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Tuesday, February 23, 2010

Transcript: 359 Savings, Taxes, Deficits, Credit Crunches, Demand

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I've been having a spirited discussion with Marshall Auerback and Edward Harrison at their "Credit Writedowns" blog on the savings rate, which finally led to this comment.

There does seem to be a qualitative difference between the current savings and that of more prosperous times. Backing up: Beginning in the 1980s "savers" were split off into those who saved by putting money in debt instruments and those who went after equities. Those who bought equities were subtractions from the savings rate. The purchase of assets is not savings, even though it is your nest egg, your retirement stash.  For a time, a long time, these guys who went after stocks were the smart ones, prudent in their diversification, much smarter than the grannies who held their wealth in 2% passbook accounts. Just as with the big guys, the little guys became more and more aggressive, but well within the bounds.  "Stocks have never fallen in any seven-year period" became proof they would never fall again.  When stocks did fall, equity positions were wiped out and people went for safety -- housing.  "Housing never goes down." 

The 2000s was an enormous collapse.  No job growth.  In spite of huge increases in household debt.  As we look back now, we see a series of bubbles, each one larger than the previous.  And we see each has been ratified by the central bank.

But the "saver," one can argue, was never different in her belief that she was behaving responsibly and wisely. It is likely, even, that savings and investment of households increased over the period, as boomers neared retirement.  

Now the savers are back to basics. Their saving is a straightforward subtraction from spending.  Combined with the pullback in borrowing, it is a crushing blow to economic activity.  As Steve Keen points out, spending plus borrowing is the full definition of effective demand. The federal government's discretionary and automatic stabilizers may provide a bottom, but are not in any sense a way out of the mess.

In a minute we'll get to another crimp in effective demand that has the regulators near panic, which is the lapse in lending to small businesses.

On Friday, we'll bring back "idiot of the week," and feature venture capitalists and business advocates who continue to be, well, idiots about obstructing efforts to get effective demand back on the road.  You'll get the full list of why full-scale demand resurrection is preferable -- in the way water is preferable to sand when you're thirsty -- to tax preferences.

Also on the blog transcript I put up the CBPP -- Center on Budget and Policy Priorities -- chart describing the source of the projected federal deficits through 2019.


You'll see the major contributor is the Bush-era tax cuts, which source comprises well more than half of the projected $1.35 trillion deficit by 2019.  The economic collapse is second in magnitude as a cause.  The Stimulus and TARP spending initially are comparable together to these first two sources, but shrink quickly to very modest scales -- assuming there are not more.  The wars in Iraq and Afghanistan roll along as the base to it all, costing $200 billion per year as far as the eye can see.  Absent these sources, the deficit is effectively zero.  Yet where are we going to look for a solution?  Likely not in these root causes.

You can draw your own conclusions.  Mine is that the tax cuts have to be reversed with carbon taxes, financial transaction taxes, high roller taxes.  Say, maybe now that corporations have full First Amendment rights and are virtual people, maybe they could start paying people tax rates.  What a concept.  From ten percent of tax revenues, maybe they could be twenty-five.  Hey.  They were fifty percent in the 1950s.  Seems to have been a pretty good decade.

Maybe we'll get back to the proof of this soon, that taxes do not decrease, but increase demand.  It's not only historically true in the U.S., but compare high-tax to low-tax countries around the world.  Or just compare the magnitude and promises of the Bush tax cuts with the prosperity we find ourselves in today.

Be careful, don't rescind them, we might jeopardize our economy.  Humbug.

Also at Credit Writedowns, we get news of a press release from the complete list of federal government regulators of the financial industry.  It -- this press release -- demands banks start lending to small businesses. 

The regulators supporting the press release were the following: The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision, and the Conference of State Bank Supervisors.

Some small businesses are experiencing difficulty in obtaining or renewing credit to support their operationsBetween June 30, 2008, and June 30, 2009, loans outstanding to small businesses and farms, as defined in the Consolidated Report of Condition (Call Report), declined 1.8 percent, by almost $14 billion. Although this category of lending increased slightly at institutions with total assets of less than $1 billion, it declined over 4 percent at institutions with total assets greater than $100 billion during this timeframe. (These are the big banks.)  This decline is attributable to a number of factors, including weakness in the broader economy, decreasing loan demand, and higher levels of credit risk and delinquency. These factors have prompted institutions to review their lending practices, tighten their underwriting standards, and review their capacity to meet current and future credit demands. In addition, some financial institutions may have reduced lending due to a need to strengthen their own capital positions and balance sheets.

Supervisory Expectations

While the regulators believe that many of these responses by financial institutions are prudent in light of current economic conditions and the position of specific financial institutionsexperience suggests that financial institutions may at times react to a significant economic downturn by becoming overly cautious with respect to small business lending. Regulators are mindful of the harmful economic effects of an excessive tightening of credit availability in a downturn and are working through outreach and communication with the industry and supervisory staff to ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound small business borrowers. Financial institutions that engage in prudent small business lending after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for loans made on that basis.
On next Saturday's relay, we'll have the Joe Stiglitz book tour at the London School of Economics.  Stiglitz remarks in that talk that the real estate collapse has hurt small businesses which formerly borrowed on the base of their real estate collateral.

Here you have every single regulator coming down on the lenders.

As Ed Harrison says at Credit Writedowns, This is official confirmation that the credit crisis is not over and that regulators are worried.

my comment

Banks have no incentive to look for small businesses when they can borrow at 0 and go get 3 or 4 in the Treasury market. Why not squeeze that margin so they are motivated to lend to real customers? I do not see that zero has created any investment. It seems to help those who have loans tied to the prime rate, identified now, I guess, as 3 percent above the federal funds rate, and more importantly, it helps the banks via backdoor bailouts. 

A 2 percent federal funds rate would squeeze them back into the real economy looking for good credit risks. It seemed to work in the early 1990s.

Finally, a comment we have resisted making on the Greek crisis.  It is our view that Greece has become the target for speculative attack.  The EU ought to get it together to backstop the Greeks and make the speculators pay as much as possible.  We would not be surprised that the author of the deceptive derivatives that aided Greece in its escape of EU fiscal restraints -- Goldman Sachs -- has a lot of trades on the short side here.  

On the other hand, we could see the Greek debt default and watch as to whether the credit default swaps that are traded over the counter -- that is, the counter in the back room -- are honored in their entirety.  Could the central banks really want the decision of whether or not to bail out another AIG?

Ed Harrison again, says 

The takeaway here is that we are still in a credit crisis. What is happening in the sovereign debt markets is going to force policy makers to unwind stimulus and accommodation sooner than later. However, doing so risks disaster because signs of recovery are still quite incomplete at this juncture. The evidence comes in both the Fed’s assessment of low credit demand and the ECB’s assessment of outright monetary contraction.  You don’t get sustainable GDP growth in a world of contracting monetary aggregates and sluggish credit demand.

1 comment:

  1. The problem is that borrowers realise that when things are tough, banks are not the people that you want to have borrowed from. They are increasing the demands on potential borrowers in order to minimise risk for the bank. Many others are paying back what they can. In an uncertain world debt is the last thing that you need. So businesses are retrenching, even if banks are willing to lend, simply because it does not make sense to increase borrowings. Then the collateral or property that they would have used to back the loan has fallen in value.

    Until businesses have got their debts under control they will not be wanting to borrow. Those that do want to borrow are probably being turned away by the banks for being too great a credit risk. The deleveraging that is needed will simply take years unless there is a crash which wipes out businesses and debts and forces governments to deal with the mess. Until this happens the deficit hawks will not allow governments to stimulate demand adequately. A lose lose situation.