The Center of the Universe

St Croix, United States Virgin Islands

MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

the mortgage foreclosure mess- just another financial crisis

Posted by WARREN MOSLER on October 18th, 2010

The latest mortgage foreclosure mess is just another financial crisis.

It’s not a real economic crisis- no houses have been actually destroyed- no fire, hurricane, or earthquake damage, etc.

So the responses aren’t about bulldozers, hammers, concrete pouring, etc.

The question is whether this financial discovery/event spills over into the real economy.

The question is, are the authorities standing by with policy responses as needed to make sure people can still go to work to grow food and eat it, build houses and live in them, make shoes and wear them, go to hospitals and take care of sick people, go to schools and teach classes, maintain the infrastructure, do cancer research, etc. etc. etc?

Of course not. And therefore it all might again needlessly/tragically spill over to the real sector.

Just like in August 2008, we might again let a financial crisis spill over into the real economy and make today’s still very bad economy even worse.

As I said then, yes, it’s critically important to identify and punish the bad guys with a vengeance, alter incentives that support fraud, etc. etc. etc.

And it’s even more important to not let the financial crisis spill over into the real economy by letting aggregate demand fall, sales collapse, and jobs get lost.

And now, as then, interest rate cuts and just about anything else the Fed might do aren’t going to do the trick, and, then as now, will probably just make it worse.

Now, as then, as always, an immediate fiscal adjustment IS the silver bullet that restores demand.

Now, as then, a full payroll tax (FICA) suspension will immediately work to restore private sector aggregate demand, sales, and jobs. For the most part, private sector jobs are a function of sales, directly or indirectly. Capitalism is driven by sales. Businesses large and small compete for consumer dollars. But here has to be consumer dollars to compete for.

Public infrastructure spending works as well, but takes a while, so the answer is to do both. Suspend FICA taxes and put in place desired infrastructure project funding, presumably in a well thought out basis with an eye to efficiency, and not in a blind rush to support aggregate demand.

So why is our government not standing by to suspend FICA taxes?
Why haven’t they already done it?

Especially as It’s a highly regressive punishing tax on the people we need most and the people who are hurting the most- the people actually working for a living who produce all the real goods and services that support our existence.

Yes, it’s the first deadly innocent fraud at work- government thinks it needs those FICA revenues to be able to make Social Security payments.

Our Federal government officials do not understand the function of federal taxes is to regulate the economy, and not to raise revenue.

The don’t understand the function of federal taxes is to take dollars away from us, and not to give them what they need to spend.
Their first clue should be that if we were to pay our taxes with old $20 bills they’d give us a receipt and then shred them. But it isn’t.
(And removing what’s restricting aggregate demand is not getting something for nothing.)

Instead, the deficit terrorists are firmly in control.

The best we can expect is for them not to raise taxes at year end when the tax cuts expire. There is no talk of lowering taxes, under any circumstances.

Even from the media’s ‘deficit doves’ who remain THE problem, agreeing that the ‘long term deficits’ is a problem, pointing to interest rates as evidence markets currently are willing to fund deficit spending, and talking about how austerity now is not the way to bring down deficits longer term- in general, flagrantly violating ‘Lerner’s Law’ and conceding the principle to the deficit hawks.

So will this latest mortgage crisis hurt the real economy?
Probably not, best I can tell. Looks more to me like it’s a potential transfer of dollars from banks and lenders with no propensity to spend to borrowers with high propensity to spend.

But I could easily be wrong. There is the risk that events could result in a further cutback in credit to the real economy.

And while this potential drop in aggregate demand is easily offset by a simple fiscal response, the odds our current gaggle of regulators and elected officials getting it right with an appropriate fiscal response seem slim and none.

50 Responses to “the mortgage foreclosure mess- just another financial crisis”

  1. djp Says:

    I have been a long time reader, and have found many clear answers and ideas reading about MMT.

    Please tell me you’re being facetious when you write:
    “Looks more to me like it’s a potential transfer of dollars from banks and lenders with no propensity to spend to borrowers with high propensity to spend.”

    If that’s really an idea for stoking aggregate demand, why don’t we just pool all net financial assets — those book-keeping entries — and just randomly redistribute them, certainly on average the new owners will be more likely to spend. But I think I’m on pretty solid ground stating that this would be disastrous for the economy, even though the net financial assets are left unchanged. How is forgiving mtg debt much different ? (except in degree)

    Reply

    WARREN MOSLER Reply:

    It’s not a proposal, just what I see as a potential outcome which will effect the economy.

