Fed tries to pump some more air into our bubble economy

Photo courtesy of MSNBC

The Federal Reserve has just announced yet another dramatic intervention in the financial markets. This time around, they are trying to jumpstart consumer lending (aka car loans, student loans, etc), as well as mortgage lending. In order to do so, the Fed is buying up more of Fannie Mae and Freddie Mac's mortgage backed securities and, according to the Washington Post (articled linked above):

creating a $200 billion program that will lend against highly rated securities backed by auto loans, student loans, credit card lending and small-business loans backed by the Small Business Administration

Now, I recognize that the economy cannot function if people cannot get access to loans for major expenditures. Nonetheless, I think this plan reflects a fundamental misdiagnosis of the root cause of our economic crisis on the part of the Federal Reserve/U.S. Treasury. That misdiagnosis could be the result of sheer incompetence, but I doubt it. Rather, I think it's more likely a function of the disproportionate role of finance in our economy, and its concomitant excessive and destructive influence over our political leadership and institutions.

According to the Washington Post and seemingly, according to the Federal Reserve and the Treasury, the most pressing problem facing our economy right now is the refusal of financial institutions to lend to businesses and consumers. Hence, the above mentioned intervention and all previous bailouts of the financial sector. However, according to Dean Baker, this argument misses one absolutely essential detail: The United States has just experienced the collapse of a gigantic housing bubble, which was allowed to grow for far too long thanks to the policies of libertarian ideologues like Alan Greenspan. As such, the country now finds itself with $5 trillion less in housing wealth today than we had, collectively, at the beginning of last year. The result?

In addition to leading to a fall in residential construction of more than 50 percent (3 percent of GDP), the loss of $5 trillion in housing wealth would be expected to lead to a fall in annual consumption of between $250 billion and $350 billion (1.7-2.3 percent of GDP)

In other words, it's not all that complicated: Housing bubble collapses --> residential construction tanks + consumer spending drops --> we're in a recession. As for the lending bit, if you were a bank, would you really want to make a car loan to someone who might lose their job next week? Thus, we're in a recession, the proximate cause of which is the bursting of the housing bubble.

If we take a broader look at this crisis, however, it goes beyond just the housing bubble. Prior to the housing bubble, we had a stock market bubble, which Dean Baker, in another piece, says was worth $10 trillion dollars. Its collapse in 2001 left us with a short, but painful recession and a slow, almost jobless recovery. Prior to that, we witnessed an explosion in credit card debt, which continues to this day. For decades, Americans have increasingly been living beyond their means and financing personal expenditure with debt. Our Personal savings have reached record lows and have been on the decline since the 1980s. In its current policies, the Fed is trying to pump some more air into the debt bubble but is doing nothing to address the route cause: we just have too much debt.

The key question, of course, is why we have so much debt. The most oft-cited explanation in the popular culture is that Americans just spend too much money on frivolous things like SUV's, flat screen tvs, meals at restaurants, and the like. If you asked a conservative, they'd likely argue that such reckless spending is the result of some sort of collective moral failure on our part and an overly permissive culture. If you asked a progressive, they might place the blame on the marketing industry and the rat race mentality that pervades our society. In actuality, none of the explanations are true (though the marketing industry is indeed rather evil) because the underlying premise--that we're in over our eyeballs in debt due to fiscal recklessness--is simply false.

One of the foremost experts on the issue of increased indebtedness is Elizabeth Warren, a law professor at Harvard. She wrote one of the chapters in John Edwards's 2007 book on poverty in America and I highly suggest you read both her chapter and the book (Yes I know I'm supposed to despise Edwards because he lied about sex, but excuse me if I think that's less of a crime than two illegal wars, warrant-less spying, and the various trillion dollar bailouts). What she's discovered is that in actuality, the average middle class family today spends less, that's right, less of their income on clothes, food, electronics and luxuries than the average family three decades ago. Rather than being due to increased frivolous spending, the average American family is suffering from increasing levels of debt because the prices of a few big ticket essential items have gone through the roof. Namely, the cost of education, transportation, and in particular, health care have gone up dramatically. (On a side note, this is why the argument that Wal-Mart benefits American workers overall because of its low prices, despite its negative impact on wages, is patently false. Wal-Mart sells things that consume less and less of our incomes, largely due to forces outside of its control, yet exerts powerful downward pressure on wages for low income workers, which are used to buy essentials like health care, which Wal-Mart doesn't sell. But I digress.) These increases wouldn't be so bad if the past thirty years saw a concomitant increase in wages. However, as most Americans know all to well, wages have largely stagnated since the late 1970s and have lagged behind productivity growth considerably. In fact, had wage growth tracked productivity growth over the past 30 years, the median American income would be $20,000 higher and the minimum wage would be $19.12 per hour. That's right, over 19 bucks an hour.

Unless we take steps to both control the cost of transportation, education, and health care and increase wages, we will inevitably continue down our current destructive path. Who knows, maybe the fed has discovered some new form of wealth, the value of which it can inflate or allow to inflate in order to create a new bubble. I doubt it, however, and even if they could it would merely delay the inevitable and exacerbate our current problem of excess debt. Thus, I would contend that policies like single payer health insurance, expanding public transportation, and the Employee Free Choice Act, which would make it less impossible for workers to join unions, are not only essential to make our society more decent and equitable but also for restoring economic growth. That would be change we can believe in.