Readers have been pressing for a solution to the financial crisis. But first it is necessary to understand the problem. Here is the problem as I see it. If my diagnosis is correct, the solution below might be appropriate.
Let`s begin with the fact that the
financial crisis is more or less worldwide. The
mechanism that spread the American-made financial
crisis abroad was
the massive US trade deficit. Every year the
countries with which the
Countries don`t put these dollars in
a mattress. They invest them. They buy up US
companies, real estate, and toll roads. They also
purchase US financial assets. They finance the
One reason the
Thus, economists were wrong to see
the trade deficit as a non-problem and to regard
offshoring as a plus for the
The fact that much of the financial
world is polluted with US toxic financial
instruments could affect the ability of the US
Treasury to borrow the money to finance the bailout
of the financial institutions. Foreign central banks
might need their reserves to bail out their own
financial systems. As the
Financial deregulation was an
important factor in the development of the crisis.
The most reckless deregulation occurred in 1999,
2000, and 2004. (See
The Bailout Will Fail,
Federal Reserve chairman Alan Greenspan`s inexplicable low interest rate policy allowed the systemic threat to develop. Low interest rates push up housing prices by lowering monthly mortgage payments, thus increasing housing demand. Rising home prices created equity to justify 100 percent mortgages. Buyers leveraged themselves to the hilt and lacked the ability to make payments when they lost their jobs or when adjustable rates and interest escalator clauses pushed up monthly payments.
Wall Street analysts pushed financial institutions to increase their earnings, which they did by leveraging their assets and by insuring debt instruments instead of maintaining appropriate reserves. This spread the crisis from banks to insurance companies.
Finance chiefs around the world are
dealing with the crisis by bailing out banks and by
lowering interest rates. This suggests that the
authorities see the problem as a solvency problem
for the financial institutions and as a liquidity
problem. US Treasury Secretary Paulson`s solution,
for example, leaves unattended the continuing
mortgage defaults and foreclosures. The fall in the
In place of a liquidity problem, I see an over-abundance of debt instruments relative to wealth. A fractional reserve banking system based on fiat money appears to be capable of creating debt instruments faster than an economy can create real wealth. Add in credit card debt, stocks purchased on margin, and leveraged derivatives, and debt is pyramided relative to real assets.
Add in the mark-to-market rule, which forces troubled assets to be under-valued, thus threatening the solvency of institutions, and short-selling, which drives down the shares of troubled institutions, thereby depriving them of credit lines, and you have an outline of the many causes of the current crisis.
If the diagnosis is correct, the solution is multifaceted.
Instead of wasting $700 billion on a bailout of the guilty that does not address the problem, the money should be used to refinance the troubled mortgages, as was done during the Great Depression. If the mortgages were not defaulting, the income flows from the mortgage interest through to the holders of the mortgage-backed securities would be restored. Thus, the solvency problem faced by the holders of these securities would be at an end.
The financial markets must be carefully re-regulated, not over-regulated or wrongly regulated.
To shore up the credibility of the
US Treasury`s own credit rating and the US dollar as
world reserve currency, the
The trade deficit is more difficult
to reduce as the
The issuance of credit cards must be brought back to prudent standards, with checks on credit history, employment, and income. Balances that grow over time must be seen as a problem against which reserves must be provided, instead of a source of rising interest income to the credit card companies.
Fractional reserve banking must be reined in by higher reserve requirements, rising over time perhaps to 100 percent. If banks were true financial intermediaries, they would not have money creating power, and the proliferation of debt relative to wealth would be reduced.
Not if Bush, Cheney, Paulson,
Bernanke, McCain and Obama are the best leadership
The Great Depression lasted a decade because the authorities were unable to comprehend that the Federal Reserve had allowed the supply of money to shrink. The shrunken money supply could not employ the same number of workers at the same wages, and it could not purchase the same amount of goods and service at the same prices. Thus, prices and employment fell.
Given the stupidity of our leadership and the stupidity of so many of our economists, we may learn what happened to us this year in 2038, three decades from now.
Paul Craig Roberts [email him] was Assistant Secretary of the Treasury during President Reagan`s first term. He was Associate Editor of the Wall Street Journal. He has held numerous academic appointments, including the William E. Simon Chair, Center for Strategic and International Studies, Georgetown University, and Senior Research Fellow, Hoover Institution, Stanford University. He was awarded the Legion of Honor by French President Francois Mitterrand. He is the author of Supply-Side Revolution : An Insider`s Account of Policymaking in Washington; Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow`s Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.