An Economics Professor’s Reflection on the Economic Crisis
October 20th, 2008This is part of an email thread that took place last month (starting the night of Bush’s address to the nation regarding the economy), published with permission. Michelle Ranville was the professor for an economics course I took last semester at Old Dominion University. If you happen to go to ODU and need economics credits, I would highly recommend taking her courses.
This is part of the email I sent:
Well, I’m sure you’re aware, and more informed than myself, about the whole economic crisis thing, complete with Presidential address tonight.
We had discussed in class about Bush’s stimulus package being a bad idea, and it made perfect sense about it being a bad idea. Apparently a part of Barack Obama’s idea for a response to the crisis is issuing another stimulus package… I could be wrong about the details of that, but I was curious, if you get a couple minutes at some point, about your thoughts on that… Thanks!
This is her insightful response:
Ah, the economy… Such a poignant topic and one that we are so helpless over at this point — at least as citizens. I saw this $50 billion stimulus package deal that Obama presented. Knowing nothing more about it, I would have to say that it really misses the point. In this situation, this would be equivalent to firing a pellet gun at a charging elephant — no effect whatsoever, and a waste of pellets.
What it boils down to is that during a time of inflation and serious structural problems in the banking and housing sectors, a fiscal stimulus package is not a good fix because it will put upward pressure on prices, but won’t jumpstart the economy because most investors are aware of these other problems and are not incited to start loaning money (and hence creating jobs) because of a little additional consumer spending. Indeed, the 2nd quarter GDP figures reflected this. Consumer spending rose by about (I can’t quite remember the exact figure right now) 6%, but investment spending (businesses) fell by 11%. Remember in class we said that this was the best indicator of economic health? Overall, GDP grew… but the fact that investment spending fell so sharply reflected the fact that the Spring stimulus package was just masking deeper issues. Apparently, the most important of these “issues” is that unregulated investment titans were able to buy up all that risky mortgage debt and convert it into all sorts of fancy investment packages (ask a finance person about this, or read more about it here), and then suddenly people stopped paying their loans. They were not regulated by the Fed and allowed to take more risks than commercial banks (the kind where “we” deposit money), because they did not directly handle individual deposits. This was poor rationale for not regulating them though, because although they didn’t handle “our” money directly, they did do business with commercial banks. For example, they could buy and sell investments to the “Wachovias” and the “Bank of Americas,” thereby entangling the financial institutions that we rely on to loan money (for business investment) in this mess.
Apparently, there are more than $40 trillion dollars in these “credit default swaps” flying around right now (which are basically insurance policies against the bad mortgage debt — the reason for AIG’s bankruptcy is that they were insuring risky debt and the debt went bad). There is not enough collateral to back them. When Johnny can’t pay Susie, Susie can’t pay Bobby, and Bobby can’t pay Timmy… and so on, and so on. $50 billion can’t even scratch this problem. The only thing that is going to fix it is an unprecedented move by the U.S. government (i.e., the bailout) to inject faith back into the economy. The Fed is going to have to promise loans to anyone who needs them to remain solvent. Even if they don’t actually do it, it is the promise that counts to get banks feeling safe enough to start loaning money again. Unfortunately, the Fed not only has to calm domestic investors but also investors all around the world…especially since we will rely largely (if not completely) on foreign entities to loan us the money to pay for this enormous bailout. If they think that we are a poor investment (which seems likely at this point), there wont be any loans to fund it… As you probably know, I am not a fan of large-scale government intervention, but this time, I think it is our only option — and it’s not even a guarantee. To let it continue is sure to lead to a massive recession.
In short, no, a $50 billion stimulus package is not gonna cut it, unfortunately.