Economists may not like to talk about this, because they can't reduce it to a
number; however, the disruption of national confidence in markets and
capitalism propagated by the escape of bankers' fortunes may prove to the worst
legacy created by the current Wall Street morass.
Getting out of this mess
The evidence mounts daily that the United States is in the greatest economic
crisis of our times, and the ultimate place of this crisis in the history of
economic disasters is yet to be determined.
The country needs more effective stimulus packages and programs to assist the
banks than policymakers have been
pursuing - a plan to stabilize conditions and avoid a complete meltdown.
More importantly and lacking from the proposals of the administration and
Congress, the nation - the government, individuals and private business - needs
to correct the structural problems that created this crisis if it is to
resurrect American growth and prosperity.
1. A stimulus package is needed because the demand for goods and
services is insufficient. Aggregate demand is insufficient because, near term,
consumers and businesses are deleveraging and many banks are dysfunctional.
Longer term, the economy suffers from a structural shortage of demand for goods
and services. As long as the economy has trade deficits that are 5% of GDP or
more when it is growing, Americans will have to consume more than they produce
to have adequate demand for US goods and services.
As currently formulated, the stimulus package will give the economy some lift
and restore some employment, but once its effects are through, aggregate demand
will prove inadequate. Without fundamental changes in the current structure of
US trade - massive imports of oil and consumer goods from Asia that are not
fully paid for with exports - either Americans will have to borrow as
consumers, businesses and investors from the rest of the world and create
another credit and asset bubble, or the US government will have to borrow on
their behalf and run successively larger budget deficits.
Unless the United States resolves the problem of the structural trade deficit,
the US economy will require ever-larger private borrowing and excessive
spending, or ever-larger stimulus packages and federal budget deficits, to keep
the economy from melting down.
2. The bad assets on the books of the banks are so huge, that no
solution short of nationalization - which I oppose - is possible without
removing those bad assets through some kind of bad bank or aggregator bank that
performs the services provided by the Resolution Trust Corporation during the
savings and loan crisis. Without such a vehicle, the amount of preferred shares
or non-interest bearing common shares the government will purchase from the
banks to help them cover losses will constitute de facto nationalization. With
the bad assets removed through a bad bank or aggregator bank, the banks could
then be recapitalized privately and then pay back their TARP [Troubled Assets
Relief Program] funds.
To resolve the structural trade deficit, the United States will have to have
very different approaches to energy and trade policies than in the past.
On the energy front, the nation needs to build out many of the alternative
energy sources and embrace many of the conservation measures the environmental
community advocates, but the nation must also do many things environmentalists
oppose. These include aggressively developing domestic sources of petroleum and
gas and building out nuclear power quickly.
Policymakers should not be fooled into believing higher energy prices alone
will provide needed results. If higher gas prices would do the trick, then the
German automakers would be leaders in hybrid autos and battery powered
vehicles, and they clearly are not.
Similarly, a CO2 [carbon dioxide] tax would disadvantage US industry vis-a-vis
foreign rivals in China and elsewhere. It would merely encourage more
manufacturing to relocate to these places and raise global CO2 emissions. Every
time a manufacturing job leaves Indiana for Shanghai, global emissions go up,
because China uses fossil fuels so much less efficiently than does the United
States. That is why with a GDP one-third the size of the United States, China
emits more CO2 than the United States.
A CO2 tax in the United States without a CO2 tax in China will make Americans
poorer and the problem of global warming worse. Such a tax without absolutely
comparable policies in China and other major developing countries is absolute
folly.
Regarding nonenergy trade, no solution is possible without addressing the trade
deficit with China, and its manipulated exchange rate and other mercantilist
practices. And given the role of the trade deficit in the nation's
macroeconomic problems and sovereignty problems foreign borrowing creates for
the United States, no public policy problem is more urgent.
Americans need to recognize that China is hardly a market economy in a Western
sense and is still highly state managed. Its financial system may not be able
to sustain an unmanaged floating exchange rate; however, China can manage the
value of its currency at 4 yuan to the US dollar as easily as it does 6.8 to
the dollar. In fact, it would be a lot easier to manage a value closer to
balance of payments equilibrium.
Simply, the United States should give China the opportunity, with a hard
deadline, to manage down its trade surplus with the United States, either
through meaningful and complete currency revaluation - complete means raising
the dollar value for the yuan to a level that reduces China's trade surplus
with the United States by one third each year and to zero after three - or
through other domestic means of Beijing's choosing.
If China declines, the United States should simply tax dollar-yuan conversion
in proportion to its official and surrogate currency market interventions. The
United States should impose a tax equal to the quarterly value of China's
intervention divided by its exports of goods and services. China would then
have a strong incentive to reduce and then stop intervening.
