NYTimes: Saved by the Deficit?


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Saved by the Deficit?

by Robert B. Reich

BOTH presidential candidates have been criticized for failing — at Tuesday’s debate and previously — to name any promises or plans they’re going to have to scrap because of the bailout and the failing economy. That criticism is unwarranted. The assumption that we are about to have a rerun of 1993 — when Bill Clinton, newly installed as president, was forced to jettison much of his agenda because of a surging budget deficit — may well be mistaken.

No, it’s ridiculous! Cutting back is for times of excess aggregate demand – hardly the case today.

At first glance, January 2009 is starting to look a lot like January 1993. Then, the federal deficit was running at roughly $300 billion a year, or about 5 percent of gross domestic product, way too high for comfort.

Why?

By contrast, the deficit for the 2009 fiscal year is now projected to be $410 billion, or about 3.3 percent of gross domestic product. That’s not too worrying.

No number per se is worrying. It’s things like output, employment, and maybe inflation that are worrying.

But if the Treasury shovels out the full $700 billion of bailout money next year, the deficit could balloon to more than 6 percent of gross domestic product, the highest since 1983. And if the nation plunges into a deeper recession, with tax revenues dropping and domestic product shrinking, the deficit will be even larger as a proportion of the economy.

True, as a matter of accounting. But none of the above is symptomatic of excess aggregate demand.

Yet all is not what it seems. First, the $700 billion bailout is less like an additional government expense than a temporary loan or investment.

It’s an exchange of financial assets, much like the Fed does continuously, with no effect on demand.

The Treasury will take on Wall Street’s bad debts — mostly mortgage-backed securities for which there’s no market right now — and will raise the $700 billion by issuing additional government debt,

No, the government first pays for the mortgage securities and then offers Treasury securities (or now, interest-bearing reserves, which are functionally the same as Treasury securities) to support the overnight rate that the Fed’s target rate.

much of it to global lenders and foreign governments.

They exchange real goods and services for balances at the Fed because they want to. We then offer them alternative financial assets in the form of Treasury securities via an auction process that is bought at necessarily attractive levels.

As America’s housing stock regains value, as we all hope it will,

Yes, deep down we all hope for ‘inflation’…

bad debts become better debts, and the Treasury will be able to resell the securities for at least as much as it paid, if not for a profit.

And that would drain aggregate demand and be contradictionary, just like a tax.

And if there is a shortfall, the bailout bill allows the president to impose a fee on Wall Street to fill it.

Also draining aggregate demand.

Another difference is that in 1993, the nation was emerging from a recession.

Yes, because the deficit was allowed to get up to 5% of GDP.

Government deficit = Non-government accumulation of net financial assets, etc.

Although jobs were slow to return, factory orders were up and the economy was growing. This meant growing demand for private capital.

If so, loans create deposits: loanable funds went out with the gold standard.

Under these circumstances, the deficit Bill Clinton inherited threatened to overheat the economy.

I don’t recall any evidence of an overheating economy back then?

He had no choice but to trim it, a point that the Federal Reserve chairman, Alan Greenspan, was not reluctant to emphasize. Unless President Clinton cut the deficit and abandoned much of his agenda, interest rates would rise and the economic recovery would be anemic.

Interest rates would rise only if Greenspan, not market forces, raised them, which he may have threatened to do.

Next year, however, is likely to be quite different. All economic indicators are now pointing toward a deepening recession. Unemployment is already high, and the trend is not encouraging. Factory orders are down. Worried about their jobs and rising costs of fuel, food and health insurance, middle-class Americans are unable or unwilling to spend on much other than necessities.

Under these circumstances, deficit spending is not unwelcome. Indeed, as spender of last resort, the government will probably have to run deficits to keep the economy going anywhere near capacity, a lesson the nation learned when mobilization for World War II finally lifted us out of the Great Depression.

Agreed!!!

Finally, not all deficits are equal. As every family knows, going into debt in order to send a child to college is fundamentally different from going into debt to take an ocean cruise. Deficits that finance investments in the nation’s future are not the same as deficits that maintain the current standard of living.

Agreed!

Here again, there’s marked difference between 1993 and 2009. Then, some of our highways, bridges, levees and transit systems needed repair. Today, they are crumbling. In 1993, some of our children were in classrooms too crowded to learn in, and some districts were shutting preschool and after-school programs. Today, such inadequacies are endemic.

Yes, trillions of USD could be spent on infrastructure. But the key to ‘affordability’ at the macro level is unemployment and excess capital in general.

