June 19, 2013
We Told You So
Posted on May 18, 2012
By James K. Galbraith, The Baffler
Securitization is a long-standing practice but the question is, at what point does it go too far? It should be clear by now that nonconforming home loans cannot be safely securitized, because the credit quality and therefore the value of the asset cannot be reliably assessed. Further, in the regulatory climate of recent years (where as William K. Black pointed out, political appointees brought chainsaws to press conferences), ordinary prudential lending practices broke down completely. The housing crisis was infected by appraisal fraud, a fact overlooked and therefore abetted by the ratings agencies. “No one looked at the loan package.” Now the integrity of every part of the system, from loan origination to underwriting to ratings, is under a cloud.
Fraud is deceit, a betrayal of trust. And it is trust that underlies valuation in a market full of specialized debt instruments, off-books financial entities and over-the-counter transactions. That trust has, as of now, collapsed. The result, as John Eatwell phrased it, is that financial crisis takes the form of market gridlock—a systematic unwillingness of institutions to accept the creditworthiness of their counterparties. This is, of course, especially grave where a counterparty has no direct resort to a lender of last resort—and so the crisis naturally erupts in parts of the system that are outside the direct purview of central banks. Deregulation is, in other words, a vector of financial crisis.
The message of all this for the Obama presidency is fairly clear. No one in the group expects the financial crisis to have disappeared, or even to be under stable control, by January of 2009. At that time there will no doubt be immediate priorities: more fiscal expansion, fast action against the wave of home losses to foreclosures, plus fast action against financial speculation in commodities would seem as of now to head the “to-do” list. But the financial problems will not go away. And that means that a seemingly benign credit expansion, such as got underway for Clinton in 1994 and carried him through his presidency, is not in the cards for Barack Obama.
Given the fact that vacated and unsold houses (unless destroyed outright) stay in inventory for a long time, there is little prospect of a housing recovery, or that a new expansion of loans to the broad population will be collateralized by home values any time soon. Recovery from this source should indeed not be expected within the policy horizon of the next presidential term. Something could happen, for reasons largely unforeseen, as it eventually did in the 1990s. But to bank on such a happy development would be an act of faith. More likely, there won’t be good news on the growth front in 2009, 2010, or 2011. Achieving economic growth in some other way will therefore be an overriding policy preoccupation.
Calls are now being heard for a “second stimulus package”; these reflect the fact that the first stimulus package [the Bush package of Spring 2008], while effective, was necessarily short-lived. But the same will be true of the second stimulus package. And once the election is over, will the coalition presently supporting short-term stimulus stay in place? If not, what then?
If the above analysis is correct, the political capital of the new presidency risks being exhausted, quite quickly, in a series of short-term stimulus efforts that will do little more than buoy the economy for a few months each. Since they will not lead to a revival of private credit, every one of those efforts will ultimately be seen as “too little, too late” and therefore as ending in failure. Meanwhile a policy of repetitive tax rebates can only undermine the larger reputation of the country; it is unlikely that the rest of the world will happily continue to finance a country whose economic policy consists solely of writing checks to consumers.
What is the alternative? It is to embark, from the beginning, on a directed, long-term strategy, based initially on public investment, aimed at the reconstruction of the physical infrastructure of the United States, at reform in our patterns of energy use, and at developing new technologies to deal with climate change and other pressing issues. It is to support those displaced by the unavoidable shrinkage of Bush-era bubbles but to do so efficiently—with unemployment insurance, revenue sharing to support state and local government public services, job training, adjustment assistance, and jobs programs. It is to foster, over a time frame stretching from five years out through the next generation, a shift of private investment toward activities complementary to the major public purposes just stated. It is to persuade the rest of the world that this is an activity worthy of financial support.
New and Improved Comments