OurFuture.org Blogs: Susan Ozawa

What Should the New G20 Agenda Be?

Susan Ozawa — Thu, 24 Sep 2009 20:02:04 -0700

The new consensus on international imbalance monitoring/surveillance attempts to reduce the problems associated with the country-specific development and growth model in the face of economic hegemony on the one hand and export-orientation of developing nations on the other to a problem of imbalances that can be solved by minor transparency gains, less regulatory arbitrage among lax structures and changes in distortions like removing soft-pegged exchange rates and reducing fiscal and trade deficits. This invokes the old neoliberal model without recognizing its failure at the country level and thus it is unlikely to succeed even in a revised form with tremendous global cooperation. The neoliberal model must change and the policies that follow must be coordinated to effectively get us out of this global recession and onto a sustainable, more equitable growth path.

National financial ministers and the international financial institutions haven’t even agreed that the development of structured investment vehicles (SIVs) and conduits which were not robust enough to withstand changes in credit ratings and interest rates spreads were problematic nor that the great articulation of the securitization markets that followed these innovations was an overgrowth that must be systematically scaled down, particularly by modifying home mortgages. The IMF’s latest Global Financial Stability Report laments how far we need to go to resuscitate securitization markets as if that were desirable. And while Barney Frank and others can be commended for resuscitating the cram down legislation it still remains unpopular with the well-funded financial community.

The new G-20 consensus involves the same neoliberal themes embodying neoclassical assumptions and new Keynesian amendments, including the view that transparency can solve all problems associated with asymmetric information in credit ratings and overextension of risk. It is the same kind of assumption holds labels on packs of cigarettes will stop the spread of cancer. There is no fundamental critique of capitalism.

There is the recognition of inequity. There is the understanding that the status quo represents the interests of the winners of the game who are few and the losers are many. This is expressed through the push by heads of state, appealing to populist sentiment, to impose stringent executive compensation standards and, more radically in the US, to standardize the incentive structures for all employees at financial institutions proposed by the Fed. There have even been calls in the UK and Europe for financial trades to be taxed to slow down speculative gains and to stifle destabilizing sell-offs echoing calls from progressives in the US. These recommendations acknowledge pure, short-term profit maximization (or maximizing shareholder return for public companies), which is at the heart of capitalism, is inherently destabilizing and leads to intolerable inequities as well as inefficiencies. This is a start, but judging by the backlash these modest proposals have received, implementing even more comprehensive redistribution plans and disempowering the financial sector are far from being on the table given the political capital of the elite who have benefitted and will continue to benefit from both the upswings and downswings inherent to capitalism. When proposals like allowing a scaled down vanilla version of the financial sector to exist in return for counter-cyclical mechanisms for gains to be shared more equitably during the booms and for losses during contractions to be borne by those at the top of the income ladder, you know we will have had a shift in our system toward democracy.

The reforms on the table are largely Band-Aids. The calls for greater capital adequacy provisions seem to hope that extra padding—wearing elbow pads—would somehow be sufficient to prevent massive coronary attacks. The call for greater provisions to the IMF can be seen as desperation, the collection plate circulating to pay for the funeral, not a real solution unwind bad debt justly. The call for the IMF for minimal increases in special drawing rights (SDRs) can be seen as a down-payment on more fundamental reforms to address currency realignment to promote continuous, equitable exchange rate coordination.

Although Zhou Xiaouchuan, Governor of the People's Bank of China has discussed the role of pro-cyclicality in precipitating and extending crisis, there is less discussion about what countercyclical mechanisms can exist without changing our current development model. The neoliberal mantra has been liberalize and prosper (and at times, liberalize or else). Nations that liberalize their financial markets are recommended to accumulate savings in lieu of implementing capital controls or gradually and partially liberalizing. They are told, even still, to accumulate savings in ways that do not promote distortions, (presumably through foreign reserves gained namely through export sales producing net foreign asset surpluses). Thus, their imbalances cannot be leveraged without structurally changing their circuits of production and investment which does not happen automatically when prices, i.e. relative exchange rates change. This was historically demonstrated after the devaluation of the US dollar relative to the yen failed to change the structural imbalances with Japan, after the Plaza Accord was enacted in 1985. Currently, however, large fiscal deficits in importing nations used to pay for structural changes are discouraged (by lenders, the IMF, credit rating agencies and fiscal conservatives) while use of foreign reserves in developing nations is encouraged to boost consumption (by the G7 nations and the IMF). However, in these developing nations GDP is being derived from export sales and domestic markets are well developed, meaning increased domestic consumption will not automatically increase imports. Thus, offloading a significant amount of foreign held reserves could destabilize the reserve currency while if “effective” could cause the trade deficit to be skewed in another unsustainable direction, promoting stagnation and deflation. The fallacy of composition is operating in this line of thought. What is needed is more policy space for fiscal policy in industrialized nations to sponsor structural shifts and more lenience with developing nations to pursue expansionary fiscal and monetary policy as well as employ any and all necessary protections.