    And yes, debt forgiveness is much the same thing.

    Reply

    RSG Reply:

    djp, have to agree with you on this….can’t see how crippling the banking system could be good for aggregate demand, particularly as it would put a halt to mortgage lending…so much for the hand-off to private credit extention.

    Reply

  2. Kristjan Says:

    Tulip mania was also a financial crises and not a crises involving real economy? Is It possible at all to malinvest? Should the government have stepped in to make investments in tulips profitable?

    Reply

    Tom Hickey Reply:

    Houses are tulips?

    Reply

    WARREN MOSLER Reply:

    no, just sustain agg demand as needed. usually that means after the crash.

    Reply

  3. Kristjan Says:

    No they are not Tom. I just wanna know how MMT deals with these fundamental issues. I am sure the tulips were worth something after the buble burst. There is an analogy with houses here. The houses might not be worth what the market paid for them once.
    Are there ever structural imbalances according to MMT?

    Reply

    Tom Hickey Reply:

    According to MMT, economics is about the production, distribution, and consumption of real resources. Distribution happens in markets, where production (supply) and consumption (demand) intersect at price points. Prices are nominal and in aggregate depend on nominal aggregate demand, which is income driven. Income is either present, past (savings) or future (credit). Potential supply responds to effective demand, therefor income present, past or future. People with funds to spend decide on what to spend it. That decides ultimately what is supplied. Productive investment creates supply that is demanded, and malinvestment does not, therefore is underperforming and eventually goes bust unless subsidized.

    All this shows up in the sectoral balances, government, households, firms, and external. MMT as a macro theory is chiefly concerned with these balances. It’s policy goal is optimal capacity utilization, full employment and price stability, with economic growth proportional with population growth.

    As a macro theory MMT is not concerned with the behavior of individual markets like housing. However, most (all?) MMT’ers are Minskians, hence, aware of the financial instability hypothesis and the long financial cycle that ends in Ponzi finance. They are also aware of the danger of debt deflation as pointed out by Irving Fisher. So their chief concern with housing is not with housing values but with the potential for debt deflation arising from mortgage default due to falling incomes. In this sense it is no matter whether the debt is from housing or tulips, the effect of leverage that cannot be serviced is the same on the financial system, and problems with the financial system spill over into the real economy, affecting production (output), distribution (prices) and consumption (incomes).

    The difference between houses and tulips is in utility. A society can do without enough tulips but not without enough housing to go around. Supporting tulips by subsidizing incomes would not further public purpose but subsidizing incomes to prevent a collapse of the housing market, and the financial sector along with it, would serve public purpose.

    The point is not to support housing prices per se but to prevent a debt deflation by assisting people to service their mortgages, either through relief of debt, like permitting cram downs, or subsidizing incomes through fiscal stimulus.

    The Fed’s QE action to flatten the yield curve may support the housing market with low mortgage rates and stave off a collapse, but it cannot bolster incomes for servicing debt to prevent default and foreclosure, which harms both the former homeowners and the creditors. According to MMT, fiscal stimulus is necessary for that.

    Structurally, the housing market was overbuilt at the high end and that is going to take time to sort out through the markets as credit contracts for some time.

    Reply

    ESM Reply:

    “The difference between houses and tulips is in utility. A society can do without enough tulips but not without enough housing to go around. Supporting tulips by subsidizing incomes would not further public purpose but subsidizing incomes to prevent a collapse of the housing market, and the financial sector along with it, would serve public purpose.”

    Ah, the arrogance of a central planner is shining through. Are you really sure that houses are more important than tulips, or is it just that houses represent a much larger fraction of our GDP than tulips? You might actually get more bang for your buck bailing out debt-burdened tulip investors. And no, I don’t agree that a society can do without enough tulips. I suppose that zero tulips may be enough, though. It’s also possible that zero 5,000 square foot homes in the desert is enough too.

    Reply

    zanon Reply:

    the arrogance of central planner is actually the least revolting of toms hickeys arrogances.

    i think big difference is between asset bubble and credit bubble.

    .com bubble was asset. it bursting was not huge deal. i do not know how people financed tulip bubble, it would be asset or credit. housing was credit bubble, it bursting is huge deal.

    so, issue is not “utility” as arrogant tom hickey says, it is whether bubble is caused by bank making loan that will not get pay back (credit) or by people buying asset (asset).

