The Meltdown Lowdown, No. 7

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Dean Baker
The American Prospect Online, May 22, 2008

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This week in economic news: House prices continue to plummet, speculation is probably not to blame for high gas prices, and new corruption is exposed in the mortgage industry.

Low-Income Renters to Pay for Housing Bailout

After reaching an agreement on a plan to guarantee new mortgages for homeowners facing foreclosure, Democrats and Republicans needed to find a way to pay for it. Their solution? Take the money from low-income renters.

This is not a joke. The leadership of the banking committee apparently decided that the best place to get the start-up funds for the bailout is a pool of money from Fannie Mae and Freddie Mac’s profits that had been set aside to provide housing subsidies for low-income renters.

This is fascinating to think about. Imagine our leaders in the Senate sitting there, debating how to find $500 million. Some economist suggested limiting the new $7,000 tax credit for buying foreclosed homes to cases where the foreclosure process had already been completed before the bill was approved. In addition to saving taxpayer dollars, this change would also avoid giving banks incentives to foreclose. But the Senate rejected this restriction.

The Senate could also have limited its new tax break for homebuilders and bankers that allows them to write-off their losses against taxes paid in the distant past. Or, going beyond the current bill, the Senate could have decided to get revenue by making billionaire fund managers pay the same tax rates as the rest of us on their wages.

But instead of doing any of this, Congress decided that low-income renters were the group to shortchange. No doubt the high life of low-income renters is offending hard-working Americans everywhere.


The Fed Says the Economy Looks Pretty Bad: Surprise!

Remember all the optimistic accounts about how the economy was still growing and the worst of the economic crisis was behind us? Well, that was yesterday. Today, the Fed has a new set of economic forecasts that show weak growth both this year and next. As the Wall Street Journal tells readers, “Fed’s Forecast Grows Gloomier.”

The Fed now predicts that growth this year will be between 0.3 percent and 1.2 percent. It projects 4th quarter unemployment averaging between 5.5 percent and 5.7 percent. Growth for next year is forecast as between 2.0 percent and 2.8 percent, with year-end unemployment between 5.2 percent and 5.8 percent.

The folks who were surprised by the meltdown are likely to be proved overly optimistic yet again. With the plunge in house prices now destroying real housing wealth at annual rate of almost $6 trillion a year (almost $80,000 per homeowner) consumption will surely fall. The plunge in prices will also lead to more mortgage defaults and hundreds of billions of additional write-downs in the financial sector. So, look for the Fed’s forecasts to get more gloomy in the future.


Inflation is Coming

The consumer price index, the most widely used measure of inflation, continues to show that inflation is pretty much under control, apart from surges in gas and energy prices. (Yes, people have to buy gas and eat, but we are talking about the underlying rate of inflation in the economy.)

The relatively low level of this “core” rate of inflation has been striking. However, the good news on inflation may be coming to an end. The core finished goods index of the producer price index showed a 0.4 percent jump in April. It has now risen at a 5.0 percent annual rate over the last quarter.

This matters to people who don’t bury their heads in such numbers because inflation is likely to translate into higher interest rates, perhaps most importantly higher mortgage interest rates. The interest rate on 30-year fixed rate mortgages is still unusually low, hovering near 6 percent. If inflation starts to tick-up, then we might expect to see the 30-year mortgage rate move toward 6.5 percent or even 7.0 percent, regardless of what the Fed might try to do keep long-term rates low. This will be yet more bad news for the housing market.


Attacking the Farm Bill for Keeping Food Prices Low/High

There are many good reasons for criticizing the farm bill recently passed by overwhelming margins in Congress. At the top of my list is its subsidies for ethanol alcohol. The most recent research shows fuel derived from corn based ethanol alcohol provides essentially zero reduction in greenhouse gas emissions relative to conventional gasoline. So why would we spend billions of dollars promoting the production of this stuff?

We can also complain that much of the money in the bill goes to wealthy farmers. But, we all know that one of the main purposes of government in the United States (a.k.a. The Conservative Nanny State) is to redistribute money from the poor and middle class to the wealthy, so Congress was just doing its job.

But the most creative attacks on the bill came from folks like the editorial boards of The Washington Post and The New York Times, both of which were unhappy because the farm bill would keep food prices high at a time when soaring food prices are leaving many people around the world hungry.

The problem with this story is that the subsidies overall have the net effect of lowering food prices. It's Econ 101 -- if you subsidize the production of a product, you get more of it. More supply means lower prices. Of course the Times and Post editorial boards used to understand this -- back then they criticized farm subsidies for keeping prices low and thereby hurting farmers in the developing world.

You have to admire the courage of the Post and the Times. They are willing to criticize the farm subsidies for keeping food prices both low and high. Such courage! Paragons of the media sacrificing their credibility for the greater good of defeating farm subsidies.

Of course, as Dani Rodrik recently pointed out, this high/low problem isn’t unique to these editorial boards; the World Bank and many NGOs suffer from the same problem. We get the point -- they don’t like U.S. farm subsidies -- but we just don’t know why.


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.