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Home Publications Blogs Beat the Press Fed Policy: What Does the Washington Post Think It Is Saying?

Fed Policy: What Does the Washington Post Think It Is Saying?

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Thursday, 29 March 2012 04:28

I can't argue with today's Post editorial on the Fed, primarily because I have no clue what they think they are saying. The Post comes out in favor the Fed's expansionary policy given the continued weakness of the labor market (yeh!). But it then warns:

"Still, these benefits [sustaining growth] come with risks attached. Among the biggest risks is that easy money from the Fed enables banks and firms to postpone necessary restructuring — and for Congress and the White House to postpone getting the federal government’s long-term fiscal situation under control."

Let's look at these separately. In terms of the banks, the Fed free money policy, and previously its special lending facilities, does more than just allow the banks to "postpone" restructuring. It allows them to avoid restructuring and continue to operate with an implicit too big to fail guarantee. 

Citigroup, Goldman Sachs, Morgan Stanley and most of the other big boys would have been bankrupt if the market was left to run its course. Instead the Fed stepped in and shoveled trillions of dollars of below market loans to these banks. This is what is known in other circles as "welfare."

The Post and other media outlets have given us the children's story that we made money on these loans. But this is just silliness. Using the Post's accounting, if the Fed gave me a 30-year mortgage at a 1.0 percent interest rate and I repaid the loan in full by 2042, the Washington Post would say that the government made money on this loan.

The reality is that at a time when the market demanded a huge risk premium to lend money to these banks, the Fed invited them in to borrow as much as they wanted at near zero rates. This both allowed them to get through the crisis and reinforced the idea that these banks carried the implicit "too big to fail" government guarantee.

In this context, it is hard to see any issue about "postponing" restructuring. The Fed allowed them to avoid restructuring. The argument that we had no choice is just false. First, the government could have put whatever conditions it wanted on these loans.

For example, Citigroup could have been forced to sign an agreement that it would break itself up into 10 much smaller banks by 2020 as a condition of borrowing the money. Its choice would then be bankruptcy or break up. 

It's also important to note that the "Second Great Depression" was just a scare story the Wall Street boys came up with to help sell the bailouts. Argentina was able to regain the lost ground from a full-fledged financial crisis in one and a half years. There is no reason to assume that Bernanke and the rest of economic team is that much less competent than Argentina's, which means that even in the worst case scenario we would have only be looking at 2-3 years of a severe downturn, not a decade of double-digit unemployment.

Moving on, it is not clear what necessary restructuring the Post expects to happen in firms. Suppose the Fed did not try to boost the economy and the unemployment rate was still in double-digits. What restructuring would we be seeing exactly? Clearly firms would lay off more workers and cut back investment, but what does this have to do with restructuring? And what part of this is "necessary?" 

Finally, the Post seems very upset that the government doesn't have a higher interest burden. It complains:

"Net interest payments on the federal debt actually fell between 2008 and 2011, as a share of gross domestic product, even as the deficit tripled. Mr. Goodman argues that this phenomenon gives policymakers a false sense of security about the federal government’s fiscal predicament."

I think the problem is that the Post doesn't have access to the budget information. If it did it would know that the reason the deficit tripled and we have anything that can possibly be called a "fiscal predicament" is that the economy collapsed.

Those who have access to budget documents know that the deficit was small, less than 2.0 percent of GDP, just prior to the crisis. It was projected to remain low long into the future. There was projected to be a long-term budget problem, but this was a result of the broken U.S. health care system driving up the cost of Medicare and Medicaid. This pointed to the need to fix the health care system, not the budget.

So any near term deficit issues are the result of the downturn. Why on earth shouldn't the Fed act to minimize the difficulty of financing this deficit? What good does the Post think would be accomplished if the Fed tried to make financing the deficit painful? Would we take away some school lunches and throw some senior citizens off Medicare?

If there is a logic to the Post's position I would be happy to hear it, but as their factchecker might say, it's not even wrong.

Comments (8)Add Comment
...
written by foosion, March 29, 2012 6:41
"Necessary restructuring" probably means cutting workers benefits. Isn't that the Post's usually recommendation for everything?
...
written by JSeydl, March 29, 2012 7:53
Haha. Oh man, this is hilarious. I wonder if reporters at the Post even read Dean's stuff. Evidently not, considering that they continue to publish such nonsense.
Argentina is a horrible model of "success"
written by A Greek Bearing Facts, March 29, 2012 9:24
Dean Baker: "Argentina was able to regain the lost ground from a full-fledged financial crisis in one and a half years. There is no reason to assume that Bernanke and the rest of economic team is that much less competent than Argentina's, which means that even in the worst case scenario we would have only be looking at 2-3 years of a severe downturn, not a decade of double-digit unemployment."