In 1993, some 35 million Americans had no health insurance and millions more were barely able to afford it. Today, 50 million are without insurance, and a large swath of the middle class is barely holding on.

Insurance is an entirely different issue than whether people are getting health care or not. He should make that point and then address the real issue (distribution of health care and other real goods and services) and not miss the financial for the real issues.

In 1993, climate change was a problem. Now, it’s an emergency.

Moreover, without adequate public investment, the vast majority of Americans will be condemned to a lower standard of living for themselves and their children. The top 1 percent now takes home about 20 percent of total national income. As recently as 1980, it took home 8 percent. Although the economy has grown considerably since 1980, the middle class’s share has shrunk. That’s a problem not just because it strikes so many as being unfair, but also because it’s starting to limit the capacity of most Americans to buy the goods and services we produce without going deep into debt.

That’s because incomes are too low, the largest taxes are the regressive payroll deductions, and the deficit is too small.

Time for a payroll tax holiday.

The last time the top 1 percent took home 20 percent of national income, not incidentally, was 1928.

Good statistic!

Perhaps it should not be surprising, then, that the Wall Street bailout has generated so much anger among middle-class Americans. Let’s not compound the problem by needlessly letting it prevent the government from spending what it must to lift the prospects of Main Street.

Agreed, but not by writing this type of thing.

Feel free to distribute.

Robert B. Reich, a secretary of labor under President Bill Clinton and a professor at the University of California, Berkeley, is the author of “Supercapitalism.”


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Here we go…


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Giving them a quantity target rather than a price target can mean overpaying to meet their mandated buying requirements.

This is a direct fiscal transfer to the sellers of the ‘overpriced’ securities without the compensation or equity costs associated with the TARP.

Fannie, Freddie to Buy $40 Billion a Month of Troubled Assets

by Dawn Kopecki

Oct. 11 (Bloomberg) — Federal regulators directed Fannie Mae and Freddie Mac to start purchasing $40 billion a month of underperforming mortgage bonds as the Bush administration expands its options to buy troubled financial assets and resuscitate the U.S. economy, according to three people briefed about the plan.

Fannie and Freddie began notifying bond traders last week that each company needs to buy $20 billion a month in mostly subprime, Alt-A and non-performing prime mortgage securities, according to the people, who asked not to be identified because the plans are confidential. The purchases would be separate from the U.S. Treasury’s $700 billion Troubled Asset Relief Program.

The Federal Housing Finance Agency, which placed the two companies in conservatorship on Sept. 7, directed them last month to start increasing their purchases of loans and mortgage-backed securities as the Treasury seeks to absorb underperforming and illiquid assets from financial companies.

“For now, they’re under conservatorship and they have to be used to keep the flow of capital going to the housing market,” former Treasury Secretary Lawrence Summers said in an interview on Bloomberg Television’s “Conversations with Judy Woodruff.” “They’re important to maintaining the flow of government finance” and need to be used actively, he said.

Adding underperforming assets to Fannie and Freddie’s combined $1.52 trillion mortgage portfolios would come at a time when the two mortgage-finance companies already hold as much as $210 billion of bad debt that may be eligible itself for the Treasury’s relief program, their regulator said Oct. 5.

A spokesman for Washington-based Fannie, Brian Faith, and Doug Duvall at McLean, Virginia-based Freddie wouldn’t comment.

Overall Goal

Neither Fannie nor Freddie has turned a profit in the past year, accumulating $14.9 billion in combined quarterly losses, largely related to bad subprime and Alt-A mortgage assets.

FHFA spokeswoman Stefanie Mullin declined to comment on the details of the program. Treasury spokeswoman Jennifer Zuccarelli wasn’t immediately available to comment.

“The overall goal of the program will be to contribute greater stability and liquidity in the mortgage market, which should enhance consumers’ access to mortgage financing and ultimately result in reduced mortgage interest rates,” FHFA Director James Lockhart said in a Sept. 19 statement.

Hard to see how it would move that needle by more than a very small amount.

Subprime loans were given to borrowers with poor or limited credit records or high debt burdens. Alt-A loans were made to borrowers who wanted atypical terms such as proof-of-income waivers, without sufficient compensating attributes. About 35 percent of subprime loans in non-agency mortgage securities are at least 60 days late, while 15 percent of Alt-A loans are, according to a Sept. 9 report by FTN Financial Capital Markets.

Growth

Non-agency, or private-label, bonds are issued by banks and don’t carry guarantees by Fannie, Freddie or government-agency Ginnie Mae. Freddie held about $207 billion in non-agency debt in its $760.9 billion portfolio as of August, according to its latest monthly volume summary. Fannie had about $104 billion of such securities in its $759.9 billion portfolio in August.

