Sunday :: Jan 13, 2008

Why The Bush Economy Really Stinks


by Mary

Well, it's finally coming: the Bush recession.

George W Bush's Ownership Society built ontop of massive debt and risky financial packages has finally come to the edge of the cliff. Back in 2004, the current housing bubble was started at the behest of Alan Greenspan and the Bush administration. In February 2004, Alan Greenspan urged people to take advantage of the low interest rates and refinance their mortgages with adjustable rate mortgages.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.

At the same time Bush touted his plan for increasing homeownership for minorities and other lower income Americans, but as this contemporaneous report says, that for the buyers, the threat was that they could be victimized by predatory lending and would be unprepared to manage the risk.

When it comes right down to it, Bush's homeownership agenda -- that heartwarming face to the "ownership society" -- has all the downsides we've come to expect from the rest of Bush's economic agenda. Based on fuzzy research and unchecked assumptions? Check. Leaves millions of low-income Americans behind? Check. Pushes risk and debt on Americans? Check. "It's the same story with homeownership as it is with any other 'ownership society' program," says Crowley. "There's a lot of potential gain to be had, but you're also asking individuals to take on a lot of risk."

Yet, rather than increase regulations, the Bush administration and Mr. Greenspan turned a blind eye while companies like Countrywide invented new and more toxic mortgage offerings to sell expensive and risky loans to those who could least afford them. There should be no question that this bubble was created by those whose primary job should have been to guide and manage the economy, rather than use it to enrich the greedy and push all the risk on those least able to manage it. And now, we are finally seeing the chickens coming home to roost.

We are truly on the brink of a recession, the magnitude not known in our country in over 60 years. What's worse, because this isn't your normal recession, the standard tools (stimulus spending or tax cuts) for addressing a recession are not up to solving the problem. (emphasis mine)

In the current downturn, something more unsettling than a traditional swing in the business cycle appears to be at work: The United States has become increasingly prone to financial bubbles -- huge, seemingly irreversible rises in the value of one sort of asset or another, followed by sudden and largely unforeseen plunges.

What makes bubbles so dangerous is that their consequences, when they burst, are wider, often more damaging, and certainly more unpredictable than those of ordinary downturns.

"We are more prone to bubbles than we used to be," said John H. Makin, a former senior Treasury official with several Republican administrations and now a scholar with the conservative American Enterprise Institute in Washington.

"The old-fashioned recession, where the consumer ran out of gas or there was an economic policy mistake, doesn't seem to occur much anymore," said Alice M. Rivlin, a former vice chair of the Federal Reserve and Clinton administration budget director. "As we've seen from recent events, bubbles seem to be playing a bigger role."

Economists such as Rivlin and Makin do not necessarily oppose traditional stimulus proposals.

"When there's a flood, I'm not against throwing in sandbags," Makin said. "It's not going to solve the problem. It's not going to reverse it. It might mitigate it."

But the overriding requirement, they say, is that economists and policymakers need to develop ways to identify potential bubbles, discourage them from growing, and limit the economic carnage if they do.

Analysts trace the economy's growing propensity to develop bubbles to an unusual chain of events. Since the early 1980s, increasingly effective Fed policymaking, coupled with financial innovations such as the expansion of credit cards, home-equity loans and exotic security derivatives, helped shrink large-scale fluctuations in the economy in what economists call the Great Moderation.

Could we have predicted this bubble? Well, I remember reading this back in 2004:

So the most irresponsible central banker in the history of the world created the biggest bubble in the history of the world, which had disastrous consequences for the stock market and the economy. In order to ameliorate that, he has created bubble-like conditions and absurd financing schemes in real estate. Meanwhile, we've seen an enormous concentration of risk develop inside the financial system: We are down to just a handful of big banks and government-sponsored entities that are using his other favorite toy, derivatives, to theoretically manage away all their risks.

So how has that favorite toy of Greenspan done? As Jon Markman writes this week, one of the most knowledgeable experts on credit/derivatives, Satyajit Das believes that they are the reason we are now on the brink of "an epic bear market." (h/t Sideshow) The entire housing market built up under Bush have relied on leveraged debt which is the reason there is such a dangerous financial situation right now. (emphasis mine)

Rather than joining the crowd that blames the mess on American slobs who took on more mortgage debt than they could afford and have endangered the world by stiffing lenders, he points a finger at three parties: regulators who stood by as U.S. banks developed ingenious but dangerous ways of shifting trillions of dollars of credit risk off their balance sheets and into the hands of unsophisticated foreign investors; hedge and pension fund managers who gorged on high-yield debt instruments they didn't understand; and financial engineers who built towers of "securitized" debt with math models that were fundamentally flawed.

"Defaulting middle-class U.S. homeowners are blamed, but they are merely a pawn in the game," he says. "Those loans were invented so that hedge funds would have high-yield debt to buy."

...So if you follow the bouncing ball, borrowed money bought borrowed money. And then because they had the blessing of credit-ratings agencies relying on mathematical models suggesting that they would rarely default, these CDOs were in turn used as collateral to do more borrowing.

In this way, Das points out, credit risk moved from banks, where it was regulated and observable, to places where it was less regulated and difficult to identify.

...When you add it all up, according to Das' research, a single dollar of "real" capital supports $20 to $30 of loans. This spiral of borrowing on an increasingly thin base of real assets, writ large and in nearly infinite variety, ultimately created a world in which derivatives outstanding earlier this year stood at $485 trillion -- or eight times total global gross domestic product of $60 trillion.

...One of the wonders of leverage is that it amplifies losses on the way down just as it amplifies gains on the way up. The more an asset that is bought with borrowed money falls in value, the more you have to sell other stuff to fulfill the loan-to-value covenants. It's a vicious cycle. In this context, banks' objective was to prevent customers from selling their derivates at a discount because they would then have to mark down the value of all the other assets in the debt chain, an event that would lead to the need to make margin calls on customers already thin on cash.

So what caused this economic meltdown? Conservative ideology which always favors greed and wealth and disdains regulation as an unbearable crimp on the economy. This too is a legacy of Bush.

Mary :: 12:44 PM :: Comments (20) :: Digg It!