There are only five things of significance about the Emergency Economic Stabilization Act of 2008 (EESA), in my opinion (although we do not yet have the final version):
- Drafted in haste, it will have many and serious unintended consequences.
- Its provisions are largely irrelevant to our economic problems, intended to treat the symptoms.
- Our leaders have no “plan B”; this is a “hail Mary” pass.
- The economic impact will be minor, or even less than minor.
- The next program (EESA-2009?), taken by the new Administration after another 4+ months of weakening, will be the first important response to this crisis.
The government’s responses so far to this crisis are like beads on a string; each larger than the one before it — but all broadly similar.
- Government approval for fraudulent accounting, to hide the extent of the problem (Section 128, suspending market pricing of assets).
- Happy talk — do you remember the Treasury’s Hope Now alliance, in October 2007?
- Cheap financing and bailouts for injured financial institutions.
The goal of this plan — assuming that there is in fact a plan behind this, and not just ad hoc grasping at straws — is probably to buy time for the economy’s natural mechanisms to work. Unfortunately this misunderstands the key aspects of our situation:
- The scale of the problem, the post-WWII debt supercycle, and
- Time is our enemy, as the global economy slows and the US economy slides into what looks like a severe recession.
- A sufficiently large solution requires an agreement with our foreign creditors.
The last is the key to understanding our government’s actions. They do not want to open such negotiations, hence can take only small actions buttressed by “Rube Goldberg” financial machinations. We cannot pay our current debts and need sums far larger than our currently massive borrowing. This requires an agreement with our creditors to do the following:
- extend the maturity of our current loans, rather than just rolling them over and over,
- provide large loans to fund both our current account deficit (running at 4-5% of GDP) and the needed restructuring costs (this and the next EESA, plus large fiscal deficit during the recession),
- provided at low interest rates (or eventual payment becomes impossible),
- with the first payments due in 3 – 5 years.
This will end our pretensions to be a global hegemon. Plus, our creditors will want concessions. For example, China will want a sphere of influence that includes Taiwan.
Precedents in US History
America has had four major financial events. The government successful responded twice, and failed twice.
(1) Alexander Hamilton convinced the Founders to honor the revolutionary war debts, and successful arranged the means to do so.
(2) FDR’s New Deal mitigated the effects of the Great Depression, but failed to end it. His solution was to end gold convertibility for US citizens, and greatly expand both government spending and regulation. After a bounce, the economy slid back down in 1938. The Depression was ended by WWII.
(3) Johnson’s “guns and butter” over-spending resulted in collapse of the Bretton Woods system. Nixon’s solution was to end gold convertibility for other nations, and increase government regulation and spending. Some examples: price controls, affirmative action (the Philadelphia Plan), the Environmental Protection Agency (EPA) and Occupational Safety and Health Administration (OSHA). He proposed, but the Democratic Congress refused to approve, national health care and a national minimum income (the Family Assistance Plan). These measures stabilized the economy for a few years, although at the cost of rising inflation — leading to the next crisis.
(4) Fed Chairman Volcker plus Presidents Carter and Reagan responded to the accelerating decline of the US economy by forced restructuring (high rates, the 1980-82 recession) plus far-reaching deregulation. This resulted in a quarter-century of economic growth with decreasing inflation.
The fifth crisis
This forms a break with previous US history, as we cannot solve it alone. Years of insane financial management have left us
- addicted to foreign borrowing, which we cannot suddenly stop without severe withdrawal pains, and
- over-indebted, unable to resolve our problems without foreign assistance.
Leaders with steady hands and clear minds can steer us out of this storm. Our job is to elect the right people and support their actions (including criticism where deserved). Prayer might also help.
Update
For a brief analysis of this bill, see “The Bailout Compromise“, David Zaring, The Conglomerate, 28 September 2008
What should we do?
That is a complex question. For a simple answer see A solution to our financial crisis.
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions in these.
Please share your comments by posting below. Please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
Some FM posts about the current crisis
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Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
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High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
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Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
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Another voice warning about the nationalization of AIG, 18 September 2008
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A vital but widely misunderstood aspect of our financial crisis, 18 September 2008
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A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
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Another step away from our Constitutional system, with applause, 19 September 2008
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What do we know about the financial crisis? What are the key questions?, 20 September 2008
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Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
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America appoints a Magister Populi to deal with the financial crisis, 21 September 2008
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Legal experts discuss if the Paulson Plan is legal, 21 September 2008
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Essential steps to surviving the current crisis, 23 September 2008
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How should we respond to the crisis?, 24 September 2008
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A solution to our financial crisis, 25 September 2008
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Is the US economy in good shape, or in terrible shape?, 27 September 2008
For a full listing see the FM reference page about the Financial crisis – what’s happening? how will this end?.
