Readers have been pressing for a solution to the financial crisis. But first it is necessary to understand the problem. Here is the problem as I see it. If my diagnosis is correct, the solution below might be appropriate.
Let's begin with the fact that the financial crisis is more or less worldwide. The mechanism that spread the American-made financial crisis abroad was the massive US trade deficit. Every year the countries with which the US has trade deficits end up in the aggregate with hundreds of billions of dollars.
Countries don't put these dollars in a mattress. They invest them. They buy up US companies, real estate, and toll roads. They also purchase US financial assets. They finance the US government budget deficit by purchasing Treasury bonds and bills. They help to finance the US mortgage market by purchasing Fannie Mae and Freddie Mac bonds. They buy financial instruments, such as mortgage-backed securities and other derivatives, from US investment banks, and that is how the US financial crisis was spread abroad. If the US current account was close to balance, the contagion would have lacked a mechanism by which to spread.
One reason the US trade deficit is so large is the practice of US corporations offshoring their production of goods and services for US markets. When these products are brought into the US to be sold, they count as imports.
Thus, economists were wrong to see the trade deficit as a non-problem and to regard offshoring as a plus for the US economy.
The fact that much of the financial world is polluted with US toxic financial instruments could affect the ability of the US Treasury to borrow the money to finance the bailout of the financial institutions. Foreign central banks might need their reserves to bail out their own financial systems. As the US savings rate is approximately zero, the only alternative to foreign borrowing is the printing of money.
Financial deregulation was an important factor in the development of the crisis. The most reckless deregulation occurred in 1999, 2000, and 2004. (See my End of American Hegemony.)
Lax mortgage lending policies grew out of pressures placed on mortgage lenders during the 1990s by the US Department of Justice and federal regulatory agencies to race-norm their mortgage lending and to provide below-market loans to preferred minorities. Subprime mortgages became a potential systemic threat when issuers ceased to bear any risk by selling the mortgages, which were then amalgamated with other mortgages and became collateral for mortgage-backed securities.
Federal Reserve chairman Alan Greenspan's inexplicable low interest rate policy allowed the systemic threat to develop. Low interest rates push up housing prices by lowering monthly mortgage payments, thus increasing housing demand. Rising home prices created equity to justify 100 percent mortgages. Buyers leveraged themselves to the hilt and lacked the ability to make payments when they lost their jobs or when adjustable rates and interest escalator clauses pushed up monthly payments.
Wall Street analysts pushed financial institutions to increase their earnings, which they did by leveraging their assets and by insuring debt instruments instead of maintaining appropriate reserves. This spread the crisis from banks to insurance companies.
Finance chiefs around the world are dealing with the crisis by bailing out banks and by lowering interest rates. This suggests that the authorities see the problem as a solvency problem for the financial institutions and as a liquidity problem. US Treasury Secretary Paulson's solution, for example, leaves unattended the continuing mortgage defaults and foreclosures. The fall in the US stock market predicts a serious recession, which means rising unemployment and more defaults and foreclosures.
In place of a liquidity problem, I see an over-abundance of debt instruments relative to wealth. A fractional reserve banking system based on fiat money appears to be capable of creating debt instruments faster than an economy can create real wealth. Add in credit card debt, stocks purchased on margin, and leveraged derivatives, and debt is pyramided relative to real assets.
Add in the mark-to-market rule, which forces troubled assets to be under-valued, thus threatening the solvency of institutions, and short-selling, which drives down the shares of trouble institutions, thereby depriving them of credit lines, and you have an outline of the many causes of the current crisis.
If the diagnosis is correct, the solution is multifaceted.
Instead of wasting $700 billion on a bailout of the guilty that does not address the problem, the money should be used to refinance the troubled mortgages, as was done during the Great Depression. If the mortgages were not defaulting, the income flows from the mortgage interest through to the holders of the mortgage-backed securities would be restored. Thus, the solvency problem faced by the holders of these securities would be at an end.
The financial markets must be carefully re-regulated, not over-regulated or wrongly regulated.
Paul Craig Roberts, a former Assistant Secretary of the US Treasury and former associate editor of the Wall Street Journal, has held numerous academic appointments. He has been reporting shocking cases of prosecutorial abuse for two decades. A new edition of his book, The Tyranny of Good Intentions, co-authored with Lawrence Stratton, a documented account of how Americans lost the protection of law, was published by Random House in March, 2008.