Facts easily verified: Argentina's peak GDP in the 1990s was attained in 1998. In inflation-adjusted local currency units, Argentina' GDP reached a low point in 2002, tumbling more than 18% below its 1998 peak. Argentina's real GDP did not climb back to its 1998 peak until 2005, meaning its slump lasted 7 years.

Meanwhile, Argentina's population was growing, which means that real GDP per person fell even further than real GDP. At the low point in 2002, Argentine real GDP per capita was almost 22% below its 1998 peak. It was not until 2006 -- 8 years after the previous peak in Argentine GDP per capita -- that Argentines' average income exceeded the peak attained in 1998.

If Dr. Baker seriously thinks this is an experience that represents a preferred alternative to the one the U.S. has gone through since 2007, even with those maddening bailouts of major financial institutions, he's overlooking a great deal that we've learned about the pain of suffering a Great Depression. It will not do to argue – as Baker does – that Argentina’s “financial crisis” did not begin until some arbitrary date, well into its deep recession. The plain fact is that Argentina suffered a massive and painful loss of income that was not remotely matched by anything experienced by the United States anytime in the post-World-War-II period. It is absurd to claim the bailout of U.S. financial institutions did not limit the economic damage sustained by the real U.S. economy after September 2008.

Holding up Argentina as an example of how to avoid a Great Depression overlooks the fact that its 1998-2006 experience looks much more like the U.S. Great Depression (1929-1941) than it does to our Great Recession (2007-???).
...
written by skeptonomist, March 29, 2012 9:54
Argentina is not particularly relevant here - its problem was the difficulty it got into by pegging its money to the dollar (which was supposed to be the solution to its previous problem of inflation), and the solution was to default on its debt.

I think that the alternative solution which Dean favored at the time of the crisis in 2008 was not to have the Fed bail out the faltering banks, but to have them taken over by the FDIC, or possibly a new similar agency if necessary. That is, rather than rely on the monetary magic (or other magic) of the Fed Maestros, use a completely different institution and methodology. Experience over the years with the Fed should not lead anyone to think that it is a body which can generally solve the nation's economic problems. It failed miserably to prevent the collapse of banking in the Depression and has generally not protected banks well since, let alone maintained full employment. If the Fed is more competent than Argentina's central bank, which is not in evidence, this is not necessarily of any importance.
Fact Checking on Argentina
written by Dean, March 29, 2012 11:14
Greek Bearing Facts,

Please note that I was referring to Argentina's financial crisis that stemmed from its default. This was in December of 2001. The economy then plummeted for 3 months and then stabilized in the next 3. It was growing rapidly by the fall and regained the ground lost as a result of the financial crisis by the middle of 2003.

You cannot attribute the downturn from 1998-2001 to the financial crisis in December of 2001 -- at least not unless you work for the Washington Post.
Whose failure?
written by David, March 29, 2012 11:31
skeptonomist says of the Fed:

It failed miserably to prevent the collapse of banking in the Depression and has generally not protected banks well since, let alone maintained full employment.


Was that an institutional failure? Or a management failure? Too bad Bernanke didn't follow his own advice after the bubble burst (I guess academic purity is difficult to translate into political reality, when your committee is stacked with private bankers? it's Ben's only excuse). But more importantly, the failure then, and now, was of the Fed Chairman to recognize a bubble when he sees one. This was not always true, for example McAdoo was able to avert a rout in 1914 as the Fed got put into place (http://press.princeton.edu/titles/8243.html [I disagree with the blurb that Greenspan was a "great ... financial leader"]). So, the Fed does have the power to avert crises, we just don't have leaders with the political will power to make that happen (why should they? the finance industry, their milk cow, does fine during downturns). It's who goes on The Committee that is the problem, where vested interests steer policy so that it's convenient for them, not for the betterment of the nation (for some this is lauded (the type of greed that Friedman was an apologist for), while some believe it is akin to treason and economic terrorism of the worst kind).
Further clarification
written by David, March 29, 2012 11:38
Dean says:
The reality is that at a time when the market demanded a huge risk premium to lend money to these banks, the Fed invited them in to borrow as much as they wanted at near zero rates.


As I recall the timeline, it's more accurate to say that Paulson invited them to, and Paulson could pull the strings to get them those rates (though it wasn't just Paulson advocating the bank rescue, there were lots of friends having to save friends/frat brothers). My point, though it be a quibble, is that it was not the institution but the players (that W put into play) that allowed this fiasco to occur.
Esquire
written by Stephen, March 29, 2012 8:13
Please destroy Stephen Marche's article on the war against youth in Esquire.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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