Above: a typical street scene in the Detroit of Obama’s economy. Lovely, isn’t it? In fact, it’s not too far off from the picture I used in Part One of my series. Oh, wait– the first picture isn’t even real. It’s from District 12 in The Hunger Games.
Part Two out of four of my case against President Obama centers on the failed monetary policy of the past four years and how such policies have both created and exacerbated the recession we have been mired in for over four years now. Part Three will focus on the truly terrible economics behind bailouts (which are only mentioned at a glance and in part here), and Part Four will expose the true cost of legislation like the PPACA, Dodd-Frank, and subsequent damage to business confidence and job creation. I’ve necessarily included a significant portion of history behind the financial crisis in order to set us up properly to read into the Fed’s actions since 2008.
The Failure of Monetary Policy
If I were to name a single man who was responsible for the financial crisis of 2008 and the prolonging of the economic slump other than President Obama (who actually has no legislative power; the stimulus was Nancy Pelosi’s project), I would name the current chief of the Federal Reserve, Ben Bernanke.
It may be unfair to criticize the presidential administration for the failings of the Fed chairman since the President actually has little power to remove the Fed chairman from office (he serves a 14 year term, and was appointed by former President Bush). However, President Obama has stated that he would reappoint Ben Bernanke come January 1, 2014, when Bernanke’s current term ends. And that, friends, is enough reason to heap the blame on Obama.
Ben Bernanke subscribes to a mixture of the monetarist school of thought expounded by the likes of Milton Friedman and Keynesian economics which many government officials and economists also believe in. In Bernanke’s mind, government has powerful levers such as adjusting interest rates which must be fine-tuned regularly to keep the economy humming along.
When the economy takes a downturn, the Fed is supposed to lower interest rates, which lowers the cost of borrowing money. When borrowing money is cheaper, people and business supposedly will borrow more money and buy more stuff – keeping the economy going. The obverse is true if the economy heats up too much: the Fed is supposed to raise interest rates, curtailing borrowing and spending.
All of that however is predicated on the consumer spending money. To do that, the consumer needs to have the money in the first place. It is no secret that, after adjusting for inflation, the middle class has remained stagnant since the 1970’s. The decline in manufacturing, outsourcing of IT jobs, and globalization have had long-running downward pressures on wages, hitting the lower-middle and blue collar workers the hardest. Forty years ago, a worker could graduate high school, get a factory job, and after twenty years get a respectable wage and benefits. You see some of this in the collective bargaining agreements that are still active in many General Motors plants – veteran workers easily make $25 an hour or more with just a high school education. But that is the exception rather than the rule. New GM workers make a fraction of that, and the $50,000 a year blue collar job is going the way of the dodo.
A Brief History Lesson on the Financial Crisis
Increasingly from the 1990’s on, consumer spending was propped up by debt financing. We saw this in the run-up of the stock market and then the rise in housing prices. Consumers could tap into the increased equity of their homes to take a vacation or buy a new car. The economy seemed to be humming along, and all was well, so long as houses continued to appreciate in value.
Problem is, Fed policy has been directly responsible for the past two recessions – the dot-com bust of 2000 and the financial crisis of 2008, which the economy continues to hemorrhage from today. I will focus primarily on the financial crisis of 2008 and the Fed response since then, which has precipitated the economic situation we are now mired in. In the early 2000’s, in response to the dot-com bust and subsequent recession, the Fed, chaired by Alan Greenspan, lowered interest rates to 1%. According to monetary theory, lower interest rates cheapens borrowing – and for the next five years, borrowing picked up significantly as people took out new loans on new houses, cars, boats, and other big-ticket items.
But the underlying economics simply weren’t there. Middle-class jobs were disappearing and incomes were stagnant or falling. Gas prices hit $3 per gallon for the first time in 2005, causing drivers of big SUV’s to lose enormous amounts of money just in keeping the tank filled up. People continued their lifestyles in the face of these pressures by floating on credit – tapping into their home equity. This was possible because many believed that houses would continue to appreciate in value indefinitely.
Thing is, that didn’t happen. The Fed, now chaired by Ben Bernanke, raised interest rates starting in 2005 in response to inflationary pressures. This was all in accordance with the monetarist school of economic thought.