Regulators initially restricted Fannie and Freddie’s growth when they seized control of the government-sponsored enterprises Sept. 7. To “promote stability” and lower mortgage costs to borrowers, Treasury Secretary Henry Paulson said the two would be allowed to “modestly increase” their mortgage portfolios to as much as $1.7 trillion through the end of next year and said they would no longer be run “to maximize shareholder returns.”

Less than two weeks later, Fannie and Freddie were told to ramp up their mortgage bond purchases as the financial crisis deepened and credit activity came to near standstill.

Fannie and Freddie which own or guarantee almost half of the $12 trillion U.S. home loan market, were given access to $200 billion in emergency Treasury financing as part of their rescue package. The companies may also be able to sell their bad debt to the Treasury through its $700 billion financial-rescue program signed into law Oct. 3.

FHFA has said the companies plan to release third-quarter results next month as scheduled. Analysts surveyed by Bloomberg project losses for both Fannie and Freddie at least through 2009.


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Fiscal Multipliers


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Payroll tax holiday right up there for a tax cut!

Fiscal economic bank for the buck
One year $ change in real GDP for a given $ reduction in federal tax revenue or increase in spending

Tax cuts
Non-refundable lump sum tax rebate 1.02
Refundable lump sum tax rebate 1.26
Temporary tax cuts
Payroll tax holiday 1.29
Across the board tax cut 1.03
Accelerated depreciation 0.27
Permanent tax cuts
Extend alternative minimum tax patch 0.48
Make Bush Income Tax Cuts permanent 0.29
Make Dividend and Capital Gains tax cuts permanent 0.37
Cut in corporate tax rate 0.30
Spending increases
Extending UI benefits 1.64
Temporary increase in food stamps 1.73
General aid to state governments 1.36
Increased infrastructure spending 1.59
Source: Moody’s Economy.com


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Germany to insure all bank deposits?


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(an email exchange)

Right,

If everyone in Germany tries to take their funds out of the banks they won’t get it, with or without the backing of the German government.

German government insurance can buy them some time, maybe even enough time to make it through if aggregate demand wasn’t falling off so fast.

In the U.S., U.K., Japan and any nation with its own currency and fiscal authority behind the deposit insurance you can get all the funds you want on demand.


>   Finally, the Germans seem to get it. This might be the best news of the
>   weekend. But they need to take the final step. Problem is there
>   is no EU treasury or debt union to back up the single currency.
>   The ECB is not allowed to launch bail-outs by EU law.

>   Each country must save its own skin, yet none has full control of
>   the policy instruments. How do they change this in a hurry?

With great difficulty!

Germany draws up contingency plans for state rescue of banks

By Bertrand Benoit

The German government was last night drawing up a multi-billion euro contingency plan to shore up its banking system, which could see the state guarantee interbank lending in the country and inject capital in its largest banks.

The contingency draft, closely modelled on the British initiative announced this week, marks a dramatic political U-turn for Europe’s largest economy after Angela Merkel, chancellor, and Peer Steinbrück, finance minister, both ruled out a sector-wide state rescue for banks this week.

A senior government official said Ms Merkel and Mr Steinbrück would decide on Sunday which of the measures to implement after consultation with their European partners. Once a political decision was made, he said, the plan could be implemented in the following days.

“We are considering all the options at present to the exception of a massive state acquisition of toxic assets,” the official said. “Whatever we do will be done in close co-operation with our G7 and European partners.”

France announced last night that it was planning an emergency European Union summit tomorrow.

Speaking in Washington ahead of a meeting of Group of Seven finance ministers, Mr Steinbrück said the time had now come for “a systemic solution . . . I am convinced that case-by-case solutions are no longer helping. They are now exhausted.”

The official said Ms Merkel was in daily contact with Nicolas Sarkozy, French president, suggesting that the plan, if approved, could be launched as a joint initiative.

Ulrich Wilhelm, the government spokesman, said: “It is the duty of the federal government to be prepared and to review all options . . . As of now, no political decision has been made.”

Under the draft, Germany could issue a state guarantee for interbank lending worth more than €100bn and provide direct lending to the banking sector. Berlin is also contemplating offering several dozen billion euros of capital to the banks in exchange for equity and may take entire ownership of some institutions.

As an additional option, the government is considering extending the blanket guarantee it issued last Sunday for account deposits to money market funds, which have experienced a steep outflow of savings lately. Fund managers have had to divest considerable quantities of assets to cover the withdrawals.

Bankers said the interbank lending market in Germany had reached near-gridlock.


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