A few of the most important posts warning about this crisis
This crisis has long been forecast by many, including in articles on this site. Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results. To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime. Here are some of those posts.
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A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
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The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
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We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
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Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
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Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end? With re-balancing of the global economy, so that the US goods and services are again competitive. No more trade deficit, and we can pay out debts.
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- What will America look like after this recession?, 18 March 208 — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
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The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
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The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
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“The changing balance of global financial power”, by Brad Setser, 22 August 2008
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“The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008
The sum and substance of all this is that Sarah Palin would be far better off hunting moose in the backwoods of Alaska than attempting to grapple with these issues in Washington, D.C..
I read in an article that the American Society of Civil Engineers concludes, that it will take 1.6 trillion Dollars to bring the American infrastructure (roads, bridges, dams etc) up to working order. Because of underfunding and wrong investment (remember the “bridge to nowhere” in Alaska?). The whole infrastructure is under a lot of pressure and has been so for several years. 30 percent of the United States bridges are “structurally deficient or functionally obsolete”. The number of unsafe dams have risen by 33 percent to more than 3.500. It would take an additional quater of a trillion dollars to bring the nation’s public schools up to a “good” condition.
To make a comparison China plans to spend 200 billion dollars just on railways alone between 2006 and 2010. They are also planning to build 300.000 kilometers of roads in rural China as well as 97 new airports.
The question of a bad infrastructure is actually just one of the many issues the United States is facing and which can’t be solved by military force. There is also the question of drought and lack of water around the country. Atlanta in Georgia was last year close to loose all its water supplies and for what I understand the issue is still very serious. There is also the issue of the border with Mexico where drugs and immigrants flow into the United States almost with impunity. There is always a chance that the violent drug war in Mexico would escalate into the United States, which might already have happened. We are talking about gangs who are equipped and fight like military units because most of them are former soldiers.
It is pretty obvious that the United States time as a superpower is over. The only question remains how it will end. If the Americans are wise they will elect men and woman who will begin a slowly retreat and a steady reconstruction of the American economy. Much like the British did in the years after 1945. If the Americans are unlucky they will elect the wrong people who will believe nothing has changed, continue to build military bases around the world, expand the war on terror and so on. In that case a sudden crash like the collapse of the Soviet Union becomes very likely, leaving thousands of soldiers stranded in different war zones.
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Fabius Maximus replies: You are referring to the “Report Card for American Infrastrstructure.” I recommend some skepticism. Is there an professional group that says “no more money needed for us?” It seems everyone now plays the game.
* Psychologists and social workers warns of epidemic of mental illness.
* Dozens of “disease of the month” groups warn that 5% of the US population is at risk (so many that I wonder that anyone remains alive).
* Civil Engineers warn that our infrastructure is collapsing, as have for years or decades (with no visible signs of the accelerating closings and disasters that should result if this were true).
There was no “golden age” in which our infrastructure was in fine shape. For example, by 1980 New York City’s transportation infrastructure was mostly of pre-WWII vintage. The PATH system, much of the subways, and Metro-North were near collapse from decades of minimal funding. This was largely fixed during the two decades decade or so, with the renovation of Grand Central Station as its climax.
This flood of alarmist PR, this jostling around the government trough, is an abdication of professional responsibility with serious consequences. So many groups so often warning of doom damages our OODA (observation-orientation-decision-action) loop, by making it difficult for the American public to see our real critical needs.
Glubb writes, in A Short History of the Arab Peoples, that “A surprising number of empires have endured for some two hundred to two hundred and fifty years.” He follows up by explaining he believes that it is a function of the number of human generations involved and how long it takes to go from tribal aggression to welfare-state lassitude. He also asserts, and I think wrongly, that technology does not/will not make a difference. I recall when first reading this that such would be a question very relevant to the fate of the American empire.