... dissolving the Federal Reserve Bank, getting our right to print our own money instead of having private bankers do if for us at outrageous interest, which doesn't pay for a single service, but simply pays for the interest of the money the Fed prints.
Doing this will also eliminate the illegal IRS, thereby allowing people to keep the 3 months of pay they give to the Fed. One can only imagine what a shot in the arm this would be for the economy.
In order to get out from the grip private international bankers have on us we need to get them out of our pockets. They serve no purpose other that to enrich themselves and enslave us.
It wouldn't be a bad idea to arrest Greenspan, Bernanke, Paulson, along with impeaching Bush, Cheney and dragging them to the Hague with the rest of their administration and convict them for crimes against humanity. This wouldn't have any direct effect of the economy but it would show any future potential criminals that their crimes will not be tolerated.
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Mr M (4 articles, 0 quicklinks, 18 diaries, 1762 comments)
on Friday, October 10, 2008 at 9:13:38 AM
There's nothing "inexplicable" about Greenspan's (and Bernanke's) interest rate policy. Regardless what the Fed's purported role in the US economy is or ought to be, they cannot pursue it in any rational way.
The biggest problem is the US Budget deficit, currently at over $10 Trillion dollars, with at least $1 Trillion to be added to it from bailout deals made in the last couple months alones. Fiscal 2008 interest expense on that $10 Trillion was $451 Billion, or about 18% of the entire budget.
The simple fact of the matter is that the Fed has to maintain low interest rates, whether they want to or not, because if they allowed it to rise, each 1% increase now represents over $100-110 Billion in annual government outlays for no services to the American people at all. Those interest outlays will continue for decades.
Keep in mind that the only line items in the Federal budget greater than $100 Billion go to the Department of Defense, Social Security, and Medicare and Medicaid.
There's simply no way the Fed can allow interest rates to rise without breaking the US Federal Budget for generations. The dilemma is obvious. The Federal Reserve is an institution that functions directly opposite of it's purported purpose. Here's an excerpt from the Fed's own documents about it's role in the economy. Given the state of that economy today, it appears almost naively humorous. See if you can tell if they've done ANYTHING right:
Today, the Federal Reserve’s duties fall into four general areas:
• conducting the nation’s monetary policy by inf luencing the monetary and credit conditions in the economy in pursuit of maximum employ- ment, stable prices, and moderate long-term interest rates
• supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
• providing financial services to depository institutions, the U.S. gov- ernment, and foreign official institutions, including playing a major role in operating the nation’s payments system
-- from The Federal Reserve System's publication Purposes and Functions.
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Robert Knowles (0 articles, 0 quicklinks, 6 diaries, 59 comments)
on Friday, October 10, 2008 at 10:40:29 AM
I respect your many years and value greatly all that you contributed and continue to contribute to understanding these troubled times. However, your closing paragraph gives me great pause.
Anytime I see Friedman's name brought up in suggestion that his understanding and market philosophy is to be weighed, I get more than the willies. This is a man whose 'free market' teachings and pratices have in great part grown to unfathomable size, the corporate personhood mentality we are buried under that has almost completely destroyed a system that is anything but free.
I trust you are ok in your personal accounts to withstand this shift we are in. I trust in the end we will eventually get through this, alas, I am sad to see that Friedman is anywhere in your thoughts in this regard.
A person lives and breathes. A corporation does not. Until we learn that, we will continue to sadly reward the failed Friedman free market rules that only devour, not create.
I believe you are a good man sir, but this threw me for a loop. I need about 20 minutes to cool off. To mellow out, I will close with this.
David Wallace told a story about two young fish who were swimming up the river one day. An old fish was swimming the opposite direction. As he approached them, he greeted the youngsters. "How you doin' today boys? How's the water?". The two youngsters looked at him in silence and swam right by, ignoring him. About a mile downstream, one youngster turned to the other and said, "what the hell is water?".
Need I say more? Perhaps I am missing something or overreacting.
peace
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mikel paul (11 articles, 1 quicklinks, 8 diaries, 457 comments)
on Friday, October 10, 2008 at 11:51:23 AM
mikel paul is very misinformed about Milton Friedman, a favorite target for demonization by leftwing ideologues. Friedman was the first economist to figure out the cause of the Great Depression. Friedman advocated the negative income tax, which became US policy and makes income grants to Americans too poor to pay taxes. Friedman argued that money payments to the poor are better for the poor than payments in kind. Friedman's defense of the market is a defense against thoughtless regulation that imposes more costs than benefits. Friedman never advocated abandoning all regulation. He merely applied a cost-benefit analysis to it. Keep it where it improves outcomes, get rid of it where it makes outcomes worse.