Protectionism perceived to be anathema to all. In crisis, especially, it is actually the knee-jerk reaction of a state to identify its best interests and to insulate those interests against complete annihilation. However, insofar as this conflicts with what other nations have identified as their best interests, we have a coordination problem, but importantly, not an essential problem with protectionism itself. What, in fact, we need is not only the ability of nations, developing and industrialized alike, to be permitted and emboldened to pursue industrial policy and implement economic plans, these need to be coordinated in an equitable international forum to ensure those nations with most vulnerabilities, requiring the most investment and protection are treated differently than wealthy nations and those with tremendous resource wealth and diversified export potentials. Full employment at equitable wages in all economies should be the overarching goal of this coordination experiment. This would require preempting two decades of multilateral and bilateral trade agreements and dismantling the liberalization and deregulation foundational tenets of the WTO but the coordination would be well-suited to function under the current WTO structure.

The industrialized nations have emboldened the IMF and made hundreds of billions in new commitments while the IMF now maintains developing nations, if well qualified, can run deficits not much larger than 2% GDP. The IMF was created to assist countries who would otherwise not be qualified for credit to avoid running deficits by borrowing a sufficient amount from the IMF, not to bail out failing banks either, so this concession is ironic, even if it’s the most generous the IMF has ever been on deficits for developing nations. The IMF still opposes the use of capital controls even as crisis and speculation are predicated on uncontrollable flows pouring in and out of an economy. There has been no recognition by the G8 or the IMF itself that the IMF’s recommendations for liberalization, deregulation and structural adjustment have failed; large checks are just being passed out. This is a bailout at the international level for those destabilizing the economies of developing nations; it’s a socialization of losses transferring the risk of the private sector to the tax payers in developing nations (let’s keep in mind these are loans with interest). So much for institutional accountability and a regime change from free market capitalism.

What do good people think about this? See a sound list of demands here.

Americans’ for Financial Reform’s G-20 agenda includes:

• The IMF allowing countries with stand by arrangements to have flexibility to expand healthcare and education spending. They recommend the Fund give countries more macroeconomic flexibility in fiscal and monetary policy, including the use of capital controls and prohibit the inclusion of financial deregulation as a condition of funding or a policy recommendation. They also endorse expanded debt cancellation, free from harmful conditionalities.
• Abandoning the terms of the WTO’s 1999 Financial Service Agreement (FSA) imposing financial deregulation on all nations regardless of their domestic laws.
• Supporting efforts to eliminate tax havens and regulate shadow banking, (hedge funds, private equity funds, derivatives and off balance sheet activity) by setting minimal regulatory standards agreed to by the nations of the G-20 in consultation with international bodies such as the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB).
• Moving from antagonistic trade relations under unrealistic and counter productive agreements to cooperation and leniency.
• Independence of financial regulatory bodies from the finance industry.

William White, head of the monetary and economic department at the Bank for International Settlements suggests taking a hard look at the monetary policy environment that feeds bubbles (less the current en vogue explanation that savings gluts in surplus nations were the cause of the global financial crisis) and notes problems in executing fiscal stimulus programs in industrialized nations without coordinated planning to address structural issues.

Philip Augar, a former investment banker and the author of Chasing Alpha, and John McFall, chairman of the Commons Treasury committee recommend breaking up the banks and re-imposing a more aggressive Glass-Steagall and scaling back the financial sector:

Taken together, these reforms would represent a wise shift toward financial stability and provide the policy tools necessary for nations to develop domestic and international strategies to achieve stable growth. Doing so requires a tremendous amount of advocacy because it requires confronting organized capital and dismantling the ideology of free market capitalism that pacified our better judgment as inequities grew around us. Watch this website for more details on how you can help fight the fight.

Food Security: All Investment Is Not Created Equal

Susan Ozawa — Mon, 17 Aug 2009 08:34:58 -0700

The G8 countries committed $20 billion in aid to address global hunger and promote more productive farming in the world's poorest countries this July in L’Aquila, Italy. Major commitments came from the United States and Japan. The challenge remains of making sure the investments are structured properly and the environment that caused the hunger crisis is reformed to ensure food security for all.

Tokyo has already begun targeting its investment in ways that might exacerbate food security problems in developing countries and demonstrates the need to maintain pressure on donor countries and the international financial institutions (IFIs) to adjust their assumptions and protocol so that the crisis is addressed in the short, medium and long-term.

Tokyo believes that expanding food production, through public-private partnership with its local trading houses and other companies, will help mitigate future risks. Among Japan’s five mammoth trading houses, Mitsui & Co, Itochu and Marubeni are expanding into food commodities such as soyabean, palm oil, wheat and corn. . . . Beyond their homeland, where demand for grains and oilseeds is relatively stable, industry observers say the Japanese trading houses seek to tap the voracious appetite for soyabean and grains in China and elsewhere in Asia, particularly in Vietnam, Thailand and the Philippines, or in Middle-East countries such as Saudi Arabia.

What is being pitched as a new agricultural revolution under these forms of investment will look very much like the colonial model of exploitation with the exception that the output will meet commodity demand in high growth countries versus demand in the colonizing nation. Regardless, the same distribution of benefits will apply without proper mechanisms to coordinate international production, as well as mechanisms to ensure investment is directed at local producers, and to ensure prices are low enough so that developing countries will have food security and access to their own goods. By simply funding industrial agricultural conglomerates, the company, in typical neocolonial fashion, will utilize the resources of developing countries, extract the raw materials and export them to sell in foreign markets at a profit.

The current framework discussed by the G8 nations and embodied in the new IFI push for investment assumes increased investment in agricultural production will generate greater supply, which will naturally decrease prices and address the problem. Although increased production will tend reduce prices generally, this does not mean that this strategy will address the global food crisis for several reasons. This line of thinking presumes the large run-up in commodity prices resulted from a uniform increase in demand against less responsive supply. Leaving aside the ways in which speculative players affect commodity prices, there is a structural supply problem because of the increasing cost of energy.

However, the issue of increasing costs is associated with a technological mode of capital intensive industrial production and transportation, which is not a food security problem as much as an investment problem in certain kinds of agricultural production and a global food supply chain coordination problem. On the demand side, there aren’t fast growing populations of hungry people in the least developed nations driving up the prices of food; there are changes in the diet preferences of high growth nations representing a dynamic middle class who are driving demand for more energy and resource intensive food sources.

Although demand exceeds supply, the demand for staple crops is driven by demand for livestock feed and for biofuel crops in addition to basic staple consumption by households. Thus, the problems of food security for the poor are being caused by structural distribution problems driving up prices on basic staples and leaving local populations, even in arable, land abundant nations, without access to their own agricultural products.

International price fluctuations wreaking havoc on production in developing countries has been particularly damaging over the past 30 years of neoliberal development policy, however, due to the privatization of their development and agricultural banks and the liberalization of their agricultural and commodity markets. The export and foreign exchange oriented development strategy promoting growth before food security presumes the distribution of gains from increased growth will benefit the population equally. However, the impact of privatization and globalization on the rural poor historically doesn’t demonstrate this happens naturally. Income inequality has grown across the developing world during this period of neoliberal polices alongside the rapid transformation small-scale agricultural producers into struggling slum dwelling communities. See more here. A solution to the global food crisis must then also address these neoliberal policy failures to address the root causes of the problem.

The original document drafted by the agricultural ministers to the G8 and the subsequent joint statement with G8 ministers recognized the significance of investment in smallholder farmers and women farmers but still maintained open and efficient trade markets were part of the solution. While this statement might have sought to address the large distortionary impact of US agricultural subsidies on the developing world’s agricultural markets, it should have stated explicitly that wealthy nations, particularly land and resource abundant wealthy nations, should work to scale-back their subsidies to large-scale successful industrial producers and the ministers should have gone further by endorsing developing countries’ use of protections to develop their agricultural sectors through whatever means necessary including revitalizing publicly subsidized agricultural banks.

A well coordinated strategy would use the WTO, not to police nations to reduce barriers to trade uniformly, but to coordinate international agricultural policy to ensure food security for all, particularly ensuring short-term efforts to address food security by dumping excess commodities on low income country markets do not crowd out domestic production of agricultural crops in the medium to long-term. Likewise, along the lines of the Kyoto Agreement, nations that are large consumers of staple-intensive livestock, should commit to lowering their consumption to less resource intensive foods. Treating wealthy nations that are agriculturally constrained differently from resource abundant nations that are poor when allocating IFI investment is also particularly important. The International Financial Corporation’s latest commitment to boost agricultural production by 30% would seem to be targeting production in developing and high risk nations, however, the companies benefiting from the investments will be donor country corporations and budding domestic partners, not traditional farmers. Funding small local producers is the right thing to do socially and politically but also makes economic sense. Walden Bello states:

[S]mall farmers have confounded those who have preached their demise by showing that labour-intensive small farms can be far more productive than big farms. To cite just one well known study, a World Bank report on agriculture in Argentina, Brazil, Chile, Colombia and Ecuador showed that small farms were three to 14 times more productive per acre than the large farms.

Kanayo F. Nwanze, president of the International Fund for Agricultural Development (IFAD) explains the value in investing in smallholder farmers over larger-scale producers in the developing world even at less astounding levels of productivity:

Eighty percent of the farmers in Africa are smallholder farmers. The majority of them are women. They produce 80 percent of the food that is consumed by Africans. Obviously, if these are the people that produce the food that we eat we must invest in smallholder agriculture. . . . We have proof that investment in smallholder agriculture is two to four times more profitable than investment in any other sector or sub-sector. It's very simple mathematics.

The investment generated to address the food crisis must be tied to measures to ensure the domestic population gains from the increased production and use of their land, energy and resources. Thus, investment should be targeted toward local producers for local consumption in low and middle income countries and these countries should be allowed to maintain tariffs on their commodities if they choose to export to wealthy and other middle-income countries. Likewise, price controls should be permitted for countries with hunger problems.

If the G-8 and IFIs were sincere about addressing the food crisis, they would be permitting more flexibility of developing countries' policy responses to address this crisis using all tools at their disposal; channeling investment on favorable terms to local producers; working with the WTO on global food production and distribution coordination; encouraging their populations eat further down the food chain; and reigning in speculation in their commodity and futures markets. Now's the time to ensure the US doesn't follow in Japan's wake.

Choosing One's Battles

Susan Ozawa — Tue, 04 Aug 2009 08:40:05 -0700

Isn’t it funny how the Obama administration outlined very rough principles for congress to hash out in designing the energy bill and health care reform while for financial regulation congress received an explicit outline of the entire structure down to the letter and now Treasury Secretary Timothy Geithner is rounding up the heads of the regulatory agencies and strong arming them to sign on, peppering his warnings with expletives in frustration that they have opinions on the matter that differ from the administration’s?

There’s an argument to be made that these two different strategies to push these sets of policy changes should have been reversed. The result of the hands-off approach with the energy bill was that cap and trade ended up significantly weakened in terms of emissions targets and creating a truly market based system for permits without crowding out private participation with governmental subsidies. Using that same strategy, health care reform with a public option appears to be in complete jeopardy and if anyone needed to be shaken vigorously by the Democratic leadership it’s the faction of the Democratic party itself that has undermined the President’s mandated platform. Still, placation and autonomy were the administration’s chosen modus operandi. But frankly, of all three pieces of legislation, financial reform has the least white papers in circulation outlining specific ways to move forward. Most that are written are penned by the financial community, so focusing on health care and stepping back from financial reform would have given think-tanks and academia some time to respond. Further, legislators could use some time to educate themselves and their constituents on the options before simply signing onto what’s been handed to them.

Knowing how important grassroots advocacy is, Treasury has already mapped out a field strategy plan for the recess and handed out talking points to congressional members to generate support for the administration’s financial reform plan. But a publicity campaign to seek the public’s support of a platform before any thoughtful dialog takes place between constituents, Congress members and regulators would seem to circumvent the democratic process. Afterall, it’s not as if Obama’s presidential platform was grounded on allowing standardized derivatives and giving the Fed discretion over systemically significant institutions in the same way his platform involved moving away from energy dependence and creating a 21st century health care system for all. More to the point, what’s wrong with healthy democratic engagement? If some of our most respected regulators and congressional committee chairs have reservations about pieces of the Obama financial reform plan like the Federal Reserve becoming emboldened without any check and balances, why not work on designing ways to address the Fed’s past failures and consider placing financial regulation within congressional jurisdiction if the Fed is to remain independent? The administration has compromised repeatedly over key points in spirit and letter on the recovery act, cap and trade and health care so why are dissidents with good points being scolded now over financial reform? It’s a bad strategy and bad PR. Did I mention it being undemocratic? It would also seem to reveal what the administration’s priorities really are and forces us question why that's the case.

It’s not too late to step back on financial reform, at the very least to wait for some findings to be released by the investigative panel on the financial crisis to motivate the changes the administration is advancing. But the soft power course on cap and trade and health care, cannot be reversed. Still, the administration could put all its muscle instead into grassroots campaigning for a public option during the recess if it was sincere about its platform promises.

This is What Happens When We Compromise with Conservatives Who are Wrong

Susan Ozawa — Tue, 09 Jun 2009 14:12:49 -0700

Many look at the American Recovery and Reinvestment Act as a victory for Keynesian economics and the progressive majority and as a down payment on fundamental investments we need in vital public services, infrastructure projects and programs that address the needs of the most vulnerable.

There is no doubt that these government expenditures were necessary to compensate for the drastic shrinkage in the economy set in motion by the financial crisis. The movement toward energy conservation and efficiency, and toward supporting various underfunded public agencies and social assistance programs, marked a significant shift in the political climate in our country after years of energy dependence and regressive economic policies.

However, we lost the battle on allocating the funding necessary to assist distressed states and we are now seeing the consequences. Conservative Democrats made a political trade-off with the right over the share of the American Recovery and Reinvestment Act devoted to tax breaks over vital spending. This trade-off was bad economic policy. Handing over money to the general population in the form of tax cuts is not as efficient an economic stimulus as money spent directly by the government, particularly on wages. But now we know the cost in human terms.

In California, plagued by tent cities of those foreclosed on and pushed off the rental market, Governor Arnold Schwarzenegger’s budget cuts paint the portrait of a state without a proper bailout. Seven days will be cut from the public school year; thousands of inmates will be released from prison and others will be packed into county jails; health care will be cut off for more than one million children, including those from low-income families who do not qualify for Medi-Cal, California's Medicaid program; $5.9 million in state funding for four poison call centers will be cut; funding for 220 state parks will be cut; 426,000 seniors will be denied in-home support services; the state Adult Day Health Care program will be eliminated, denying services to about 36,000 Californians and culling 6,500 employees jobs at the state's 300 centers. It’s difficult to overstate the human toll of reconciling a $24 billion budget gap.

And these cuts are on top of cuts at the municipal level. In Los Angeles County, 2,250 teachers are expected to lose their jobs. This is in a public school system already struggling with large classroom sizes and significant underfunding.

Those of us advocating for aid to states and municipalities were not using pie-in-the-sky figures of pet projects; we were pushing for the minimum funds required to meet projected shortfalls reported by the states so that the fabric of the country’s vital services could remain intact.

We argued on rational terms. We argued on economic terms. We argued on moral terms and we lost to those who were sure compromise was the only game in town. We lost more than we could afford in our compromise with Bush-era thinking, believing we were still in a Bush-era political climate and not in a crisis that requires triage and backbone, not pawn-brokering where you sell your valuables at a loss when you get into trouble.

These kinds of cuts are just the beginning. According to the Center on Budget and Policy Priorities:

Some 47 states are facing financial stress in their fiscal 2009 or fiscal 2010 budgets.
Budget deficits are already projected in 46 states for the upcoming fiscal year.
Combined budget gaps for the remainder of this fiscal year and state fiscal years 2010 and 2011 are estimated to total $350 billion to $370 billion. The CBPP lists more cuts.

Soon, most of us will all understand the only kind of trickle-down economics that has ever functioned—the regressive rule in the distribution of costs—that when times are tough those most vulnerable bare the burden, unless our elected representatives pay the price for failing to represent our needs.

Now that we see the link between political compromises and human suffering, we must act without equivocation. The ultimatum given to Congress by former Treasury secretary Hank Paulson to secure a $750 billion Wall Street bailout was wrong-headed and uncompromising, done without evidence or moral justification. Congress jumped. We must see that there is no compromise required when states and municipalities are flailing from the bursting of a crisis they did not cause. There is only one place to turn and that's Congress.

Three things you can do:

Tell your Congressional representatives they need to answer to you and not Wall Street. If they voted to weaken the Economic Recovery and Reinvestment Act, for the passage of the Wall Street bailout and against mortgage cramdowns, campaign for a new candidate who will fight for those struggling because of this crisis. See where they stand here.
Support Health Care reform by urging Congress to institute a public plan option, especially the Blue Dog conservative Democrats who are equivocating in their support. See how true health care reform would relieve states here.
Prepare for a fight on more funding for states and those in need from Congress. See the list of those gearing up for the next battle here.

Whatever you do, do not go gentle into that good night.

TARP Or Reconstruction? No Contest

Susan Ozawa — Wed, 08 Apr 2009 14:35:02 -0700

At a conference hosted by Dēmos today, economic experts "lifted the TARP" to expose the flaws in the Treasury Department’s plans to repair the nation's financial markets.

“Lifting the TARP: Is a Reconstruction Finance Corporation a Better Way to Restore the Banking System?”, took a critical look at the Toxic Asset Relief Program and the implicit assumptions and criteria for intervention via the Emergency Economic Stabilization Act of 2008 (EESA). Damon Silvers, who serves as associate general counsel of the AFL-CIO and deputy chairman of the Congressional Oversight Panel on the TARP but who was speaking for himself at the conference, said that the Treasury Department said those assumptions and intervention criteria were:

1.) Protect all existing investors, including equity holders by all means necessary
2.) Keep these transactions off the Federal balance sheet
3.) Basic interventions are targeted at infusing liquidity without due diligence regarding what is being purchased and what price is justified
4.) Losses that have happened are not real, but are caused by a temporary disturbance in confidence that can be staved off by buying time.

Page 11 of the Congressional Oversight Panel’s latest Oversight Report, released April 7, states, “This approach assumes that the decline in asset values and the accompanying drop in net wealth across the country are in large part the products of temporary liquidity discounts due to nonfunctioning markets for these assets and, thus, are reversible once market confidence is restored.” But that, “Treasury and key policymakers in the Administration argue that the recently-passed fiscal stimulus passage, Treasury’s foreclosure mitigation plan, and the public-private program to revive markets for toxic assets will strengthen the fundamental value of these assets.”

Thus, as the revelation of losses echoing through the system became more real, the strategy shifted its assumption that all can be restored to its previous state, to the fiat all must be restored to its previous state by implementing programs that subsidize the activities of those experiencing the greatest losses and vulnerability.

This tack represents denial. Even if it were possible or desirable to return to the old system of structured finance and the proliferation of derivatives, Treasury's current outlays fall short of the need. Goldman Sachs has projected losses from U.S.-originated credit assets at $2.1 trillion, the International Monetary Fund estimated $2.2 trillion and Nouriel Roubini estimates losses yet to be written down at $3.5 trillion.

Robert Kuttner, a Distinguished Senior Fellow at Demos and the Co-Editor of The American Prospect, stated unequivocally that trying to restore the old system is antithetical to rebuilding a sound economy given “structured finance is parasitic of the real economy.” Our objective, he emphasized, must be winding down these sectors to approximate a plain-vanilla, pre-1975 banking system.

Thus the bailout efforts that stem from a fundamentally misguided assumption will continue to be misguided. While restructuring is being avoided and markets, instruments and entities are being supported under the assumption these can be temporarily sponsored and resuscitated in the near future, recognizing these losses and managing the distribution of the pain in an orderly, preferably fair way is the only way out of our crisis.

Toward this end, the report focuses on historical examples of financial crises handled correctly. Silvers outlined the sequence of steps all successful interventions share in common:

1.) New management replaces the old in failing institutions, not for moral reasons, but because of the difficultly in objectively evaluating the mess you’ve just made.
2.) The true value portfolios must be made. A hard valuation of the assets of the entities must be made, generally on a cashflow basis, which requires management overseeing the valuation can be trusted to appropriately estimate this revenue.
3.) Once the gap is established, equity is wiped out.
4.) For the remaining fixed obligations there is some flexibility in resolution with possible haircuts and different scenarios possible for debt holders.
5.) In this process, the more taxpayers are participating in funding the restructuring of these failed entities, the more upside should be sought for the taxpayer once these entities are restored and the stake unwound.

Tellingly, Silvers stated, the length of time it takes to get through the three stages—denial, subsidy and government takeover—determines the speed at which the crisis can be resolved and is a directly proportionate to how corrupt the system is.

Kuttner said that the situation of Japan and its 1990s "lost decade"—during which their economy was stuck in the subsidy phase because it was just successful enough to not require the authorities to move to plan B—is where we are headed. The point of this conference was clearly to identify a plan B. As the title of the conference suggests, the answer to, “Is a Reconstruction Finance Corporation a Better Way to Restore the Banking System?” is a resounding "yes."

Two pages of necessary reading identified by Walker Todd, a Research Fellow at the American Institute for Economic Research and former legal and research officer at the Federal Reserve Bank of Cleveland, can be found here under: “Six Lessons Learned from the RFC” page 27-28 and here scrolling down to the bottom to “Stress Testing the Banks”.

As Silvers notes, every moment is a potential moment for correction, but with every moment that passes the more costly it becomes.

The Truth Behind Spending

Susan Ozawa — Mon, 02 Mar 2009 14:49:55 -0800

While the budget is being shopped around you will hear much trepidation from deficit hawks but you will notice that few are in fact economists. Most economists know that the government is the only sector able to finance our recovery at present and that deficits, if they are to be run, should occur when needed to get the economy back on track.

The scale of this crisis is unprecedented. As unemployment accelerates more and more dramatic spending will be required to compensate for losses in consumer expenditure and private sector investment.

After World War II began the deficit to GDP ratio gained historic heights in the high twenties which coincided with a drastic reduction in unemployment.

The figure in Pumping Life Back into the U.S. Economy: Why a Stimulus Package Must Be Big and Targeted by Scott Lilly, released January 2009 by the Center for American Progress, makes a compelling visual.

This massive government spending that funded job creation alongside an esprit d’corps lead to a populous eager to pursue hard work, develop new skills and buy government bonds moved the economy from the great depression into the golden age of American prosperity. Let us not wait for decades of unnecessary suffering and a horrific World War to pursue these goals this time around.

Progressive Principles for Nationalization

Susan Ozawa — Tue, 24 Feb 2009 11:36:57 -0800

Champion “nationalization” if you want, but there are such things as “good” nationalization and “bad” nationalization. The definition of which is which depends on the point of view of the stakeholders. So what kind of “nationalization”—or government ownership scheme—should we be calling for as progressives and taxpayers?

Here are three principles that I think make sense for us to demand:

1. Regulation of financial institutions' practices, including underwriting and securities selling, needs to come first, before any subsidies, bailouts or incentives are dished out. Otherwise we set ourselves up for a repeat of the Enron debacle.

Recall how partial deregulation of the energy sector in California ended up being a horrific nightmare for the consumers and taxpayers and a windfall for Enron, who exploited gaps in the government's involvement in the sector? The failures at mortgage giants Fannie Mae and Freddie Mac reflect the same problem in partial government intervention; in this case our giving government guarantees and subsidies to private entities without sufficient oversight and regulatory enforcement.

2.) If they say an institution is “too big to fail,” let’s see the proof. Show us the simulations, modeling what the consequences of their failures might be. Otherwise, there’s no way to distinguish real threats from scare tactics.

The only example of what a too-big-to-fail failure might look like is drawn from the Lehman Brothers’ collapse, which occurred at the beginning of the crisis and precipitated a drastic stock market decline and a retreat of credit from money markets and interbank lending. But we are not in the same world as we were when that collapse happened in September 2008. The kinds of assets that Lehman was holding have been significantly written down across the board and a lot of contraction has taken place throughout financial markets. Letting a bank fail now, with few other safe outlets for holdings, will result in market volatility and revulsion, to be sure, but the revulsion will be temporary as investment has few other places to go.

We are being threatened and these threats at least need to be substantiated by simulations that demonstrate the taxpayer will lose x amount if we do not bail out these entities versus amount y that we will pay over the long term for bailing them out. Needless to say, if x > y we bail out, keeping in mind the current outlays and government funds at risk for y is about $9.7 trillion. Economists like Stiglitz and Roubini and others should review the parameters used and be involved in evaluating the assumptions in the models. Once these simulations are run, we can decide which banks we must save.

3.) Taxpayers' costs need to be minimized in our overall strategy and at every juncture. To do that, the timing of the takeovers and the terms are imperative.

Former Federal Reserve Chairman Alan Greenspan pushed for his brand of "nationalization" paired in conjunction with the establishment of a “bad bank”, which Treasury Department officials are essentially pursuing with the Public-Private Investment Fund that would serve as a repository for assets of dubious value. His plan would entail cleaning the banks for complete private takeover and having the government assume responsibility for the assets of uncertain value.

But what price will be paid for these assets? What share of that price will be borne by the taxpayer and how much by the private sector? And would taxpayers share in the increased value of these assets over time, or would just private entities profit?

The same questions should be asked about the original TARP funds. How much will be lost in converting the preferred shares injected through TARP under the current adverse circumstances versus when the financial entity is becoming more healthy down the road?

These guidelines—1.) no money without strings, 2.) proof that bailout is in taxpayer’s interest and 3.) taxpayer cost minimization/benefit maximization demonstrated at every point going forward—must be the test of any Treasury/Fed/FDIC action from now on—whether the end result is called “nationalization” or bears some more politically acceptable label.

Trusting Anti-trust

Susan Ozawa — Wed, 18 Feb 2009 08:40:18 -0800

Wal-Mart’s doing well. Great. Listen, if we are serious about addressing our trade deficit and really want wages to rise in China to address it, one thing we can do is enforce anti-trust law here in the U.S. Trade economists know that market concentration at the retail level squeezes prices down the supply chain, especially if there is strong competition down the supply chain. What does that mean? If the only buyer is a big company who sells to 80% of the buyers of your products, they set the price at which you will sell them your goods. Timing is of essence and it is better to control monopolization while it is occurring rather than after the fact, when competition has been essentially wiped out, but incentivizing small to medium size businesses while enforcing compliance with labor and environmental laws on the giants like Wal-Mart with extreme penalties otherwise, while devising ways to break them up would be a good start.

For another strong sell, becoming truly serious about anti-trust law, taking up the mantle of another Roosevelt, (Teddy), would be advisable going forward after we rationalize our banking sector. No financial institutions should be too big to fail and incentivizing credit unions and community banks would also ensure market concentration doesn't occur on the downswing, especially after all our support of the oligopoly banks. Luckily we have laws to ensure competition exists. Let’s enforce them, shall we?

Foreclosure Crisis Plan Coming Down the Pike

Susan Ozawa — Tue, 17 Feb 2009 14:02:38 -0800

According to Geithner’s announcement last week the following will be pursued to address the foreclosure crisis:

1.) measures to reduce the interest rates on mortgages using TARP funding,
2.) the Fed will continue to buy Government Sponsored Enterprise (aka GSEs, e.g. Fannie Mae and Freddie Mac) issued mortgage backed securities (MBSs are bundled securities made up of mortgages). The Fed will also buy debt. Both will be funded by increasing the original Treasury funded facility by $100bn from $500bn,
3.) $50bn will be used to prevent foreclosures for owner-occupied middle class homes,
4.) a set of mortgage modification guidelines will be devised as standards for government and private programs (although it’s not clear if these will be binding) and
5.) for outstanding mortgage foreclosure relief programs, modifications will be allowed for a greater number of borrowers.

Taking them in order:

1.) Measures used to reduce the interest rates on mortgages could very well involve buying long-dated Treasuries which is an indirect way at creating lending floors (by pushing down the yield which is used as a benchmark for mortgage rates) and also distorts the bond market and expectations on the dollar and thus on investment in dollar denominated instruments. A more direct way to do this has been floated, namely for the government to buy new mortgages from private issuers at a targeted rate. Both proposals would primarily encourage refinancing which could stop some foreclosures.

2.) Underwriting GSE issued MBS that would otherwise not be by the market led to our moral hazard problem with the GSEs originally. Going forward, the terms of the loans should reflect sound origination (common sense underwriting practices) and the MBS market should be allowed to contract. $600bn also might not be sufficient to clean up the system comprehensively. The benefit of this tack is only that the government is incentivized to modify the loans on terms that are actually reasonable to the borrower once we’re left holding them.

3.) It is unclear how the $50bn will be used to prevent foreclosures for owner-occupied middle class homes, but if he will be taking up recommendations circulating these funds might target servicers to grant them incentives to modify the principals and terms of distressed loans. More direct assistance to homeowners would be the government declaring modifications mandatory; the lenders would be let off the hook for the original amount and servicers would collect what could reasonably be paid. (Many contingents would be satisfied with the original Bair proposal.) Another idea was floated, in Fort Myers. “Obama outlined an arrangement in which banks would accept lower payments from homeowners in return for an equity stake once housing prices recover,” which I find to be asymmetric given the gains to the originators and those who sold the MBSs would not be encroached upon, but more to the point, it makes default more attractive to the borrower.

4.) Mortgage modification guidelines are absolutely necessary but would be most effective if they were binding, not recommended standards. Self-regulation and incentives will not solve this problem systemically by relying on voluntary writedowns.

5.) Mortgage writedowns should be harmonized and mandatory for all homeowners subject to a means test against outstanding debt payments particularly for mortgages that are underwater.

Other good ideas:

Reward Good Mortgage Underwriting with TARP Funds

At the Thinking Big Thinking Forward Conference, February 11, Michelle Collins, Senior Vice President of Mortgage Lending at Shore Bank highlighted the fact that as a responsible lender ShoreBank did not issue one subprime loan. She stated however that currently her clients were suffering and indeed the mortgage crisis had spilled over into ShoreBank’s pristine portfolio. The criteria they use to deny new loans, 1.) insufficient income (affected by the larger job market contraction) and 2.) insufficient collateral (affected by the housing bubble bursting reducing these values) have stifled their ability to issue sound new loans. She identifies ShoreBank’s need for governmental support and makes the case that other local and community banks which have solid histories of common sense underwriting should be the first candidates for governmental assistance through TARP.

Dean Baker’s “Right to Rent” Plan

Legislation embodying this idea, H.R. 6116--110th Congress (2008): Saving Family Homes Act of 2008, was introduced to Congress May 21, 2008, sponsored by Rep. Raul Grijalva [D-AZ], Cosponsors, Rep. Dennis Kucinich [D-OH] and Rep. Edward Pastor [D-AZ]. The bill,

[g]rants eligible mortgagors subject to foreclosure proceedings the right to continue to occupy foreclosed properties subject to the payment of fair market rent for a period of 20 years that begins upon the commencement of occupancy of such property.

The cost would be negligible, but it would freeze the foreclosure crisis in its tracks.

In sum, it’s encouraging that Obama is taking this plan to the people and that it will entail restructuring household mortgage debt. Its true test will be the plan’s ability to stop foreclosures if not encourage a reflation of the MBS market.

Robert Wade - A Change of Financial Regimes

Susan Ozawa — Tue, 17 Feb 2009 09:05:28 -0800

A Change of Financial Regimes Robert Wade, Development Studies Institute, LSE Speaking at the 2nd Workshop: "Developing Joint UK Policy Responses to the Financial and Economic Crisis" organized by the Bretton Woods Project and School of Oriental and African Studies, Research on Money and Finance, Dec 15th, 2008.

Wade makes the case for industrial planning on a global scale.