I think the results are in and they show that technology is value-neutral but an accelerant… hence a 20th Century where the battle among the US, Russia, and Germany over who would succeed Britain took decades rather than centuries, primarily due to the power of manufacturing, radar, missiles etc.
In a world with no physical frontiers where genocide and wholesale theft of resources are relatively impossible, there is essentially no profitable war, all sides always lose. The destruction of physical resources, the loss of young men in their prime, are a net loss for humanity no matter what. What makes sense is to sublimate the matter into economics, as has been done on a civilian/internal level with competitive sports.
This actually began in the 1990s, when West Germany essentially purchased the East from Russia, and when a global coalition essentially bought Kuwait from the US… assuming, of course, our ability to deliver;-). One can then see that the error of the current administration was in not figuring out a ‘deal’ that would take care of al-Qaeda, another for Saddam Hussein, and a third for Palestine.
FM’s core insight that a positive way to manage our imperial decline rather than fight it, by implementing a three-fer ‘vassals for sale’ program, is exactly right. We know the Chinese will ‘overpay’ for Taiwan due to emotion, and that our expenses and overextension will be reduced, add that to the ‘base value’ and it’s a triple gain. What remains is to figure out what other deals we can strike.
Given that Israel is more than capable of defending itself with atomic and other weapons, there is a deal to be cut with the oil states about Palestine, which again will save us money and make us money. The real conundrum remaining, presuming the relatively easy deal that can be cut with Iran around Iraq, is what to do about Pakistan/Afghanistan which are really one problem.
And the answer is relatively simple here as well. Either the Pakistanis figure out a way to manage their internal situation and their borders in a way that doesn’t allow for further 9-11s, or, we ‘sell’ them to India. Like it, or lump it.
Robert —
You’re right. The two big lakes that provide most of Atlanta’s water, Allatoona and Lanier, were completed in the late 1950s, when the area’s population was around 1 million. Today, it’s pushing 6 million. As if that weren’t enough, we’ve been out of gasoline for more than a week. Both of these problems are symptomatic of our failure to tend to the infrastructure, despite our having (or once having had) plenty of money to do so.
It might be nice to have back the trillion dollars we’ve flushed down the black hole of Iraq.
Chet Richards, Atlanta
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Fabius Maximus replies: Since gasoline is provided by the private sector in the US, I doubt that the Iraq War funding is responsible for your problems.
The change in the North Atlantic hurricane cycle — more, bigger — caught experts by surprise. The Gulf oil production, refining, and transporation infrastruture worked fine in the last cycle, and time will be required to modify it for current conditions. Note that the post-Katrina modifications to the offshore facilities worked well, with no major damage from Ike.
As for the Atlanta water problem, did this result from (a) lack of funding or (b) a defective OODA loop? If (a), experts warned that the water supply was inadequate, and the Executive and Legislature siad that they just did not have the money. If (b), the relevant experts did not foresee the problem — or they did warn and were unheard by State and City decision-makers.
I now have a more simple answer for ‘what should we do’ — the Treasury should buy houses, not paper. It’s too late, I know, but I’m pretty sure this bailout will be sure to save most of cash of the wealthy, without solving the housing crisis. The wealthy in this case include the Chinese prior and future buyers of US debt.
Which is really two separate issues:
1) a HUGE reduction in value of housing, and
2) a HUGE uncertainty in what the real value of the housing is.
The uncertainty, like Bartlett was talking about, can crash the whole system. The huge paper wealth evaporation is less likely to crash the system, but the scrambling of all the wealthy to get out first/ minimize their own loss, increases the total loss/ reduction.
All based, as Fab said earlier, on too many houses. The gov’t, even after this rich-banker bailout, should still be buying more houses.
Did you all see the now-famous “Burning Down the House” video?
Support for home ownership of those who can’t afford it, starting in 1995, is the underlying issue, with Fannie Mae a big villian.
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Fabius Maximus replies: Since you are posting on my site, it would be polite to at least mention that I have given vast amounts of data showing that this is not a mortgage or housing crisis — rather than just repeating this stuff.
The problem is that American households have too much debt — and both households and the nation are addicted to foreign borrowing to support consumption. How are we better off by the government borrowing money from foreign central banks to buy homes?
BTW — there is a vast body of historical evidence and economic theory that the government cannot maintain prices of a key asset above market levels. In this case, homes. The idea is absurd.
“Is there an professional group that says “no more money needed for us?” It seems everyone now plays the game.”
