Friday, September 26, 2008

Another Input Source for Congressional Deliberation

In the time since I made my assertion this morning that "the Congress should recognize that there are more voices to hear in addition to the Treasury Department and the Federal Reserve," The Nation has provided us with one of those voices, Joseph Stiglitz. For those who may have forgotten, Stiglitz is the Nobel laureate in Economics who co-authored, with Linda Blimes, The Three Trillion Dollar War: The True Cost of the Iraq Conflict. This provides us with a useful perspective:

  • He is not afraid to get down and dirty with his mathematics.
  • He is not afraid of large numbers.
  • In the tradition of his fellow Nobel laureate, Robert Solow, he knows that talk about "value" is a dangerous proposition; so he keeps his eye on the ball of price.
  • He is not afraid to speak truth to power.

If Senate Banking Committee Chairman Christopher Dodd does not invite Stiglitz to appear before his committee, it would not hurt for him to drop whatever else he may be doing and give Stiglitz' Nation piece a serious read. My guess is that he will then make it required reading for everyone else on his Committee and pass it on to the House Financial Services Committee.

Thus far my primary argumentative position has been to question the consequences of adopting the Treasury proposal. Stiglitz takes a different approach: He grants the problem it does solve and then identifies three problems that it ignores. Here is how Stiglitz frames his argument:

There are four fundamental problems with our financial system, and the Paulson proposal addresses only one. The first is that the financial institutions have all these toxic products--which they created--and since no one trusts anyone about their value, no one is willing to lend to anyone else. The Paulson approach solves this by passing the risk to us, the taxpayer--and for no return. The second problem is that there is a big and increasing hole in bank balance sheets--banks lent money to people beyond their ability to repay--and no financial alchemy will fix that. If, as Paulson claims, banks get paid fairly for their lousy mortgages and the complex products in which they are embedded, the hole in their balance sheet will remain. What is needed is a transparent equity injection, not the non-transparent ruse that the administration is proposing.

The third problem is that our economy has been supercharged by a housing bubble which has now burst. The best experts believe that prices still have a way to fall before the return to normal, and that means there will be more foreclosures. No amount of talking up the market is going to change that. The hidden agenda here may be taking large amounts of real estate off the market--and letting it deteriorate at taxpayers' expense.

The fourth problem is a lack of trust, a credibility gap. Regrettably, the way the entire financial crisis has been handled has only made that gap larger.

Paulson and others in Wall Street are claiming that the bailout is necessary and that we are in deep trouble. Not long ago, they were telling us that we had turned a corner. The administration even turned down an effective stimulus package last February--one that would have included increased unemployment benefits and aid to states and localities--and they still say we don't need another stimulus. To be frank, the administration has a credibility and trust gap as big as that of Wall Street. If the crisis was as severe as they claim, why didn't they propose a more credible plan? With lack of oversight and transparency the cause of the current problem, how could they make a proposal so short in both? If a quick consensus is required, why not include provisions to stop the source of bleeding, the millions of Americans that are losing their homes? Why not spend as much on them as on Wall Street? Do they still believe in trickle down economics, when for the past eight years money has been trickling up to the wizards of Wall Street? Why not enact bankruptcy reform, to help Americans write down the value of the mortgage on their overvalued home? No one benefits from these costly foreclosures.

The administration is once again holding a gun at our head, saying, "My way or the highway." We have been bamboozled before by this tactic. We should not let it happen to us again. There are alternatives. Warren Buffet showed the way, in providing equity to Goldman Sachs. The Scandinavian countries showed the way, almost two decades ago. By issuing preferred shares with warrants (options), one reduces the public's downside risk and insures that they participate in some of the upside potential. This approach is not only proven, it provides both incentives and wherewithal to resume lending. It furthermore avoids the hopeless task of trying to value millions of complex mortgages and even more complex products in which they are embedded, and it deals with the "lemons" problem--the government getting stuck with the worst or most overpriced assets.

Finally, we need to impose a special financial sector tax to pay for the bailouts conducted so far. We also need to create a reserve fund so that poor taxpayers won't have to be called upon again to finance Wall Street's foolishness.

I am not saying that Main Street will quickly grasp all the twists and turns of Stiglitz' reasoning, but he has expressed himself with a rhetoric that may well be the best retaliation against that "shock doctrine" thinking that has Main Street so convinced that they are about to be "bamboozled" again, this time for an astronomical sum. If Franklin Roosevelt tried to reassure the United States by telling its citizens that the only thing they had to fear was fear itself, today's citizens need to recognize (and may, indeed, have recognized) that what they most need to fear are the very purveyors of fear.

Needless to say, we should not be seduced into trying to find that Holy Grail that will resolve all four problems in one fell swoop. Mencken's precept remains: Complex problems are rarely (if ever) resolved by clear and simple solutions. The Congress should not immediately embrace everything that Stiglitz has to say, just because he has demonstrated that, whatever Hank Paulson and Ben Bernanke may tell them, there are alternatives worth considering. A good first step for the Senate Banking Committee would be to decide whether or not they accept Stiglitz' proposition that the current crisis is grounded in more than a single problem. If they can agree on that, then perhaps they can also agree on how many in Stiglitz' list of four need to be addressed, if not in terms of a single solution then by asking if solving the first problem will end up making matters worse for the others (meaning that it will only be a matter of time, more likely sooner than later, that they will be deliberating yet another expensive proposal). For that matter they may even ask if that first problem on the list is really the first one that should be addressed.

The good news is that Dodd has the support he needs to hold to his conviction that doing things right is more important than doing them quickly. Main Street clearly shares that conviction. They also know better than to fall for that "My way or the highway" line. They may not know where the straight path is, but they know when someone is trying to bamboozle them into taking a crooked one.

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