The Meltdown Lowdown, No. 1

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Dean Baker
The American Prospect Online, April 10, 2008

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This week in economic woes: Congress acts to worsen the foreclosure crisis, why we should hope investment banks move to England, and how ordinary Americans are subsidizing fancy yachts and private clubs.

Congress Takes Bold Action to Worsen the Foreclosure Crisis

During its spring recess, Congress heard from constituents who were concerned about losing their homes and about plunging home equity. Spurred into action, the Senate quickly approved a bill whose main provisions would give tax breaks to banks and homebuilders and provide an incentive to carry through foreclosures.

The tax break allows firms to write off losses this year and next against the prior four years' profits. Under current law, they can only seek to reclaim taxes paid in the last two years. Who has big losses now but large profits three and four years ago? That's right, homebuilders who got caught up in the irrational exuberance of the housing bubble and mortgage bankers who pushed predatory loans. I'm sure that we're all sympathetic to the plight of homebuilders and bankers who have fallen on hard times, but whatever happened to personal responsibility?

But wait, as the infomercials say, there's more! The package also includes a $7,000 tax credit for anyone who buys a foreclosed home. This is not entirely a bad idea. Many foreclosed homes have been allowed to deteriorate and would require several thousand dollars in repairs and renovations to be habitable.

However, the tax credit as structured by Congress is not quite the answer. First, it is not refundable. As a result, many moderate-income families seeking to buy foreclosed properties would not get the full benefit of the tax credit, since they will not owe $7,000 in taxes. More importantly, the credit would apply to homes that are still in the foreclosure process. This gives banks more incentive to carry through a foreclosure, rather than attempt to work out new terms with the current homeowner.

Tax breaks for homebuilders and banks and new incentives for foreclosures -- whom exactly did Congress spend its recess talking to?


Investment Banks Move to England. Good!

The prospect of investment banks moving overseas in response to more stringent regulation has been raised repeatedly by opponents of such regulation. This raises an obvious question: Why should we care?

We buy shoes, toys, cars, and steel from abroad; why should anyone be bothered by the prospect that we would be getting our investment banking services from other countries?

There could even be an important fringe benefit from getting our investment banking services from England: We wouldn't have investment bankers intervening in our politics. I'm thinking of course of Peter Peterson, a top executive at the Blackstone Group, who has gotten incredibly wealthy from the income from his banking business and the fund managers' tax subsidy.

Mr. Peterson has spent much of the last two decades trying to cut funding for Social Security and Medicare. He founded the Concord Coalition in 1992 to advance this end. This group has put out hundreds of papers and held numerous conferences, the vast majority of which covered the supposed need to cut Social Security and Medicare. More recently Mr. Peterson announced the creation of a new foundation dedicated to restoring fiscal soundness, which to his mind means cutting Social Security and Medicare. If we had better regulations of investment banks, perhaps Mr. Peterson would be living in England and trying to dismantle its Social Security system.


Greenspan Says We're In a Recession, Puppies are Cute, and the Pope is Catholic

Well, he got that one right. We have had four consecutive months of job loss in the private sector. This has never happened except in periods associated with a recession. There are enough other pieces of economic data that scream "recession" -- declining retail sales, rising unemployment rates, plunging tax collections -- that we really should no longer be debating whether the economy is in a recession; the question now is how long will it last and how bad will it get.

The remarkable part of this story is that reporters relied on economists as the experts on this topic. Economists do not see recessions. That's not a joke, that's a fact. Almost no economists saw the 2001 recession coming until we were in it. (In the fall of 2000, every one of the "Blue Chip" 50 forecasters projected healthy growth for 2001.)

The story is the same this time. Everyone saw good times through the fall, and it was only as the holiday season rolled around that some of the brave forecasters began to raise the possibility of a recession. I'll leave the analysis of this systematic bias to others, but reporters and the public at large should recognize it. Just as creationists cannot acknowledge the evidence for evolution, economic forecasters cannot talk seriously about the risks of recession.


How You and I Are Giving Billions of Dollars to Investment Bankers

We all know about the credit crunch and the Fed's heroic efforts to keep the financial markets functioning. But we should not forget who is funding these efforts -- the taxpayers.

The Fed has opened its discount window to the investment banks, allowing them to borrow at a below-market interest rate. Currently this rate is 2.5 percent. Commercial banks have long had this option, but in return, they had to submit to transparency requirements and regulations. In other words, if taxpayers were going to back them up, banks needed to act responsibly. Unlike the commercial banks (banks where people have checking accounts and get mortgages), the investment banks are not subject to reserve requirements and do not have their books reviewed by the Fed. That's not all. When the Fed rescued Bear Stearns, Fed Chairman Ben Bernanke said that he would also come to the rescue of any other major investment bank in trouble. This promise is incredibly valuable. Mr. Bernanke effectively told the creditors of the other investment banks that they don't have to worry about Morgan Stanley's, Lehman Brothers', or Goldman Sachs' creditworthiness. If these banks aren't good for their debts, the Fed is.

To understand the value of this guarantee, consider going downtown and selling huge insurance policies that would earn you billions of dollars in fees. When someone asks whether you can really pay off on any claims on these policies, you get to tell them, "Don't worry, the Fed is backing them up." The customers will happily hand over the cash knowing that they have the best guarantee they could possibly find.

Cheap money and free guarantees: That's what we're giving to the investment bankers. So, when we see their huge mansions, private jets, and impressive foundations, we should all feel a sense of pride. After all, we paid for them.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.