answers and speculation--not bickering and fighting. While considering your responses, please try to articulate simple, logical constructions that relate recent events to basic, underlying principles. Look, we all know we’re not likely to posit any proofs here (if someone does, great!); so we should all be open to constructive criticism.

[BigJon3475]

Fannie and Freddie are "government-sponsored enterprises" (GSEs), chartered by Congress. As such, they had an implicit promise of taxpayer backing and could borrow money at rates well below competitors.

Because of this, the Bush administration warned in the budget it issued in April 2001 that Fannie and Freddie were too large and overleveraged. Their failure "could cause strong repercussions in financial markets, affecting federally insured entities and economic activity" well beyond housing.

Mr. Bush wanted to limit systemic risk by raising the GSEs' capital requirements, compelling preapproval of new activities, and limiting the size of their portfolios. Why should government regulate banks, credit unions and savings and loans, but not GSEs? Mr. Bush wanted the GSEs to be treated just like their private-sector competitors.

But the GSEs fought back. They didn't want to see the Bush reforms enacted, because that would level the playing field for their competitors. Congress finally did pass the Bush reforms, but in 2008, after Fannie and Freddie collapsed.

The largely unreported story is that to fend off regulation, the GSEs engaged in a lobbying frenzy. They hired high-profile Democrats and Republicans and spent $170 million on lobbying over the past decade. They also constructed an elaborate network of state and local lobbyists to pressure members of Congress.

When Republican Richard Shelby of Alabama, then chairman of the Senate Banking Committee, pushed for comprehensive GSE reform in 2005, Democrat Sen. Chris Dodd of Connecticut successfully threatened a filibuster. Later, after Fannie and Freddie collapsed, Mr. Dodd asked, "Why weren't we doing more?" He then voted for the Bush reforms that he once called "ill-advised."

But Mr. Dodd wasn't the only Democrat to heap abuse on the Bush reforms. Rep. Barney Frank of Massachusetts defended Fannie and Freddie as "fundamentally sound" and labeled the president's proposals as "inane." He later voted for the reforms. Sen. Charles Schumer of New York dismissed Mr. Bush's "safety and soundness concerns" as "a straw man." "If it ain't broke, don't fix it," was the helpful advice of both Sen. Thomas Carper of Delaware and Rep. Maxine Waters of California. Rep. Gregory Meeks of New York berated a Bush official at a hearing, saying, "I am just pissed off" at the administration for raising the issue.

Democrats had ready allies among lenders accustomed to GSEs buying their risky mortgages. For example, Angelo Mozilo, CEO of Countrywide Financial, complained that "an overly cumbersome regulatory process" would "reduce, or even eliminate, the incentives for the GSEs and their primary market partners."

It took Fannie and Freddie over three decades to acquire $2 trillion in mortgages and mortgage-backed securities. Together, they held $2.1 trillion in 2000. By 2005, the two GSEs held $4 trillion, up 92% in just five years. By 2008, they'd grown another 24%, to nearly $5 trillion. They held almost half of all American mortgages.

The more the president pushed for reform, the more they bought. Peter Wallison of the American Enterprise Institute and Charles Calomiris of the Columbia Business School suggest $1 trillion of this debt was subprime and "liar loans," almost all bought between 2005 and 2007. This bulk-up in risky paper made it possible for banks to lend imprudently on a massive scale.

WSJ.com

[ovcatto]

Originally Posted by GhostInTheShell

We've focused more on macro-level, situational cause and effect than on trying to identify and examine the roles of the underlying forces or principles (of which there are probably only a few) that govern those macro-level events. I’m certainly no economist, but I believe that no matter how complex or mathematically complicated the economic phenomena we observe become, those phenomena are most likely all governed by the same basic principles. Do you agree? If so, I have a few questions for you.

I'm not sure as to how you define macro economics as being situational. In the broadest sense both macro and micro economic as "situational." So, would you mind either rephrasing the question or expanding on what it is you are trying to address?

One of the recurring themes I see among many of the posts is the notion that we need to spend money to keep the economy going. Is this true or false?

True.

I believe we should save.

I hate to answer a question with a question but, what are you going to save if you don't have surplus income? In a period of growing unemployment, reduced earnings, where does the savings come from? Some analyst note that payroll withholding fell 2% in 2007 and another 10% in December. At the same time $30 billion of personal investments (savings) were withdrawn from stock and bond funds. In short, investments (savings) are being used to pay for current expenses. So, if purchases are down, and savings and investments are being liquidated, where is this surplus income supposed to come from.

