The Meltdown Lowdown, No. 6

May 16, 2008

Dean Baker
The American Prospect Online, May 15, 2008

See article on original website

This week in economic news: Barney Frank’s bailout would mainly benefit banks, stimulus checks provide little stimulus, and the benefits of higher prices from China.

Barney Frank’s Bailout Mostly Benefits Banks

A new bill sponsored by Rep. Barney Frank, chairman of the House Financial Services Committee, directs the Federal Housing Authority (FHA) to buy up loans that are facing foreclosure. If the bill passes, the FHA will guarantee new mortgages at a price 15 percent below the current appraised value of the house. This would require the current lender to take a hit, since it will not get back the full value of the home, but even 85 percent of the full value of the home is likely more than the lender would get by foreclosing. In principle, homeowners will also benefit, since they get to stay in their home with a new lower-interest mortgage.

The big problem is that prices in many markets are still hugely inflated by the housing bubble. This means that even a price that is 15 percent below the appraised value is actually more than the house is likely to be worth in the near future. Prices are likely to drop further, leaving the government holding the bag.

It’s also not a great deal for homeowners. They will be paying far more in ownership costs than they would pay to rent a comparable home — taking away money that they could be spending on their kids’ health care, child care, and other necessary expenses. The families also don’t end up with any equity in a house with a falling price.

There is an easy way around this problem — just set the guarantee price at a multiple of annual rent of a comparable home (15 to one, for example). Rents never got out of line with reality even at the peak of the bubble. A guarantee price grounded in rent would therefore reflect the fundamentals of the housing market.

If A Stimulus Doesn’t Stimulate, Is It Still a Stimulus?

Just before the North Carolina and Indiana primaries, Sen. Clinton declared war on the economics profession, claiming that she would stand with hard-working Americans against economists. While her choice of issues was poor (a temporary cut in the gas tax will primarily benefit the oil industry), I expressed sympathy with the broader sentiment.

It looks like we may soon have another chance to put Sen. Clinton’s newfound populism to the test. The great minds in the economics profession thought that a tax rebate would be the quickest and most effective way to boost the economy. (Mea culpa, I included a tax rebate in a stimulus package that I designed with two colleagues.)

While the checks are still in the mail, there is reason to believe that their impact may be less than had previously been predicted. Economists looked back to the 2001 rebate, when half of the checks were spent within six months. However, there is a big difference between 2008 and 2001.

In 2001, house prices were rising rapidly. In 2008, house prices are falling rapidly. House prices are now falling at close to a 25 percent real annual rate, destroying almost $400 billion ($5,000 per homeowner) in housing equity a month. As a consequence, many homeowners will be using their rebate checks to rebuild their savings or pay down debt.

So what would actually stimulate the economy? As a start we could spend money subsidizing mass transit, increasing bus lines, and providing generous tax credits for energy-conserving improvements to homes and businesses. Let’s also install more efficient power lines and build a 21st-century infrastructure. Mainstream economists tend to be wary of public investments as stimulus, but we don’t have to listen to them, right Sen. Clinton?

The “What Recession?” Crew

There is a whole group of economic pundits who eagerly celebrated the economy’s 0.6 percent growth rate in the first quarter. While a 0.6 percent growth rate is pretty dismal by any standard (growth averaged more than 4.0 percent per year from 1996 to 2001), it is positive and so rules out a recession for the quarter.

But these folks still picked a strange excuse for a party. We know that the economy has lost jobs for four consecutive months. The unemployment rate is already up by half a percentage point from its low last year and the safest bet this election year is that it will go higher.

Retail sales are down in two of the last three months, home starts and sales continue to plummet, and even nonresidential construction is now headed down. The only economic indicators headed up these days are the prices of food and gas and the foreclosure rate. If Sen. McCain embraces the “no recession” refrain his campaign will be the only thing declining faster than house prices.

High Prices From China Are What We Need

Higher food and energy prices are the most well-known drivers of inflation, but in fact, prices have been rising more rapidly for a wide range of items. In particular, over the last year, the prices of imports from China have risen by an average of 4.1 percent. The price increase is the result of both higher domestic prices in China and a rise in the value of the Chinese yuan relative to the dollar.

While no one is going to be happy paying higher prices, there is no way around this pain. The United States has an unsustainable trade deficit and the biggest chunk of this deficit is from trade with China. The only way to get this deficit down is to have the price of Chinese goods rise relative to the price of domestically produced goods. The price of Chinese imports will actually have to rise much more over the next few years, but the end result will be that we produce more of what we consume in this country and perhaps we also get back some of the good-paying jobs we lost in manufacturing over the last decade.


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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