The title of this diary comes from none other than Will Rogers, and it asks a seemingly silly, yet quite perceptive question. Why can't we get out of this mess like we got into it?
The responses to the financial crisis so far has been a bit like a deer caught in the headlights, disbelief followed by panic, fixated on trying to stop the blinding light, instead of trying to get off the road.
"The U.S. is repeating many of the mistakes that Japan made, and that's surprising," said Makin, the economist, "because American policy makers were all too ready to supply advice to Japan."
This diary will look, in very simple terms, at what needs to be done in 10 key areas - NOW.
1. Fix the banks: The Treasury Secretary's plan includes a stress test for the major banks to see what kind of shape they are really in. Is anyone else surprised that after giving the banks 100's of billions of dollars that someone finally decides that maybe it would be a good idea to see if the banks are actually solvent. Talk about a no-doc loan (or a NINJA). This has to be the biggest in history.
The Secretary's plan so far seems to be a rational attempt to get to a longer range solution, diametrically opposed to Paulson's and Bush's Sunday night specials (a new plan every Sunday night before the markets opened - a plan which was then thrown under the bus a few days later once the crisis had moved on). Geithner and Obama seem to be working strategically, but they are trying to make up for months of lost time and mistakes (thanks Bush).
The ultimate solution that will be arrived at (once it becomes politically possible) is the one many are already advocating - some form of nationalization of the major banks (citi, BofA etc). The shareholders will be wiped out, the debtholders will get a massive haircut and have some of their debt converted to equity in a new bank, and the taxpayers will for a very short time take control of these banks. Once they are stripped of their toxic assets they will be refloated to the private sector (a Swedish style solution). These new banks will also be limited to being "banks", not cesspools of leveraged risk. The other plus to this idea is it is recommended by Roubini Ideally this "nationalization" will take place quickly (say once the stress test is done showing that the banks are in fact wildly insolvent.)
Thus, paradoxically nationalization may be a more market friendly solution of a banking crisis: it creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and – most certainly – even the unsecured creditors in case the bank insolvency hole is too large; it provides a fair upside to the tax-payer.
2. Capital markets: Time for decent regulation again. Just as a game needs a referee, so too do markets. The trick is finding the right amount of intervention. Just as you don't want a referee to be the focus of the game, you also don't want the game to spiral out of control.
Canada has done more than survive this financial crisis....Over the past 15 years, as the United States and Europe loosened regulations on their financial industries, the Canadians refused to follow suit, seeing the old rules as useful shock absorbers. Canadian banks are typically leveraged at 18 to 1—compared with U.S. banks at 26 to 1 and European banks at a frightening 61 to 1. Partly this reflects Canada's more risk-averse business culture, but it is also a product of old-fashioned rules on banking.
In Canada banks are much more restricted in what they can do. The government has in the past stopped them from merging. It makes forays into insurance difficult, and it tries to keep them focused on boring old "banking".
3. House prices: The housing crisis is at least partially due to the goal of home ownership for the masses. Now, I'm not saying there is anything wrong with the goal, it's just that a vigorous pursuit of that goal can have serious unintended consequences.
Zakaria makes the important point in his article - despite all the artificial stimulation to the housing market in the US, the rate of hoe ownership is the same as in Canada where that stimulation does not exist.
the Canadian tax code does not provide the massive incentive for overconsumption that the U.S. code does: interest on your mortgage isn't deductible up north. In addition, home loans in the United States are "non-recourse," which basically means that if you go belly up on a bad mortgage, it's mostly the bank's problem. In Canada, it's yours. Ah, but you've heard American politicians wax eloquent on the need for these expensive programs—interest deductibility alone costs the federal government $100 billion a year—because they allow the average Joe to fulfill the American Dream of owning a home. Sixty-eight percent of Americans own their own homes. And the rate of Canadian homeownership? It's 68.4 percent.
Ultimately house prices will find their true value based on affordability (a function of wages, interest rates etc). Attempts to put a floor under prices to protect or save banks and or homeowners will be counterproductive, and make the long term pain worse.
The only honest and viable solution here is the "cramdown". Let bankruptcy judges force banks and hedge funds to write down the mortgage principal. That way it is the lender that takes a haircut and the taxpayer is kept out of the equation. In addition have mortgage money available (through Fannie and Freddie) to qualified buyers to take over foreclosed properties, even at distressed prices. the important thing is to try to clear the inventory as quickly as possible, and if it takes a temporary overshoot in prices to the downside, so be it. It is better than a slow gradual neverending drop (see Japan).
4. Innovation: Government spending will not end the recession. It can do little more than soften the blow and provide a more stable platform from which to move forward.
The way forward comes from doing things differently. Car companies will never employ as many as they did (just like railroads don't employ as many as they did at the turn of the last century), neither will financial institutions. Like it or not, the pace of change continues to accelerate, and the population of the planet continues to increase. Those who recognize and can deal with these realities are best positioned to do well.