Friedman won the Nobel Prize for the excellence of his work, not for being an ideologue.
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paul roberts (0 articles, 0 quicklinks, 0 diaries, 31 comments)
on Friday, October 10, 2008 at 12:03:45 PM
I will go back and read. I appreciate your thoughts as I said and will look again at it. I know Mr. Friedmans nephew and in that relationship have found much to question. Certainty is scary to me and it is in sincerity that I will attend to understand what you suggest I do not.
peace
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mikel paul (11 articles, 1 quicklinks, 8 diaries, 457 comments)
on Friday, October 10, 2008 at 12:36:26 PM
1) About the mark-to-market rule - You're advocating that it should be suspended, so that assets wouldn't have to be written down to current market value, & instead could be kept on the books at (say) purchase price. I see that this would reduce the pressure on balance sheets, but it sounds very much like "Enron-style accounting," where balance sheets would reflect pleasant fictions, rather than current realities. Isn't there something intrinsically deceptive & ultimately harmful about an accounting rule that lets companies ignore market realities, even if they're unpleasant?
2) You write, "Instead of wasting $700 billion on a bailout of the guilty that does not address the problem, the money should be used to refinance the troubled mortgages..."
- Here's how I understand this would work in practice. (Tell me if this is right.) Suppose I bought a house at a price of $600,000, and owe monthly mortgage payments to some bank at (say) 6%. Suppose the market value of the house has fallen to $500k, tempting me to walk away from the house & default on my mortgage. Then you're proposing that the government would lend me the money to pay off the current mortgage -- at the full original price of $600,000. And I'd then be left owing the govt a monthly payment at a rate of say 4%. So the original lender is made whole, and the house price is perhaps maintained at $600k, and the main difference for me is just that I now have to pay off that amount at a lower rate. Meanwhile the government accepts being paid less interest on their loan, than the original mortgage issuer (the bank) was willing to accept.
3) Finally, you write, "But the US government must cease to force private lenders to breech the standards of prudence..."
- Here you're speaking to the question of "Whose fault is the mess, the predatory lenders or the unqualified borrowers?" The political right is heavily stressing the borrowers' responsibility for the mess, while the left-leaning elements are emphasizing the lenders' responsibility. I concede that there's an argument to be made for both views, though I personally see it as mainly the lenders' fault, since they knew exactly what they were doing, & through their hirelings in Congress got to make all the rules. Where do you stand on this, exactly? Are you more critical of the lenders or the borrowers?
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Richard Mynick (2 articles, 3 quicklinks, 1 diaries, 1226 comments)
on Friday, October 10, 2008 at 12:20:31 PM
Does Richard Mynick prefer the huge cost of financial collapse to fixing the problem in the absence of perfect fixes? Do we do nothing because of the absence of perfect fixes?
1) about the mark-to-market rule. In times of panic there is no known current market value. The values that are being placed on the mortgage-backed securities are so low as to be every bit as deceptive as original purchase price. Merrill Lynch sold theirs at 20 cents on the dollar. Does anyone believe that 80% of the mortgages are bad?
2) The default problem is mainly due to lost jobs and to rising adjustable rates and interest rate escalator clauses in some mortgages. Refinancing the mortgages, as was done during the Great Depression, halts the defaults that are creating the problem. If some mortgages have to be subsidized, better to subsidize the homeowner where the problem is than the banks. subsidizing the banks does nothing to stop the defaults.
3) the article is completely clear as to all the parties responsible for the problem. It is not a blame game. It is a "be aware of all the problems and fix them all" message.
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paul roberts (0 articles, 0 quicklinks, 0 diaries, 31 comments)
on Friday, October 10, 2008 at 12:53:03 PM
No, I don't "prefer the huge cost of collapse" to trying to
fix the problem in the absence of perfect fixes. On the other hand, Paulson could have used that same argument to justify his proposal 2 weeks ago, & it already appears his proposal has been a colossally expensive failure.
But your point of course is well taken. One must try to understand the problem as accurately as possible, then take the risk of basing action on that understanding.
Would you say that my rendering of point #2 above, about how your suggested refinancing would work in practice, was basically a correct understanding of your proposal (even though I worded it differently)?