If China does not reduce and eliminate intervention and chooses for the United
States to tax currency conversion, then the benefits from a revalued yuan of
higher prices for Chinese imports that should go to Chinese businesses would
instead go into the US Treasury. If China reduces and then eliminates one-way
intervention and lets its currency rise to a value that balances trade, Chinese
businesses would capture those benefits in the form of higher dollar prices for
their goods.
Eliminating the trade deficit with China by eliminating or at least redressing
currency manipulation would have a much greater stimulus effect on the economy
than the package just approved by Congress. It would inspire a renaissance in
manufacturing and restore American growth and wages in a manner and magnitude
no public policy this Congress could implement could ever achieve. Simply, it
would permanently increase aggregate demand for US goods and services while
raising revenue for positive public purposes; it would restore incentives for
the efficient use of labor and capital that free trade should normally provide.
Redressing the trade deficit with China in this manner would not be
protectionist. China's actions now are protectionist, and constitute a modern
day Smoot-Hawley. China's policies are about as protectionist and predatory as
could ever be conceived by the most skilled 17th century mercantilist and are
an absolute threat to US prosperity and sovereignty.
I am not advocating protectionism - let China stop rigging its currency and
trade and the United States can and should compete. I am advocating the United
States abandon a policy of appeasement in commerce and embrace self-defense and
self preservation.
All countries practice the equivalent of "Buy American" and in most cases more
aggressively than does the United States. The WTO Procurement Code provides for
exchange of national treatment for certain purchases, and that is the extent of
US international obligations. It does not apply to developing countries, like
China, that have declined to sign the code.
Americans should not expect much of China's stimulus package to be spent in the
United States owing to its protectionist policies, and given China's
contribution to the current mess here, it would be folly not to apply Buy
American to US purchases that might otherwise go to China and other countries
that have not signed the code, or whose actions in the current crisis do not
warrant national treatment.
Regarding the banks, the Treasury needs to take the following steps: initially,
it needs to organize a bad bank or aggregator bank to sweep all the
questionable mortgage-backed securities from the books of the banks and require
the largest banks, including securities companies with bank status, to
undertake aggressive and sweeping management reforms and changes in
compensation schemes for professionals engaged in commercial banking and
securitization activities.
Such changes should be required for any institution enjoying bank status under
the TARP, at the Federal Reserve discount window or FDIC [Federal Deposit
Insurance Corporation] insurance.
With these in place, the banks should be able to raise private capital and
repay TARP funds, and the Congress should reconsider the segregation in
ownership of banks and near banks, meeting the above criteria, from other
financial institutions.
The bad bank or aggregator bank could be capitalized with US$250 billion from
the TARP, and it could raise additional capital by selling $250 billion in
shares to private investors and another $500 billion to $1.5 trillion by
issuing bonds. The commercial banks could be paid for their securities with 25%
in special common shares and the rest in cash. These special shares could only
be redeemed after TARP financed shares, private shares and bond holders were
paid.
This entity could purchase all of the questionable mortgage-backed securities
from commercial banks at their current mark-to-market values on the books of
the banks and purchase those in the hands of other investors too. If $2
trillion in TARP and private money is not enough, then the above dollar figures
could be scaled up proportionately and even doubled.
The bad bank or aggregator bank could determine the number of defaults by
performing triage on mortgages - deciding which homeowners if left alone will
pay their mortgages, which if offered lower interest rates and moderate
principal writedowns could reasonably service new loans, and which must be left
to fail.
Implementing those standards and necessary mortgage modifications across the
entire market would, at once, limit the number of defaults and determine how
much housing prices will ultimately fall. That is something the individual
banks cannot accomplish acting independently.
By sweeping all the mortgage-backed securities off the books of the banks and
limiting losses on those securities, the bad bank or aggregator bank would earn
money by collecting payments on the majority of mortgages that ultimately pay
out and sell off repossessed properties at a measured pace. Like the savings
and loan Crisis Resolution Trust, and the Depression-era Home Owners' Loan
Corporation, it would likely make a profit.
Relieved of the mortgage backed securities, the banks would not be trouble free
- they still have auto loans and credit card debt to repent. However, having
huge deposits and vast networks of branches, they would be worth a lot to
investors again, and could raise new capital, repay their TARP contributions
and write new mortgages.
Notes
1. The Smoot-Hawley Tariff Act, signed into law on June 17, 1930, raised US
tariffs on over 20,000 imported goods to record levels against the objection of
more than 1,000 economists. Many countries retaliated with their own tariffs on
imports from the US. The higher barriers are seen as contributing to the
reduction in international trade as the Great Depression developed.
2. Regulation Q puts put a limit on the interest rates that banks in the US
could pay, including a rate of zero on demand deposits (checking accounts).
3. The Glass-Steagall Act of 1933 prohibited commercial banks to own,
underwrite, or deal in corporate stock and corporate bonds. It was repealed in
1999.
Peter Morici is a professor at the University of Maryland School of
Business and former chief economist at the US International Trade Commission.
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