We need to stop trying to make things as they used to be (prop up home prices, fix the car companies, bail-out the banks), and instead focus on new ways of doing things. This is where the Obama administration needs to show its stuff, not by trying to pick winners, but in openly encouraging new approaches to old problems. This can be as simple as setting higher CAFE limits, or global warming targets, or putting a person on Mars, or... Set high goals and let the people and companies and departments focus on how to achieve them. Project a future of immense possibilities. People need to see the "hope" amidst the gloom.
5. Energy. Ultimately a lot of the trade deficit the last few years has been due to net energy imports. Any recovery will be short lived if it does not reduce or eliminate this weight from the economy.
The approach needs to be two-fold, with both approached being spear-headed by the government. It must focus on reducing demand for imports and on increasing the supply of alternative energy.
We have seen small steps on the first (insulation credits etc.), but with the government involvement now in GM and Chrysler there is a wonderful opportunity to "dictate" where research and development dollars should go, and should not go (high mpg cars).
Secondly infrastructure money needs to be used to research and build out (or finance) alternative energy systems (primarily wind and solar, not ethanol). It is far better to spend money here, especially in public/private co-operations, than in building or rebuilding more roads (which only make the problem worse).
6. Public sector wages/pensions: This one is coming, like it or not, and the sooner it is adjusted the less pain there will be. Federal, state, and local governments are facing a drastic drop in revenues. For state and local governments especially this means big problems. I anticipate we will see several local governments going bankrupt before this is done.
As painful as it may be salaries and benefits of public employees are going to have to be adjusted downwards. There really is no alternative. The longer the wait to do this, the bigger will be the hole to get out of (see California).
7. The US dollar. One of the major reasons the US is in its current mess is the role of the dollar as a reserve currency. Any other nation following the same spend and borrow polices, would have faced the wrath of the markets and the IMF long ago. The dollar's reserve status allowed the rest of the world to keep selling more rope to the US (to hang itself with), and convinced the US to keep buying it.
The current flight to quality status of the US dollar is also impeding the economy. As the dollar continues to soar in the face of an economic meltdown, US companies are losing any competitive advantage that they used to have as exports become more expensive to foreign buyers, and imported goods continue to get cheaper.
It is time to look at a replacement for the US dollar as a reserve currency - most likely using a basket of foreign currencies instead.
The unspoken danger of course is that the dollar's unsustainable highs will unravel at a speed rarely seen before, effectively imploding in a new crisis. This is quite likely, though the timing is impossible to guess (just as the housing bubble popping was possible to forecast, though not its ultimate timing).
8. DEBT. The new worst four letter word.
This one will take time. Lot's of time. Debt needs to be paid down. This means spending less than income for quite a while. This means frugal is in again, and that is actually a good thing (believe me, I have been living frugal for a long time, and it is not that bad).
This is where I disagree with the authorities and I agree with Will Rogers. More spending and more debt will NOT cure a problem caused by too much spending and too much debt. I have no problem with spending on an expanded safety net, or on spending on long term infrastructure, or on major "economic transformations" (energy, defense, health care), but I do have a problem with attempts to "pump" the economy (primarily because most of that money will just be siphoned off to pay for stuff made in China).
Every dollar being spent now has to be borrowed or printed, neither of these options being a good thing. So, every dollar being spent now must be spent extra wisely.
9. Health Care. Now is the time to use the shock doctrine on "them". Economic crisis are painful, but they also present opportunities.
This crisis is a golden opportunity to introduce a universal health care system. Companies are hurting, health care costs are increasing, and as workers lose their jobs they lose coverage. No one is winning here and everyone is afraid. What better time to introduce universal care? This is the best time in years to convince corporate America to buy in to universal health care.
Companies would see their costs go down (the cost of universal health care is less) while workers and the unemployed would feel more confident knowing that they would not be wiped out by a health emergency.
Its [Canada's] health-care system is cheaper than America's by far (accounting for 9.7 percent of GDP, versus 15.2 percent here), and yet does better on all major indexes. Life expectancy in Canada is 81 years, versus 78 in the United States; "healthy life expectancy" is 72 years, versus 69. American car companies have moved so many jobs to Canada to take advantage of lower health-care costs that since 2004, Ontario and not Michigan has been North America's largest car-producing region.
10. Defense: When you are running a $1 trillion plus deficit and spending upwards of $500 billion on defense (about 1/2 of what the entire world spends) it is time to cut back. Don't forget not only is this money being wasted, it is being borrowed, from foreigners, and has to eventually be paid back, with interest. Every single penny being spent on defense needs to be reexamined int hat light. Every penny spent must be useful or it must be cut. It should be quite easy to cut 50% of the defense budget.
Conclusion: This mess has been a long time in the making, and has been created by a lot of stupidity, more than enough to go around. It will NOT be solved quickly. The best than be hoped for is that the hard landing is cushioned a bit and that a platform is established from which future advancement is possible.
The hole is going to be very deep as the economy overshoots on the downside as much as it did on the upside. Attempts to re-establish a culture of growth built on debt will fail and fail miserably (i.e. STOP TRYING TO GET PEOPLE TO BORROW MORE MONEY).
Now is the time to do things differently. Enough with the stupidity.