    WARREN MOSLER Reply:

    back to the govt being responsible for public infrastructure for public purpose and markets left to areas where expressions of individual value are desirable.

    (see Pirsig’s ‘Lila’)

    Winslow R. Reply:

    Both of you make the point that politics are needed to resolve disagreements regarding public purpose.

    MMT provides an economic framework for discussing those disagreements.

    Thankfully, neither of you are saying government checks will bounce.

    Tom Hickey Reply:

    ESM, my thinking here is that in the tulip bubble there was no obvious public need to sustain the tulip industry (unless it was a core national industry at the time) whereas it is necessary for the US to sustain automobile manufacturing, housing and finance as core national industries. I don’t see claiming that core national assets need to be restructured rather than liquidated as malinvestment as being “central planning.” Of course, the tulip industry in Holland may have been comparable at time to housing, heavy manufacturing, and finance in the US now, in which case it would not be prudent for the government to allow it collapse to liquidate malinvestment, thereby causing mass unemployment and widespread economic and social hardship.

    WARREN MOSLER Reply:

    And for me, I’m also most concerned with how to keep a bursting bubble form spilling over to the real economy, real output, and unemployment.

    No reason to let a bunch of spread sheet entries, lender and borrower fraud, etc. etc. keep us from provisioning ourselves with real goods and services

    Reply

  4. Charles Yaker Says:

    Looks like the Frence don’t get it either raising Retirment age from 60 to 62. Only in France the citizens have taken to the streets.

    Reply

    ESM Reply:

    What’s wrong with raising the retirement age? We should be doing that here too. A 60 year old worker today is probably the equivalent of a 50 year old worker half a century ago in terms of health and vigor. Not only is nutrition and medical care better, but most jobs aren’t as physical demanding as they used to be. And in France, they only work 35 hours per week and take 5 weeks of vacation per year.

    In the US, we should lock-in everybody 60 years or older at the retirement age prevailing when they reach the age of 60. For everybody else, the retirement age should rise at the rate of 2 months every year. So if you’re 60 now, you’ll get full SS benefits when you turn 65 years old. If you’re 55 now, you’ll get full SS benefits when you turn 65 years, 10 months old.

    Reply

    Winslow R. Reply:

    Again a difference in politics.

    At least you’re not saying we can’t afford to have people over 60 retire because their retirement checks would bounce.

    Reply

    Winslow R. Reply:

    Interesting video of French youth protesting 60 year olds taking jobs.

    http://www.youtube.com/watch?v=islpsqqb06c&feature=player_embedded

    Winslow R. Reply:

    I should add, in theory France could have government checks bounce since they don’t directly control the creation of their currency.

    Tom Hickey Reply:

    ESM, a lot of blue collar workers work hard physically in demanding and dangerous jobs, and they are ready to be replaced at about age 60. There could be testing for job type, here, with white collar workers retiring later.

    Reply

    Jim Baird Reply:

    It’s not just blue collar workers. I work in the computer field, and I sometimes wonder if I will even make it to 60 in my career. If you are in a purely technical role, most companies are not much interested in hiring anyone over 40. Unless I change careers or move up into management, I can foresee finding myself out of a job at 50 with no prospects of finding another.

    WARREN MOSLER Reply:

    in a good economy there’s a continuous labor shortage with all available labor in demand

    ESM Reply:

    Well, if there is an externality in a particular job, then the employer and employee should have to pay for it somehow. That’s part of the problem with having these social welfare programs. They create externalities which wouldn’t exist in the absence of such programs. If coal miners have to retire at age 50 and be supported by the government for 25 years, doesn’t it make sense to build that into the price of coal? But wouldn’t it get built into the price of coal automatically if there were no government support system to take advantage of?

    This is why illegal immigration has become such a mess. Illegal immigrants come here to do work for $5 per hour that poor Americans won’t do for $5 per hour, but the illegals get various family benefits worth up to $40K per year (free education, free health care, food and housing assistance programs), which poor Americans get already.

    Anyway, my basic point is that social welfare programs should be revamped as safety nets; they should not be sinecures. People who genuinely need help should get it, but those who are capable of working should be encouraged to do so. And the way to do that is pare down the benefits to make them less attractive and drastically lower the income tax to make work more attractive. Perhaps we can have a wage tax which goes down the older you get, and actually becomes negative when you hit age 60.