The wheels fell off elsewhere. In response to increasing pressure to get more loans out the door, unscrupulous bankers and their sales agents invented the “ARM” mortgage, short for adjustable-rate mortgage. Essentially, the bank would fire off a loan with a gimmick rate to a buyer who may or may not be qualified, giving the unsuspecting buyer the greasy assurance that he or she could refinance in the future if rates began to rise. This allowed bankers to get more loans out the door, increasing profits and commissions for salesmen.
In order to free up the capital again to make another loan, the bank then packaged the unqualified lender’s mortgage with a bunch of good mortgages and resold the package as a “mortgage-backed security.” Essentially, the investor, rather than the bank, would assume the risk of the homeowners defaulting in exchange for the returns on the good mortgages. Credit-rating agencies such as Moody’s and S&P gave these mortgage-backed securities an AAA rating, indicating that they were the safest kind of investment. So, thousands of risk-averse investors – bond buyers, pension funds, people who hate losing money – loaded up on these mortgage backed securities, thinking they were safe.
Take a step back to the original homeowner, who got one of those adjustable-rate mortgages. When Ben Bernanke raised interest rates starting in 2005, the interest rates on these mortgages began to rise as well. Many of the homeowners who had qualified for an ARM mortgage didn’t qualify for a refinance despite the banker’s assurance in the past – thus, they watched their interest rate and corresponding monthly payment hit the roof. It wasn’t long before the defaults and foreclosures began.
By 2008, the peak had been reached – and after that, foreclosures multiplied and housing prices began a historic and precipitous drop. Once investors became aware of how many of their “supposedly safe mortgage backed securities” were actually terrible investments, they panicked and quickly dumped them on the banks, which were forced to take them back. Once banks became aware of the magnitude of the problem, they just as quickly realized how many of them other banks had, too – and suddenly had no idea what assets and liabilities other banks actually had on their balance sheets.
That froze up the credit markets and cost us long-running financial companies such as Bear Sterns, Lehman Brothers, Countrywide Financial, and IndyMac. As the bottom fell out of demand for housing due to credit disappearing, housing prices began to fall too. In some of the hardest-hit places such as Nevada and California, houses are still worth 50% of what they were five years ago. Thus, the equity-financed economic boom suddenly began to work in reverse – as now millions of people were now underwater on their loans: that is to say, their house was worth less than the loan they had out on it.
This sudden collapse in spending put the skids on the economy which was already reeling from $4/gallon gasoline and a divided and unpopular Congress at home. The stock market consequently lost almost half its value in a few months and housing prices are still down nationwide by a quarter or even a third from their 2007 levels.
In short, Alan Greenspan caused the rise, and Ben Bernanke caused the fall.
Ben Bernanke, however, continues to kick us while we’re still down.
It’s All Ben Bernanke’s Fault
In response to the credit markets freezing, Treasury secretary Henry Paulson engineered a $700 billion “bailout” of the banks, which would provide temporary and emergency liquidity to markets that had by then largely frozen up. Despite widespread opposition, Republican leaders such as President Bush and Mitch McConnell strongarmed the bailout through the Senate and forced the House to come to terms within a week, giving the Treasury broad authority to create and hand out as much as $700 billion, often sent in lump sum cash payments to the banks – which became known as TARP, the Troubled Asset Relief Program.
By most objective measures, the program worked – it freed up the credit markets enough to get them going again, banks were permitted to take over troubled assets of other banks, and the final cost to taxpayers is somewhere in the $80 billion range. All is fine and well, and indeed TARP’s payback exceeded even my wildest expectations.
Ben Bernanke responded by quickly dropping the interest rate to 0%. That’s right, zero percent interest. It’s been there since 2008, and currently the Fed is talking about keeping it there until at least 2015. If you’ve ever wondered why your savings account isn’t paying jack crap anymore, it’s all Ben Bernanke’s fault.
If you’ve ever wondered why CD’s at the bank don’t pay jack crap anymore, it’s all Ben Bernanke’s fault.
