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Joined: 28 Dec 2005 Posts: 11980
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Posted: Sat Nov 22, 2008 4:19 pm Post subject: Third Major U.S. Policy Mistake |
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The $700 billion TARP was originally for exchanging a strong asset (i.e. cash) for a weak asset (e.g. mortgage-backed securities). Then, it was decided exchanging cash (an asset) for stock (a liability) was a better plan. Banks may be more cautious when liabilities increase (since they have to be paid back). Buying "toxic" securities at premiums would seem to make banks more willing to lend.
The Fed was on a path to achieve a soft-landing or a mild recession. However, two major mistakes (see third section below) by the Paulson Treasury, i.e. one that worsen the problem and the other that's ineffective changed that path (stock prices, since September 2008, also reflect those mistakes). There's good government policy, bad government policy, and neutral government policy. Imbalances could have been corrected slowly rather than suddenly.
A fourth policy mistake is saving the remaining $410 billion of TARP for the Obama Administration rather than using it now.
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Foreigners sold their goods too cheaply in the U.S. (to maintain acceptable employment levels). This caused the U.S. to overconsume (foreign goods) and underproduce (domestic goods). Foreigners also had to lend those dollars too cheaply (to balance the balance of payments), i.e. through low interest rates, or low rates of return, which spurred U.S. consumption even more. It was a virtuous cycle, for the U.S., of foreigners selling goods too cheaply and then investing that money too cheaply. However, it was unsustainable, because of diminishing marginal utility, i.e. the U.S. cannot overconsume forever without increasingly larger losses by foreigners.
The financial crisis was caused by the economic policies of foreign governments. Foreigners were paid through U.S. consumption. However, foreign investment was mostly in the U.S. government, i.e. Treasury bonds. So, fiscal policy was restrictive (the U.S. budget deficit shrunk to $162 billion in 2007, or a little more than 1% of 2007 GDP, while U.S. monetary policy was also restrictive, until late in 2007). The U.S. government had to give that money back. However, U.S. consumers, or households, gained at the expense of U.S. financial firms. So, the U.S. government has to fund U.S. financial firms.
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The first was predictable. However, the second was completely unexpected.
The Bernanke Fed kept a restrictive monetary stance for too long, i.e. the Fed Funds Rate at 5 1/4% until September 2007, and fell behind the curve easing the money supply. This may have resulted in a mild recession.
However, the second major policy mistake turned out to be a disaster. The Paulson Treasury allowed Lehman Brothers to fail, on September 15th, 2008, which coincided with the Ted Spread rocketing and froze the credit market quickly. This single inconsistency in the government's "too big to fail" policy resulted in enormous damage on a global scale. This may result in a moderate or severe recession.
Moreover, the negative news by the liberal media and politicians, which almost completely ignored the benefits of the free market system, including the steeper rise of living standards by U.S. households and the huge efficiency gains of U.S. firms, influenced the masses perceptions and emotions, contributing to a self-fulfilling vicious cycle.
(Hank Paulson was the CEO of Goldman Sachs)
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"The trouble with the world is not that people know too little, but that they know so many things that aren't true."--attributed to Mark Twain |
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