    WARREN MOSLER Reply:

    illegal immigration has been a form of corporate welfare.

    ESM Reply:

    Jim, if we had a government which understood MMT, there would be plenty of jobs for people who were willing and able to work, no matter what their age. Of course, you might be alluding to a different phenomenon, which could be stated this way: as a person gets older, his productivity drops, but his opportunity cost rises. When you’re young, you might be able to produce $50 per hour, but you only value your excess leisure time at $20 per hour. Therefore you have your pick of jobs. When you’re old, you might be able to produce only $25 per hour, but you value your excess leisure time at $30 per hour. Now, there are no jobs that make sense (except working for the government!). That’s a problem, but a negative wage tax might help.

    Tom Hickey Reply:

    Well, if there is an externality in a particular job, then the employer and employee should have to pay for it somehow. That’s part of the problem with having these social welfare programs. They create externalities which wouldn’t exist in the absence of such programs. If coal miners have to retire at age 50 and be supported by the government for 25 years, doesn’t it make sense to build that into the price of coal? But wouldn’t it get built into the price of coal automatically if there were no government support system to take advantage of?

    How would you get the mine owners to distribute the gains from true price equitably in terms of worker safety, wages, and pensions through the market. Or do you see the need for legislation, regulation, and oversight for this?

    Matt Franko Reply:

    ESM,
    Ive always thought that we should come up with more ways to keep our seniors involved in the workforce, but I also agree with Tom that their roles might have to change as we all do pay a physical/mental toll over time. I think the Job Guaranty might help in this regard also.

    Resp,

    PS Any thoughts on the FRBNY now suing BofA? I thought all of this could not get any more absurd, but now this is indeed a new low…

    Reply

    ESM Reply:

    I don’t think the Fed is directly suing BofA over bad mortgage loans. In fact nobody is at this point. Bondholders are forming voting blocs (you need 25% of the voting rights in a deal) to either ask the lazy, good-for-nothing, obstructionist trustees to force the underwriters to buy back defective loans out of securitized deals or to bypass the trustees and do it themselves.

    My guess is the Fed didn’t even make the decision to join the bondholder bloc itself. Blackrock, which is managing the Maiden Lane portfolios (the legacy Bear Stearns and AIG toxic waste) for the Fed, is probably making the call.

    This is going to cost the banks, particularly BofA, a pretty penny. Estimates run as high as $80B, although it will be spread out over many, many years. I think BofA’s purchase of Countrywide may be the worst takeover in the history of the Milky Way galaxy, surpassing even Wachovia’s purchase of Golden State.

    WARREN MOSLER Reply:

    the real questions are:

    do we want people to work longer?

    at what age do we want to make sure there is a ‘safety net’ of an income not connected to work?

    These are not simple matters.

    Reply

    ESM Reply:

    Well, at the very least, I don’t think we should discourage people from working beyond some age. Doesn’t the SS system do that? Doesn’t some portion of your benefits get taxed if you have earned income after retirement?

    Also, I believe that there is a consensus in the medical community that people who continue to work after the retirement age live longer than people who don’t, even after adjusting for the obvious selection bias. While not dispositive, that’s certainly a point in favor of encouraging seniors to work.

    WARREN MOSLER Reply:

    yes, best not to reduce benefits for people who continue to work.

    it’s mostly that way, but still some negative incentives remaining that I’d eliminate

    Tom Hickey Reply:

    do we want people to work longer?

    This is an impending problem. The baby boomers have skewed the economy at every stage of the passages of life. They will also as they retire. If the retirement age is extended and they have to work longer, this is going to seriously crowd out jobs for the less numerous generations following them, as well as postpone advancement on their career tracks.

    WARREN MOSLER Reply:

    which means taxes can be even lower!

    ESM Reply:

    “… this is going to seriously crowd out jobs for the less numerous generations following them…”

    I believe that the idea of job crowding out is a fallacy akin to the idea of investment crowding out. If there are not enough jobs, then it is a problem of too little aggregate demand, not too many workers.

    WARREN MOSLER Reply:

    right- taxes can be even lower!

    zanon Reply:

    ESM: In the abstract what you say may be true, but in US you go onto SS which is automatic stabalizer. So, if people encourage to retire, say by temporarily lowering SS age, then you will see boost to automatic stabalizer and AD.