If you’ve ever wondered why 10-year US treasury bonds are stuck at 1.6%, it’s all Ben Bernanke’s fault.
And if you’ve ever wondered why inflation is on the march, gas prices are rising, food prices are rising, and wages aren’t keeping up, it’s all Ben Bernanke’s fault.
Ben Bernanke lowered interest rates to zero in the mistaken belief that lower interest rates would cheapen loans and increase consumer spending. That is true, except when the underlying economics don’t make sense. I’ve used the phrase “underlying economics” multiple times so far, and I’ll keep using it – when middle class jobs aren’t there, when hours and pay are being cut, when people are squeezed by high gas prices – people simply aren’t going to spend money they don’t have, no matter how “cheap” the loan is. That’s why, despite loan rates at historic lows, loans simply aren’t going out in the same numbers that they used to.
Ben Bernanke, on his part, doubled down on his mistaken bet and launched a round of unconventional monetary policy, called “quantitative easing.” Don’t led the Fed chairman fool you on this one – it’s simply printing money. The Fed prints money (electronically, these days) and plows it into Treasury bonds in an attempt to drive down the interest rates even further. Ideally, it drives interest rates below zero (after counting inflation) and will provide an extra impetus for borrowers to… well, borrow.
Trouble is, the lenders see right through this malarkey – and just won’t lend anymore. Now, it is nearly impossible to get a decent loan unless you have stellar credit – because the risk to the bank is too great, even with a small chance of default, in the face of such miniscule returns.
So what does good ole Ben Bernanke do? He then triples down on his bet, engaging in even more quantitative easing, now known as QE2 and QE3. The first time, the Fed handed out large amounts of money to the banks (about $1.5 trillion) and the banks turned right around and parked the money in TIPS – treasury inflation-protected securities.
The second time, Ben Bernanke tried buying up about $75 billion of US government bonds monthly for a time of about six months (or about 70% of all the bonds being issued monthly). All this did in the summer of 2011 was stoking unwanted inflation and gas prices again flirted with $4 a gallon, more than offsetting any gains made in consumer spending via the loan markets.
Then came QE3, starting in summer 2012 – where the Fed would buy roughly $40 billion of government bonds indefinitely. That should scare you, me, every economist, and every other rational thinker out there. Printing $500 billion a year is simply inviting disaster. Although current core CPI indicators remain low (primarily because they don’t consider food or fuel), we are going to be reaping a whirlwind of inflation before long.
What, then, does this have to do with President Obama? After all, I’ve spent the past ten minutes beating on Ben Bernanke, an unelected Fed chairman with virtually unlimited power and no accountability to anyone.
The tie back to President Obama comes in the form of the President’s political support of Ben Bernanke. Although Bernanke is a Bush appointee, President Obama is on the record as supporting Ben Bernanke, and has all intent on re-nominating Ben Bernanke for another fourteen-year term as Fed chief on January 1, 2014. That means Bernanke would be on that post until 2028. I’m not convinced America could take another fourteen years of sub-zero interest rates, inflation, and misguided monetarist economics.
A Potentially Successful Monetary Policy
As someone who received his bachelor’s in economics, I feel like I’m uniquely qualified to answer this question – so, bear with me.
As President, I would immediately seek a political solution and bring as much pressure as possible to force Ben Bernanke to resign, effective immediately. Although there is no established political procedure for doing this, a President can heap bad publicity, pressure Congress to officially condemn any continued money-printing, and legislatively revoke portions of the Fed’s charter.
I would appoint Richard Fisher, current Fed chairman out of Dallas, to be Fed chairman, with a specific mandate to get inflation under control and reverse all forms of “quantitative easing” as quickly as possible. The interest rates would necessarily have to rise to a minimum of 2, maybe even 2.5% in order to give banks a proper incentive to loan money again.
Of course, that would have a disastrous short-run effect on the stock market – expect the Dow index to drop by two thousand points within a week. But they’ll get over it. After this, the Fed must maintain a hands-off policy, allowing the economy to recover on its own terms. That, of course, is a political solution (creating good middle-class jobs), not a monetary solution.
And I’ve already began to discuss the woeful job President Obama has done in creating good middle-class jobs.