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Richard Mynick (2 articles, 3 quicklinks, 1 diaries, 1226 comments)
on Friday, October 10, 2008 at 1:31:43 PM
I don't believe very much of the problem is people voluntarily walking away from their homes. The problem is foreclosures, people being evicted. Regardless, the problem has to be dealt with at the default/foreclosure level. Dealing with it at the investor level does not stop the foreclosure/defalts. Therefore, housing supply piles up in inventories, further depressing prices. A number of conservatives claim that if troubled mortgages are refinanced, people will walk away from good mortgages in order to get a better deal, too. But there is nothing to compel government to give a deal to a person with a job and a fixed rate mortgage, and it does not appear to have been an experience of refinance during the Great Depression. One million mortgages were refinanced, and foreclosures were halted by the refinance.
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paul roberts (0 articles, 0 quicklinks, 0 diaries, 31 comments)
on Friday, October 10, 2008 at 2:02:42 PM
If as you suggest, the problem is indeed at the default/foreclosure level, why is it that lending liquidity between the credit institutions is garnering the bulk if not darn near all of the attention? I find it quite difficult to comprehend giving internal debt relief to the banks who borrowed at up to 30 to 1 (reserves). It's like giving them more bullets with which to shoot themselves (and us) with. Where are the good thinkers?
peace
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mikel paul (11 articles, 1 quicklinks, 8 diaries, 457 comments)
on Friday, October 10, 2008 at 2:31:28 PM
Perhaps I missed something when I dropped out of school. It appears to Me that many of our problems aside from the private Federal Reserve is the fact that we use fiat money. According to the CONSTITUTION only silver and gold may be used as legal tender. I have doubts that we have any gold left in Fort Knox to issue gold coins. An audit of the Fed (never been done before) might give us some idea of the scope of looting that has taken place. It has been reported a cool trillion is "missing" at the Pentagon. Whether there exists enough silver in the US to coin real money is also in doubt.
With the level of betrayal we have suffered having our jobs moved offshore and our treasury looted at will by the present and past regimes, the looting of Social Security funds and selling off of US infrastructure and lands to the World Bank and other foreign interests, a looming carbon-tax brought on by a possibly non-existant global warming, the 1913 creation of the Fed it appears to many of us as a long-term plan to destroy the middle-class and join the burned-out hulk of our nation to a North American Union and the creation of a new "global" cashless society.
I know Mr. Roberts You do not believe the "conspiracy" theories that circulate. The 1st brigade of the 3rd infantry has just deployed on US soil to quell any "unrest". I feel Your suggestions for a solution fall very short and deny the obvious web of betrayal and criminal organizations that have reduced us to slaves since 1913. Hard money Mr. Roberts, HARD MONEY.
He who is not part of the solution is part of the problem.
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john riggs (0 articles, 0 quicklinks, 0 diaries, 440 comments)
on Friday, October 10, 2008 at 4:24:34 PM
Actually, the only reference to gold or silver in the Constitution restricts STATES from making anything but gold or silver coins from being legal tender. There's no such restriction on the Federal government.
Article I Section 10:
No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.
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Robert Knowles (0 articles, 0 quicklinks, 6 diaries, 59 comments)
on Friday, October 10, 2008 at 4:48:50 PM
You said a mouthful. Fiat You want,fiat You got. As Your savings and retirement dwindle away thank paper money and its manipulation. I personally am putting what I can save into metals.
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john riggs (0 articles, 0 quicklinks, 0 diaries, 440 comments)
on Saturday, October 11, 2008 at 7:25:00 AM
It was Dr. Paul Craig Roberts who posted this article, correct? Look then at the number of articles he's posted, thenplease take look at how many "Paul Roberts" has posted.
Is it me, or is Paul Roberts pretending to be Dr. Paul Craig Roberts?
Paul Roberts, if you are not thee Dr. Roberts, then I suggest you cease with this senseless charade of misinformation.
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Munich (0 articles, 74 quicklinks, 13 diaries, 914 comments)
on Friday, October 10, 2008 at 4:32:52 PM
You get an A. As you noticed, it is curious by the "0" articles attributed to PR, not P'C'R. Flag raised and an inquiry sent to Kall. It crossed my mind the dropping of 'Craig' from the comments. You went further and looked. Double scoop for you.