Excellent point, and one that ties in the socalled “special interests” that have all but ruined America.
At the sametime FM, have you done much driving lately? I can’t say how it maybe where you are, but in VT some roads are becoming impassable and unsafe at virtually any speed. A marked departure from say 15 years ago, when VT roads in combination with scenery were a major attraction.
This in turn takes a further toll with even less tourisism.
“It might be nice to have back the trillion dollars we’ve flushed down the black hole of Iraq.”
No kidding Chet, excellent, but I have yet to hear anyone in the mainstream media make that connection. Not to mention the plans for Afganistan, Pakistan, Iran, Syria, N. Korea, Venusella, Cuba, Russia, and China.
Personely, and I’ve had this argument with FM privately, I’d say that the United States as we knew it, has turned the corner, and is over, finished, and never to return.
As empires come and go, 60 or so years, (since WW-2) is pretty lame. Before you get on your high horse, Better than the 3rd Reich, or the Soveits is nothing to brag about either.
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Fabius Maximus replies: I have been driving for 3 decades, over large stretches of the US. In some places the roads are better, in some worse (California!), in some unchanged. One thing is constant: people’s belief that things are worse today vs. an imagined golden era of the past. They are seldom able to cite hard data to support their view.
Fab —
You mean … BP isn’t a government agency? Shell? Chevron? Whoda thunk it? Are you sure? Amazing what you learn on this site!
No, but those resources might have been part of the solution, or could have been a part of future solutions. Gone now, I’m afraid.
If we figure the eventual cost of the war at $3 – $5 trillion (following Bilmes – Stiglitz), it at the very least adds to the debt problem, and I guess it would be impolite to point out the opportunity cost it represents. Makes the bailout seem positively cheap.
As for Atlanta’s water problems, the place has had periodic droughts, with attendant water restrictions, since I moved here in the early 80s when the regional population was about half what it is today. And they haven’t built any new lakes or discovered any new aquifers. So I think the trend was pretty easy to spot. Why didn’t we do anything? It would have required raising taxes or restricting property rights (particularly of developers), and there was no public support for that sort of thing. And after all, we had survived previous droughts.
And we survived other gas shortages without generating support for improving the public transformation infrastructure: Out of the 10 counties in Atlanta’s inner core, our subway / urban rail system, MARTA, serves two.
Chickens coming home to roost? You bet, but it sure would be nice to have our share of that trillion bucks back, or three trillion, or five. Don’t know how we’re going to pay for better water and transportation infrastructure today — think maybe the Chinese will loan us the money?
I called it a speedhump on a cliff face, Steve Keen (debtdeflation.com) said “its like giving the first class passengers on the Titanic a thimble”.
It was a bad plan, now correctly dumped. However any plan, no matter how good, is not going to avoid a (almost certainly worldwide) recession and a lot of bancruptcies, the important thing is just how well it will reduce the fundemental problems, shorten the pain period and set the scene for an eventual recovery. A bad plan will actually prolong the pain.
But B.A.U as we knew it, is gone forever. And with it will go the reserve status of the dollar. An “interesting” new world awaits.
It is interesting to speculate just how this will impact the Iraq and Afghanistan wars, the 700+ US bases and expensive (and apparently marginal) projects like missile defence, the JSF, FCS and the like. Equally EU, Russian, Chinese and Asian (inc Indian) arms expenditures are going to come under a lot of pressure. If this starts up the creaky wheels of international cooperation again (treaties are a lot cheaper than weapons systems after all), then some good may come out of all this.
“some good may come out of all this.”
Ahh, yes to dream, the impossible,,,.I wouldn’t bet on it. You under estimate the collective sheer stupidity that perimates America.
Update: Comments about the bill’s approval for fraudulent accounting, to hide the extent of the problem (Section 128, suspending market pricing of assets) — From Calculated Risk:
“Suspending mark-to-market accounting, in essence, suspends reality.”
— Beth Brooke, global vice chair at Ernst & Young LLP, WSJ, 30 Sept 2008 (link)
“Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.”
— analyst Dane Mott, JPMorgan Chase & Co., Bloomberg, 30 September 2008 (link)
“Suspending the mark-to-market prices is the most irresponsible thing to do. Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings.”
— Diane Garnick, Invesco Ltd., Bloomberg, 30 September 2008 (link)