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October 10, 2008 at 05:33:47

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A Solution?

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By Paul Craig Roberts (about the author)     Page 1 of 2 page(s)

opednews.com     Permalink

For OpEdNews: Paul Craig Roberts - Writer

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.

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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 (more...)
 

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Book Recommendations for "Banks Credit Crisis Depression"
Financial crisis and the great depression: a regime switching approach.: An article from: Journal of Money, Credit
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Number of pages: 28
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Have you mentioned this to Mike Roberts? by GLloyd Rowsey on Friday, Oct 10, 2008 at 9:10:27 AM
One thing you didn't mentioned ... by Mr M on Friday, Oct 10, 2008 at 9:13:38 AM
The Fed and "inexplicable" interest rate policies by Robert Knowles on Friday, Oct 10, 2008 at 10:40:29 AM
A solution by paul roberts on Friday, Oct 10, 2008 at 11:36:59 AM
Mr. PCR by mikel paul on Friday, Oct 10, 2008 at 11:51:23 AM
A Solution to the financial crisis by paul roberts on Friday, Oct 10, 2008 at 12:03:45 PM
Thank you Mr. Roberts by mikel paul on Friday, Oct 10, 2008 at 12:36:26 PM
3 questions to PCR about this proposal - by Richard Mynick on Friday, Oct 10, 2008 at 12:20:31 PM
A solution, yes by paul roberts on Friday, Oct 10, 2008 at 12:53:03 PM
No, I don't "prefer the huge cost of collapse" to trying to by Richard Mynick on Friday, Oct 10, 2008 at 1:31:43 PM
a solution, yes by paul roberts on Friday, Oct 10, 2008 at 2:02:42 PM
On one point, An understanding is requested... by mikel paul on Friday, Oct 10, 2008 at 2:31:28 PM
Mr. Roberts by john riggs on Friday, Oct 10, 2008 at 4:24:34 PM
Gold and Silver are only restrictions on States by Robert Knowles on Friday, Oct 10, 2008 at 4:48:50 PM
"there is no restriction" by john riggs on Saturday, Oct 11, 2008 at 7:25:00 AM
Can we clarify one thing here? by Munich on Friday, Oct 10, 2008 at 4:32:52 PM
Munich.... by mikel paul on Friday, Oct 10, 2008 at 5:54:09 PM
Hyper-inflation is on the way by Davaru on Friday, Oct 10, 2008 at 5:02:32 PM
Maybe some more tax cuts for the rich are the answer? by Charlie L on Friday, Oct 10, 2008 at 7:16:57 PM
Solution not possible without addressing the money supply by Paul Rye on Friday, Oct 10, 2008 at 9:50:11 PM
a solution, yes by paul roberts on Saturday, Oct 11, 2008 at 4:34:55 PM
A completely different viewpoint by Philip Pease on Saturday, Oct 11, 2008 at 11:37:51 AM

 
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