March 31, 2009
The New Normal?
In a new article, economist James Galbraith of the University of Texas raises a troubling question: what if the fundamental assumptions guiding the Obama administration’s response to the recession are too optimistic?
Galbraith says that a bedrock belief of modern economists is that “the economy is a self-stabilizing system” that always will right itself in the long run. A key question in a recession, then, is what, if anything, policymakers can expedite a return to normal levels of growth. This, in fact, has been the experience of the American economy since World War II. But what if this time is different? Argues Galbraith:
The Bush-era disasters guarantee that these happy patterns will not be repeated. For the first time since the 1930s, millions of American households are financially ruined. Families that two years ago enjoyed wealth in stocks and in their homes now have neither. Their 401(k)s have fallen by half, their mortgages are a burden, and their homes are an albatross. For many the best strategy is to mail the keys to the bank. This practically assures that excess supply and collapsed prices in housing will continue for years. Apart from cash—protected by deposit insurance and now desperately being conserved—the American middle class finds today that its major source of wealth is the implicit value of Social Security and Medicare—illiquid and intangible but real and inalienable in a way that home and equity values are not. And so it will remain, as long as future benefits are not cut.
In addition, some of the biggest banks are bust, almost for certain. Having abandoned prudent risk management in a climate of regulatory negligence and complicity under Bush, these banks participated gleefully in a poisonous game of abusive mortgage originations followed by rounds of pass-the-bad-penny-to-the-greater-fool. But they could not pass them all. And when in August 2007 the music stopped, banks discovered that the markets for their toxic-mortgage-backed securities had collapsed, and found themselves insolvent. Only a dogged political refusal to admit this has since kept the banks from being taken into receivership by the Federal Deposit Insurance Corporation—something the FDIC has the power to do, and has done as recently as last year with IndyMac in California.
This confluence of factors, writes Galbraith, means that a short-term rebound is unlikely. Rather a varierty of steps — steps which Galbraith describes in great detail — must be taken to strengthen the American economy over the long-term. And the time to start taking those steps is now. Concludes the article:
A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.
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3 Comments Add yours »
The banks were being directed by the government to make risky loans to low income people. It is rediculous that some idiots in this world believe the housing problem was caused by not having enough government involved in the market.
interesting article in WSJ about the difference of opinion about defining a ‘depression’. The article says an indicator might be unemployment of over 10% for several years. Well guess what North Carolina, we are already there!
James K. Gailbrath’s nails it in his book “The Predator State: How Conservatives Abandoned The Free Market And Why Liberals Should Too.” He was on Democracy Now last week discussing his article “The New Normal”. Its too bad Raleigh Community TV doesnt carry this show.