The Financial Crisis Part II

This was supposed to be just a discussion of the financial crisis – the second part of a two-part post – but the day after the election there are a couple of things that need to be observed. First, it was not a realigning, overwhelming Democratic victory. Gains in the House and Senate were considerably smaller than expected –17 and 5 seats respectively, as of this writing (with a couple yet to be determined). Second, if Obama’s election was a victory against racism, the election did not herald a similar turn against homophobia: California, Arizona,and Florida all passed referendum measures banning same-sex marriage, and Arkansas passed a measure prohibiting same-sex couples from adopting children (apparently the children are better off being left in foster care, another brutal example of a willingness to make children suffer in order to avoid the danger of actually expressing approval of a same-sex couple’s household.) Coleman holds a narrow lead in Minnesota and – almost incredibly – it appears that Stevens was re-elected in Alaska. In other words, while the election may have been a repudiation of the laissez-faire, free market, trickle-down element of conservatism, it said nothing of the kind about other in the American Right (interestingly, though, two proposed abortion bans were defeated).

But the election of Obama did give him a clear mandate to use the powers of the Executive as well as his leadership in Congress to intervene in the economy. So here are the four things the Obama administration needs to focus on right away.

First, the bailout program has to be adjusted to make it address the actual problem, which is the absence of short-term credit caused by the decline in inter-bank lending and the unavailability of commercial paper. The easiest way to do this is to follow the British lead: supply money to banks only for the purpose of lending. Any program that simply puts money into banks coffers is at best indirectly related to theproblem at hand; it’s that same market mentality that says that if you tweak the incentives or the psychological conditions, “the market” will solve problems as if by magic. In this case, the claim is that if you give banks enough money they will stop feeling insecure and resume lending. The problem, of course, is that banks are not governed by feelings, they are governed by calculations of interest (that’s a pun, get it?), and as long as it appears to be more profitable to simply sit on the money until some point in the future, that’s what will happento it.

Second, with respect to mortgages we have to keep people in their houses. To do that we have to have ways to renegotiate their mortgages. During the campaign, Obama proposed using federal powers to clamp down on fraudulent lending practices (including the creation of a federal crime of mortgage fraud), establishing a “Credit Card Bill of Rights” to help prevent people from being driven into bankruptcy in the first place, and reform of the bankruptcy system to allow judges or estate trustees to renegotiate mortgages and the creation of an exemption for bankruptcies caused by medical expenses. Those are all good ideas, but there has to be a program to renegotiate predatory mortgages before bankruptcy occurs. The problem is to makesure that such a program is only used in appropriate cases of need to keep people in their houses, not gamed to increase the value of investment properties. Conversely, there is a problem of fairness if people who entered into mortgages they can not pay –whether through stupidity (defined here as “listening to Alan Greenspan”) or as a result of predatory lending – are rescued on terms more favorable than those available to the people who acted prudently and carefully in the first place.

The fairness problem is political, not economic. Historically, the way to get a large-scale social welfare benefit of this kind through is to make it extend to everyone: think Social Security or Medicare. It may be that as a combination of politics and economics the only alternative is to give every mortgage holder a one-time shot at a 30-year fixed rate set at a reasonable but not unduly favorable interest rate: say 7.5 or 8.0%. Such a rate is high enough that banks that were careful lenders are not being punished for the misdeeds of others. It is also high enough that people whose mortgages are already below that rate – the people who got good mortgages from prudent lenders – will have no incentive to take advantage of the program. True, some people in the middle who arenot truly in need will benefit, and some people will be unable to make the payments even on those terms and have to face foreclosure. But it is very difficult to conceive of another solution that does not end up rewarding the people who caused theproblems in the first place while punishing people who “played by the rules.”

The third thing is jobs. This one is a no-brainer. The economy has already hundreds of thousands of jobs, and it’s not over yet. Now, we are not going to let those folks who have lost their jobs go hungry. So we have a choice. We can give them public housing, and food stamps, and Medicaid, or we can give them real, meaningful work. The obvious answer: make the government the employer of last resort, and put people to work making infrastructure repairs. We desperately need a national program of public works projects to fix, clean up, and maintain our public facilities and spaces, roads and bridges, the electricity grid, and a wide range of other publicly owned facilities. Combine it with training programs, including adult education programs: put some of our unemployed workers to teach others. This is a long-term investment in human capital as well as infrastructure.

Fourth is education. We have already seen that along withcar dealerships, among the first casualties of the credit squeeze are student loans. Lenders are cutting back or canceling those programs. Senator McCain proposed an across the board spending freeze; the effects of that would have been catastrophic for higher education in this country. I actually thought this was the single most reckless and destructive position in McCain’s campaign, and the best reason to vote for Obama.

The State of California has announced a $7 billion shortfall, the State of Wisconsin is short $3 billion, and that pattern is being repeated across the country. A number of states have already started cutting back on public expenditures, and the system of public higher education is right in the cross-hairs. Without help from the federal government, that is going to mean more cutbacks in student loans, higher tuition at public colleges, fewer scholarships. And that’s not all. Pretty soon colleges – small private colleges and public colleges, community colleges and technical training institutes – are going to start to fail, because those schools depend on the ability of their students to get student loans and scholarships. Secondary and primary schools will alsobe starved for funds as districts’ ability to get bond issues underwritten is weakened just at the time that property tax revenues are in a sharp decline.

The consequences of the contraction in our educationalsystem could be terrible. Making post-secondary education available to more young Americans has been one of the signature achievements of the post-World War II era, and it was accomplished with public investment in the G.I. Bill, the expansion of the public college system, and student loans. If it is sensible to use government resources to keep people in their homes, it is just as sensible – and in the long run, just as important – to keep young adults in their schools and their schools open for business.

There are an awful lot of other things I would like to see the new administration undertake, but these four responses to the crisis that has spread out from the financial sector will do for a start.