Tuesday, August 21, 2012

What went so wrong?

Ezra Klein wrote a nice piece yesterday arguing that the big problem in the recession was housing debt and the central failure of Obama's economic policy was ignoring this big problem.

Here's his synopsis:

The precise nature of the administration’s misunderstanding was that the key problem was household debt, and until that problem was solved the economy couldn’t recover. But while it had a clear strategy for attacking bad debt in the banking system, and a clear strategy for attacking the fall in consumer spending, it never had a clear strategy for reducing housing debt.

He then points out that there are really no politically viable solutions to "bad" housing debt.

And indeed, what occurred was the bursting of a massive bubble in housing that left us much poorer than we thought we were. And since houses are relatively non-liquid assets, and often the main savings vehicle for many households, that bursting has long lasting ill effects on the economy.

I agree that ex-post, it's a very hard problem to solve and stay in office. Ezra talks about the massive forgiveness paid by the taxpayer approach. The other extreme is the get tough, foreclose like crazy, put it all behind us ASAP approach. We muddled through somewhere in between, though closer to option II than option I.

The best policies here are ex-ante and preventative. Looking back, perhaps the Fed should not have kept rates so low for so long, setting off a desperate search for yield that engendered a massive demand on Wall St. for mortgages to repackage. Perhaps the rating agencies should not have granted AAA status to synthetic instruments that they did not understand. Perhaps regulators should not have turned a blind eye to the blatant level of fraud that was occurring in the mortgage market. When a whole category of loans is referred to as "liar loans", that might be a problem down the road.

And of course, none of these policy failures can be reasonably laid at President Obama's door, but as Ezra points out, they are a factor in this pitiful recovery which undoubtably will hurt Obama in November (I don't agree with Ezra that Obama has no other significant economic policy failures, but I'll save that for another post).

It was often said that the role of the Fed was to take away the punch bowl just as the party was getting started. That clearly did not happen, nor did any of the other regulatory agencies or politicians show any inclination to get the country to drink responsibly.

So here we are. What do we do?

Krugman and Eggertsson have a new paper arguing that in our current predicament (which they, like Ezra attribute to excessive private debt) more government borrowing and spending is a very effective policy tool.

As I see it, this path seems unlikely to be taken without a Democratic sweep of the election.

So here we are. What do we do, or stop doing? Tell me in the comments!


Anonymous said...

Ultimately, the housing foreclosure crisis is caused by lack of American jobs. The lack of jobs has been caused by a change in government policy to outsource production of goods to foreign countries, with the idea that lower cost goods are better for the American consumer, and better for American corporations, and to improve foreign relations by giving access to the the lucrative American market. This policy is obviously not better for the American worker, white collar or blue collar, with blue collar workers hit the hardest. I recall reading at the beginning of the downturn that families in which the husband and the wife both worked, would probably be down to one job. This is a structural change to the American economy, and near term can only be addressed by a jobs creation program. Over a long-term period, say 30-40 years, market forces will correct the situation withour government intervention.

Anonymous said...

Here's a solution: make BK easier, but obtaining credit harder. Admit that Tyler's right, we're not as rich as we thought we were, and move on from there. Americans can live with buying less stuff once they get used to it. It's China and Europe that will suffer.

kebko said...

Well it boils down to one thing...Cash for Clunkers wasn't nearly large enough. But, it was the best Obama could do with obstructionist Republicans hulking around. The good news is that I see the recovery strengthing because we really haven't seen all of the benefits of cfc yet.

Joshua Wojnilower said...

A major factor highlighted here is the overhang of excessive private debt (especially household). One solution is a modern day debt jubilee (i.e. principal forgiveness). This is pretty clearly a political non-starter.

Another option is massive refinancing, which would reduce the interest burden. This, however, would probably be fought tooth-and-nail by the banks.

A third option, is that the govt continues to run large deficits, allowing the private sector to slowly deleverage. This does not need to involve increased spending, but likely would regardless of the election outcome. This appears to be the most probable outcome.

As you note, a better solution would be to correct the causes of the initial crisis. Possible solutions, in this sense, are limiting mortgages either to a LTV ratio or loan-to-income ratio. Separately, mandatory down payments could be raised from the ridiculous 3.5% currently required by the FHA. Further, the tax code could remove deductions and credits that provide incentives for taking on debt to purchase homes.

I'm sure I could come up with more, but those actions would be a great start.

Jim Oliver said...

Have the fed increase teh inflation rate.

BR said...

Jim Oliver wins the prize. Print money to the point it creates wage inflation, while restricting credit. It's an obnoxious and sad remedy, that I wouldn't actually advocate, but...

Anonymous said...

Answer: Pray to God that somehow someway in a fit of sanity Dr.Ron Paul wins the election in Nov. 2012 and is able to implement his "Plan To Restore America."

"The man who hopes absurdly, it appears, is in some fantastic and gaseous manner a better citizen than the man who detects and exposes the truth."
HL Mencken

Steven Rodgers

Has there ever been a problem in which Krugman's solution isn't "more government borrowing and spending"?

Mark J. Maresca said...

@Steven Rodgers: