Sensible Actions from an Senseless Administration

Paul McCulley from Pimco presents the sensible actions that the US federal government has to do to get the country out of its current mess:

...the paradox of thrift posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow.

This principle is part of a whole range of macroeconomic concepts under the label of the paradox of aggregation: what holds for the individual doesn’t necessarily hold for the community of individuals. Understanding this paradox is absolutely vital to understanding macroeconomics and even more so to understanding what is presently unfolding in global financial markets. ...

Once the double bubbles in housing valuation and housing debt burst a little over a year ago, everybody, and in particular, every levered financial institution – banks and shadow banks alike – decided individually that it was time to delever their balance sheets. At the individual level, that made perfect sense.

At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed. ...

As Keynes taught us long ago, that somebody is the same somebody that needs to step up spending to break the paradox of thrift: the federal government, which needs to lever up its balance sheet to absorb assets being shed through private sector delevering, so as to avoid pernicious asset deflation. ...

Fortunately, Congress is finally grappling with this reality, as it moves towards passage of Mr. Paulson’s plan for backstopping Fannie and Freddie with taxpayer funds. It’s not a fun thing to do, particularly following the use of $29 billion of taxpayer funds to facilitate the merger of Bear Stearns into JPMorgan. But it is the right thing to do. And it is further the right thing that Congress is doing it, not the Fed under Section 13(3), except as a possible bridge to Treasury authority.

Note: for those of you who are allergic to reading, here is the video version available on Bloomberg.

McCulley has it right. This action is necessary. Instead of the non-response of the Bush Administration to Katrina, this catastrophe is on a scale and at a scope that simply won't allow the "no government is the best government" ideology of the Bush administration to continue to be applied.

Instead, this calls for Keynes. Just like the Great Depression, the current situation is one of those classic economic catastrophes where government has to step in and act as the economic agent of last resort to save the capitalist system from itself. The good news is that there are enough capitalists with common sense to realize this. Sure, there will be the odd ideologues over the next two or three generations who will grumble and complain just as they do over FDR's efforts to save the capitalists from themselves. But sensible people will applaud sensible actions even when it is done to save a fool from his own foolishness!

Hang on...

Before I get too rapturous with praise for the Bush administration, I should point out that there are voices crying in the wilderness telling us that all is not sweetness and light. Here is Dean Baker from the American Prospect:

BIll That Will Cause 140,000 Homeowners to Face Second Foreclosure Passes Congress

Okay, that would not have been my headline, but when all the news accounts keep saying that the bill will "help" 400,000 homeowners, this fact really does deserve some attention. Just to remind everyone, the bill allows the banks -- not the homeowners-- to decide which loans get placed in the program.

If you are a troubled homeowner with the sheriff at the door with the eviction papers, this bill does nothing, as in zero, as in nada, for you, unless you can persuade your lender to take part in the program. The Congressional Budget Office expects that lenders will only place their worst loans into the program and that 140,000 of the homeowners who get new mortgages issued under the program will subsequently face foreclosure a second time. This means that only 260,000 homeowners will on net be able to keep their home as a result of this program, based on the CBO estimates. This is approximately 5 percent of the 5-6 million foreclosures expected over 2008 and 2009.