    It is like imports — they are AD leak and there are far better ways to get AD back up but as 4th or 5th best solution banning imports would help AD overall.

    WARREN MOSLER Reply:

    better to not have incentives not to work.

    working = more useful output, lower health costs, etc. etc.

    Tom Hickey Reply:

    That is true, but no one realizes it, so nothing will be done about it, and the younger people will indeed be crowded out by people who would have retired but are working longer to make ends meet, even people that are on SS because their nest eggs have been halved.

    zanon Reply:

    when SS is “bankrupt” then it is of course suicide to push more people into system.

    And if SS is not bankrupt because you can print money, why does Obama not lower taxes instead of just channeling money to be recycled into democratic votes and contributions?

    i am being sarcasm of course

  5. Kristjan Says:

    “The difference between houses and tulips is in utility. A society can do without enough tulips but not without enough housing to go around.”

    Here you are making assumtions that are based on your own judgement. Housing sector can be overbuilt and there could be too many tulips around. Both have economic value. This is like central planning where some government official decides what has utility for the society.

    “So their chief concern with housing is not with housing values but with the potential for debt deflation arising from mortgage default due to falling incomes. In this sense it is no matter whether the debt is from housing or tulips, the effect of leverage that cannot be serviced is the same on the financial system”

    Good point

    “and problems with the financial system spill over into the real economy, affecting production (output), distribution (prices) and consumption (incomes)”

    The same with tulips. Theory is exactly the same.

    When MMTers say that It’s only a financial problem and don’t let It spill over to real economy-don’t they ever think that all this financial transactions merely reflect the allocation of resources in real economy. Obviously the choice to allocate the resorces in such a way was not the best one.

    I read Bill Mitchell blog recently and he is saying that there is not crises severe enough that deficit spending cannot take care of It. Including tulips as I understand.

    “Looks like the Frence don’t get it either raising Retirment age from 60 to 62. Only in France the citizens have taken to the streets.”

    Deficit spending cannot compensate for aging population.

    Reply

    Tom Hickey Reply:

    Deficit spending cannot compensate for aging population.

    Bill and other MMT’ers point out that deficit spending cannot compensate for real resource deficiency. If the aging population would require real resources that are not available, then deficit spending cannot acquire them, although it might be used for public investment to secure them if resources could be developed, but the private sector is unwilling or unable to do so.

    Reply

    Tom Hickey Reply:

    If tulips were highly leveraged, yes. Debts are contracts that created obligations that must be repaid, restructured, or defaulted on, regardless of what is involved. A lot of existing credit card debt was used to purchase “tulips,” for instance.

    Reply

    Tom Hickey Reply:

    When MMTers say that It’s only a financial problem and don’t let It spill over to real economy-don’t they ever think that all this financial transactions merely reflect the allocation of resources in real economy. Obviously the choice to allocate the resorces in such a way was not the best one.

    Given the choice between summarily liquidating malinvestment at the risk of debt deflation and providing sufficient demand to support incomes necessary to service debt and save to rebuild balance sheets, MMT chooses the latter.

    Reply

    zanon Reply:

    Toms:

    You are correct in what you say in this block. Good explanation

    Reply

    Tom Hickey Reply:

    Thanks, Zanon.

  6. Winslow R. Says:

    “Deficit spending cannot compensate for aging population.”

    Huh?

    Reply

  7. Kristjan Says:

    “Given the choice between summarily liquidating malinvestment at the risk of debt deflation and providing sufficient demand to support incomes necessary to service debt and save to rebuild balance sheets, MMT chooses the latter.”

    Always? Hundreds of greenhouses growing tulips?

    Reply

    Zanon Reply:

    Always

    Ppl do not need to stand around idle while extra greenhouse is pull down

    If asset bubble no problem. If credit bubble, recapitalize sector fairly so nominal problem does not become real problem and you do not lose real output, even as you write off past real malinvestment

    Reply

    Jim Baird Reply:

    We had 4 years of the biggest “malinvestment” in history during WWII when about half of the productive capacity in the country was used to build useless stuff to be sent off to be blown up. Was it then rational that all the workers in war industries should laid off until we could “work off the bad investments”, or should they instead have been converted over to civilian uses, as was done?

    Reply

  8. Symmetry Capital Management, LLC » Foreclosure Update Says:

    [...] tips are due, but unfortunately, I forgot to note them. Most are via Warren Mosler’s blog post linked [...]

Leave a Reply

XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>