We spend because we don’t want to delay reward. We feel entitled to too much.

I agree, that in the future Americans are going to have to reconsider their formula for spending/savings but when you have an economy where by some estimates, 70% of GDP is dependent upon consumer spending, there are some far more fundamental and structural changes that will be required to develop an economy where surplus income (wealth) can be created.

[GhostInTheShell]

Originally Posted by ovcatto

I'm not sure as to how you define macro economics as being situational. In the broadest sense both macro and micro economic as "situational." So, would you mind either rephrasing the question or expanding on what it is you are trying to address?

I’m not sure how best to put this into words, but I’ll try. People appear to be saying, “We did A when C, and now B happened. So A and C must cause B. Or, B always happens if A and C.” Sure, A may very well have caused B, but it also may not have. Perhaps A if C and D caused B, or A and not E caused B, etc. In my line of work I’ve noticed a lot of people resort to that type of behavior (i.e. making assumptions they shouldn’t) when problems get complicated. They jump to conclusions rather than try to simplify the problem. Regarding most of the recent threads on our economic crisis, most people (including myself) appear to have tried to analyze bits and pieces of the problem without looking at the bigger picture. And when we try to look at the bigger picture, the magnitude of it overwhelms us. None of us (not even the economists) are likely to be able to reach good solutions to the problem without simplifying it somehow (simplifying it, but not isolating the pieces, since they’re inter-related) before trying to analyze it. The difficulty with simplifying the problem is that most of us (perhaps all of us) don’t understand basic economic principles nearly as well as we’d like to believe.

Originally Posted by ovcatto

True.

I understand that we need to pay our bills and purchase goods and services. I certainly wasn’t suggesting that we halt all economic activity. However, I have to question people whose mantra has become spend, spend, spend. Are you saying that we should try to spend as much as possible right now (i.e. try to continue going the way we’ve been going)? This bothers me, because I suspect one of the best ways to prevent all this from happening again is for us to adjust ourselves to more sensible (i.e. less materialistic) lifestyles. Once things are in balance again, we could begin gradually improving those lifestyles as innovations make goods and services less costly.

Originally Posted by ovcatto

I hate to answer a question with a question but, what are you going to save if you don't have surplus income? In a period of growing unemployment, reduced earnings, where does the savings come from? Some analyst note that payroll withholding fell 2% in 2007 and another 10% in December. At the same time $30 billion of personal investments (savings) were withdrawn from stock and bond funds. In short, investments (savings) are being used to pay for current expenses. So, if purchases are down, and savings and investments are being liquidated, where is this surplus income supposed to come from.

I suspect many investors are simply playing it safe because they’ve lost confidence in our businesses--especially the banking industry--as the earnings reports and other news items have been released. (Actually, someone has to be buying these treasury bonds and IOUs; otherwise, how is the treasury funding the bailouts?) But if you’re right and these people are using the money they’ve withdrawn from stocks and bonds to cover their current living expenses, and they’re making sensible lifestyle choices, there’s not a lot else they can do right now. If that’s the case, we should begin saving as soon as we have the opportunity to save, which for many of us may be after the recession ends. However, if you’re wrong, instead of buying many nice-to-have, but ultimately frivolous things, perhaps we should consider saving and investing some of our money. Does investing $1000 in a U.S. stock fund instead of purchasing a $1000 Japanese TV not do as much for our economy? How else are we ever going to create wealth?

Originally Posted by ovcatto

I agree, that in the future Americans are going to have to reconsider their formula for spending/savings but when you have an economy where by some estimates, 70% of GDP is dependent upon consumer spending, there are some far more fundamental and structural changes that will be required to develop an economy where surplus income (wealth) can be created.

I agree completely. Surely we’re not limited to an economy from now until the end of time that requires that we always spend 100% or more of our income. In what ways do you think we could get back on track (i.e. implement these changes) given our current approach to the problem as opposed to my hands off suggestion? I called the hands off suggestion in my first post a form of tough love. It’s a form of tough love because I suspect we’d almost immediately sink into a much deeper recession if the government ceased all bailouts. Although a recession along the lines of the Great Depression would be very difficult to live through, I’m beginning to believe it might be best for our country in the long run if the end result was that people humbled themselves and started saving again. I also suspect it would be much shorter in duration than the years of economic malaise we’re now likely to see.