The economy is at an epochal inflection that presents critical questions about what will fuel growth in the future. We’ve used the expansion of debt — both consumer and business — for the past 50 years to help fuel growth in consumption and production. The past 10 years simply were a super-charging of the debt bubble, with housing values, inexpensive equity and enthusiastic consumption helping to drive the growth.
The net result is an over-levered economy: too much debt on households and businesses.
The announcement today of the Geinther plan to create a market for the so-called “toxic” assets on bank balance sheets has been greeted with skepticism on a number of fronts. A common thread among these commentaries is that the only solution to righting the economy is to re-calibrate it and let the necessary de-levering happen. This will mean significant pain for many individuals and companies, not only the financial institutions that are holding over-priced assets on their balance sheets.
One strong perspective came from Paul Krugman of The NY Times today. He is positively plaintive in mourning the moves of the Obama administration.
But the real problem with this plan is that it won’t work. Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact.
You might say, why not try the plan and see what happens? One answer is that time is wasting: every month that we fail to come to grips with the economic crisis another 600,000 jobs are lost.
Even more important, however, is the way Mr. Obama is squandering his credibility. If this plan fails — as it almost surely will — it’s unlikely that he’ll be able to persuade Congress to come up with more funds to do what he should have done in the first place.
All is not lost: the public wants Mr. Obama to succeed, which means that he can still rescue his bank rescue plan. But time is running out.
Another perspective comes from Rolfe Winkler writing on Seeking Alpha:
Policy-makers not only misunderstand the economic crisis, they continue to underestimate it. Consequently, solutions to date have not only failed to “fix” anything, they have made the problem worse. The problem isn’t falling asset prices, it’s not rising foreclosures, it’s too much debt. With an assist from mark-to-market accounting,* too much debt inflated the asset bubble in the first place. Yves Smith has it exactly right that the only “solution” to this crisis is price discovery, to allow asset prices to fall to whatever level they need to in order for markets to clear. This is bad news for over-levered balance sheets, but there’s nothing else to be done.
Winkler argues that debt assumed at current interest rates — particularly by homeowners, is seductively cheap, and that fair value of assets priced at these rates could decline even further when the inveitably higher interest costs are factored in.
These are the sorts of arguments consistently used to object to the policy levers being pulled to prop up the economy.
The counter is to describe the economy we are bridging too. We’re like survivors of a shipwreck right now, using the meager resources we have to keep all of us on the lifeboat going, feeling certain that we’ll be picked up by the rescue teams in short order. It’s a bet of confidence and that the system works. What would be most powerful right now would be a clear picture of what the new economy is going to look like, where it’s going to be centered and how we’re going to benefit from it as a country.