A good thinker you are Munich. We shall see.
peace
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mikel paul (11 articles, 1 quicklinks, 8 diaries, 457 comments)
on Friday, October 10, 2008 at 5:54:09 PM
The G7, bankers, etc. will keep on applying short-term bandaid fixes to the hemmoraging phony fonancial system, leading us into the abyss. They will pump billions of backed-by-nothing currency into the dying patient to stimulate it back to life for a short while, to fend off panic and keep their jobs aflioat. This is like feeding heroin to an addict; this solves nothing. The result of this delusiuonal charade will be, as history has shown us, hyper-inflation and deeper chaos.
If the system is scrapped and we go back to a gold standard, then we can expect a better world. Ron Paul is on the right track. The bankers and G7 are taking us for a ride on the Wring Way Expess into to the abyss. And the US taking over the banks is, as Thomas Jefferson said, a dissaster:
"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the Government at defiance. The issuing power should be taken from the banks and restored to the people to whom it properly belongs." –President Thomas Jefferson.
"If the American people ever allow private banks to control the issue of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered." –President Thomas Jefferson
"I wish it were possible to obtain a single amendment to our Constitution. I would be willing to depend on that alone for the reduction of the administration of our government to the genuine principles of its constitution; I mean an additional article, taking from the federal government the power to borrow money." –Thomas Jefferson
Dave
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Davaru (1 articles, 0 quicklinks, 0 diaries, 25 comments)
on Friday, October 10, 2008 at 5:02:32 PM
Solution not possible without addressing the money supply
A fractional reserve banking system based on fiat money appears to be capable of creating debt instruments faster than an economy can create real wealth. Add in credit card debt, stocks purchased on margin, and leveraged derivatives, and debt is pyramided relative to real assets.
True.And debt instruments (credit) circulate as money, meaning the money supply is inherently unstable.
Fractional reserve banking must be reined in by higher reserve requirements, rising over time perhaps to 100 percent. If banks were true financial intermediaries, they would not have money creating power, and the proliferation of debt relative to wealth would be reduced.
Nonsense.A reserve requirement of 100% implies no lending (zero credit).A bank then, could not make a profit.
The only way a "bank" could perform as a pure financial intermediary would be for it to charge a fee for storage of deposits and processing of checks and deposits (negative interest).If this is your suggestion, it would make more sense for Government to provide a public utility to do it, but it would not be a "bank", at least not in contemporary terms.
There are alternative monetary systems, though, where Government could perform a service such as you suggest, and inject or withdraw money from the system by direct spending and by taxation, keeping an essentially permanent money supply in balance with the economy. The advantage of such a money supply is that it would be far more stable than what exists now and would be incapable of a catastrophic deflationary collapse of credit, a collapse such as the one the banking system and Government are trying to stave off now.
There is NO solution to the problem we are experiencing now, regulatory or otherwise, except to directly address the inherently unstable nature of a credit based money supply. Regulation will NOT work because the profits to be made by issuing credit will always permit the issuers of credit to corrupt the lawmakers.
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Paul Rye (7 articles, 2 quicklinks, 17 diaries, 352 comments)
on Friday, October 10, 2008 at 9:50:11 PM
Paul Rye is incorrect that 100% reserves prevents banks from lending. Banks would lend on the basis of collateral. A borrower would sign over a real asset, gold or silver bullion, property, inventories, raw material, to cover the bank's loan. The collateral becomes an asset among the reserves on the banks' books against which the bank loans depositors' cash. If the loan is not repaid, the bank sells the asset and replenishes its deposits. This is the way a pawn shop functions. The collateral is worth more than the loan amount. This differs from a bank lending on the basis of a borrower's balance sheet and handing the borrower a new demand deposit or checking account created by the bank.
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paul roberts (0 articles, 0 quicklinks, 0 diaries, 31 comments)
on Saturday, October 11, 2008 at 4:34:55 PM
Last night I watched the PBS program NOW about the effect of the gas price rise on peoples financial problems. In essence it pointed out that lots of people moved to surburban housing developments. With relatively cheap gas prices they did not even consider the cost to commute to work in their decision to buy their dream home in suburbia. Cheap home loans were available to help them buy.
Suddenly and unexpectedly gas prices began to rise at a rate that caused their commute cost to rise by several hundred dollars a month and they found themselves going into debt. Credit cards were then used to cover their shortfall in their finances. Add the rise in food prices, home heating and airconditioning costs; and then the variable rate mortgage interest adjustment and people were quickly in very serious financial trouble.
With so many people suddenly in serious financial dificulty they had no choice but to cut back spending to bare necessity level to survive. For many they had insufficient margin to
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