Helping the wrong people [u]

Faced with the worst recession since the Great Depression, Obama’s key economic advisors opted to bail out financial institutions, those largely responsible for the expansion and then collapse of the housing bubble. Over time, regulatory relaxation of Wall Street led to both consolidation within the sector and greater appetite for risk using others’ money. So when the whole thing unraveled, the now too-big-to-fail banks begged to be rescued. But by whom? Well, of course, the only institution left with sufficient resources to recapitalize the banks was the federal government, which promptly infused trillions of dollars into the financial community, enabling Wall Street to resume its rapacious ways.

Five years on the economy still sputters. Wages have stagnated. Millions of Americans have simply stopped looking for work. Could it be that Ben Bernanke et al. got it wrong, that there was a better place to put the cash than into the coffers of the rich and greedy? Yes, say two MIT-trained economists. The money should have gone to bail out over-leveraged homeowners, millions of whom lost everything when the bubble burst. The New York Times:

Atif Mian and Amir Sufi are convinced that the Great Recession could have been just another ordinary, lowercase recession if the federal government had acted more aggressively to help homeowners by reducing mortgage debts.

If, as Paul Krugman and other economists aver, the economy is currently demand-constrained, with too few people able to purchase the goods and services that comprise roughly 70 percent of gross domestic product, then there is something intuitively obvious in replenishing the bank accounts of the Rest of Us than enabling further rent seeking by the One-Percent. The Times:

“If you actually look at the argument that people like Mr. Geithner make, they almost always point to financial metrics like risk spreads and interest rates,” [Mr. Sufi] said. “But if you look at the real economy, it just tends to come out in our favor.” Millions of Americans remain unemployed almost five years after the formal end of the recession.

The two economists have written a book, House of Debt, which counters the arguments made by Timothy Geithner in his Stress Test, just released.

Krugman and others believe that we are up against a zero lower bound, rendering normal government actions, like expanding the monetary base, ineffective. The Times:

The people taking the risks are the ones with the least financial wherewithal to absorb setbacks. As a result, during an economic downturn, they tend to cut their spending most sharply. Standard economics sees little problem in this, because it assumes that interest rates will fall as a result, inducing others to spend more. But in a big downturn, rates would need to fall below zero to create a sufficient incentive. The only way out, Mr. Mian and Mr. Sufi say, is for society either to forgive the debts, or to step in and impose some of the losses on the creditors instead of the borrowers.

According to the economists, the Occupy-Wall-Street crowd had it right.

____________

UPDATE (May 16, 2014):

I neglected to mention that Messrs. Sufi and Mian have their own website, houseofdebt.org.  They argued against Geithner’s book and policy here.

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