The Meltdown Lowdown, No. 5

May 08, 2008

Dean Baker
The American Prospect Online, May 8, 2008

See article on original website

This week in economics news: Hillary Clinton’s curious stance on the gas tax, adventures in JohnCare, and sub-prime analysts look to the past in order to misread the future.

Sen. Clinton Versus the Economists

It is highly unusual for a serious presidential contender to take on the consensus within the economics profession, as Sen. Clinton did in arguing that her gas tax temporary cut would provide relief to hard-pressed working people. Unfortunately, on this one Sen. Clinton seems to have thrown in her lot with the creationists and global-warming deniers of economics. It is just about impossible to find anyone with any knowledge of economics who doesn’t believe that the oil industry would be the main beneficiary of this tax break as I explained last week.

Of course, if Sen. Clinton really does want to take on the mainstream of the economics profession on behalf of her beer-drinking buddies in bowling alleys, there are several policies that would be much better ideas than a gas tax. Here are four of my favorites:

  • Impose reserve and transparency requirements, leverage limitations, and caps on CEO pay for the big investment banks that are now benefiting from the taxpayers’ generosity through the Federal Reserve Board.

  • Impose a financial transactions tax to keep Wall Street in line. The $150 billion raised can be used for extending health care, child care, and middle-class tax cuts.

  • Negotiate trade agreements that subject highly paid professionals (doctors and lawyers for example) to competition with low-paid workers in the developing world, rather than making manufacturing workers bear the brunt of globalization.

  • Develop alternatives to government patent monopolies for prescription-drug research so that all prescriptions can be purchased for $4 a piece at Wal-Mart.

These are all areas where Sen. Clinton can take on the mainstream of the economics profession in a way that actually would benefit working people. It will be interesting to see if she is up to the task. Her history suggests otherwise, but Sen. Clinton has demonstrated a remarkable capacity for change. After all, less than two months ago this economic populist’s list of economic saviors was headed by Paul Volcker, Alan Greenspan, and Robert Rubin, who she proposed to head a committee to solve the current financial crisis.

Adventures in John Care

As Meltdown Lowdown readers know, Sen. McCain put forward a proposal last week that would end health insurance as we know it. He would get rid of the tax deductibility of employer-provided health-care insurance and instead give every adult a refundable $2,500 tax credit to buy health-care insurance.

This would almost certainly mean a quick end to employer-provided health insurance, since employers would have little incentive to waste time negotiating with insurers. Instead, employers would just tell their workers to get their own plan.

Suppose we all had to hunt down insurance in the private market. This would not be easy since the insurers generally don’t tell you which treatments they cover or how much they pay for each treatment. So most of us would be left fishing through our various options, hoping that we don’t pick a plan that happens to exclude whatever diseases we might eventually acquire.

According to a study by the Medicare Payments Advisory Commission, the typical Medicare beneficiary took 8 hours to decide which prescription-drug plan to choose. Choosing a general health-care plan will take far longer because there is far more at stake, and the choices are more complex (for a start, health-care plans include prescription-drug coverage).

If the prospect of spending 30 to 40 hours choosing between health-care plans sounds unappealing, don’t worry. The McCain plan will undoubtedly create a large market for health-insurance brokers who can help workers decide which plan to choose, just as mortgage brokers steered people to the best mortgage. And what could be wrong with the kind of people who brought you sub-prime mortgages also being responsible for your health?

Housing Market Analysts Are Still Clueless

The Wall Street Journal reports that analysts are looking at the 2003 default rates on the sub-prime mortgages issued in 2000 to get an idea of what to expect next year for the default rate on mortgages issued in 2006.

This one is really, really painful. In the years from 2000 to 2003, the housing market was in the middle of a bubble. House prices were soaring, especially in the markets with lots of sub-prime loans. When house prices rise, homeowners accumulate equity. Homeowners with equity don’t default on their mortgages. They either borrow against their equity or they sell the home and put money in their pockets.

The present could hardly be more different. Home prices are now down nationwide by close to 10 percent from their levels a year ago. In many of the big sub-prime markets they are down by more than 20 percent. Furthermore, prices are falling rapidly. In another year or two years, most recent homebuyers in these markets will still have negative equity and possibly quite a lot of it. Given this difference, what can the default rates from 2003 tell analysts about the default rates in 2009? That’s right, absolutely nothing. How do housing analysts get their jobs?

Crisis? What Crisis?

The New York Times tells us that the Fannie Mae and Freddie Mac, the huge government-created mortgage intermediaries, could be facing financial troubles. I wonder how that could be?

Let’s see, we have two financial corporations, one with $2.8 trillion of mortgages or guarantees on mortgage-backed securities, the other with $2.1 trillion of mortgages or guarantees on mortgage-backed securities, and $45 billion and $38 billion, respectively of core capital. House prices are seeing their sharpest plunge since the Great Depression, which is in turn pushing default and foreclosure rates to the highest level on record. Now, how could anyone think that there could be a problem here?

It looks like the folks who missed the bubble before it burst still can’t seem to understand it even as it is bursting all around them. Anyone connected with the housing market is going to see serious losses. When the economy loses $6 trillion in real housing wealth over the course of a year (roughly the current rate of price decline), there is no way that the financial institutions that sit in the center of the mortgage finance system can escape without serious damage.


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 ( 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.

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