The debate on the subprime mortgage crisis solution discusses various actions and proposals by economists, government officials, journalists, and business leaders to address the subprime mortgage crisis and the wider financial crisis of 2007-08.
Video Subprime mortgage crisis solutions debate
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The debate concerns both a direct response to the ongoing subprime mortgage crisis, as well as long-term reforms to the global financial system. During 2008-2009, the solution focused on support for the ailing financial and economic institutions. During 2010, the debate continued with regard to the nature of reform. Key points include: splits of major banks; whether storage banks and investment banks should be separated; whether banks should be able to make risky trades on their own accounts; how to loosen large investment banks and other non-depository financial institutions without the impact of taxpayers; the extent to which financial cushions should be maintained by each institution (leverage constraints); the creation of consumer protection agents for financial products; and how to organize its derivatives.
Critics have stated that the government treats this crisis as one of investor confidence rather than a highly indebted institution unable to lend, delaying appropriate improvements. Others argue that this crisis represents economic activity, rather than recession or cycle decline.
In September 2008, major instability in world financial markets raised awareness and concern for the crisis. Agencies and regulators, as well as political officials, are beginning to take a more comprehensive step forward to deal with the crisis. To date, various government agencies have committed or spent trillions of dollars in loans, asset purchases, guarantees and direct spending. For a summary of the US government's financial commitments and crisis-related investments, see CNN - The Bailout Scorecard.
In the US during late 2008 and early 2009, the $ 700 billion Treasury Assistance Program (TARP) by President Bush was used to capitalize the sick banks through taxpayer fund investments. The US response in 2009, governed by US Treasury Secretary Timothy Geithner and supported by President Barack Obama, focuses on earning private sector money to recapitalize banks, as opposed to bank nationalization or a further taxpayer funded capital injection. In an April 2010 interview, Geithner said: "The differences in the strategies we adopt when we enter are to try and maximize the opportunity that capital needs can be met personally, not publicly." Geithner used a "stress test" or analysis of bank capital requirements to encourage private investors to capitalize the banks to $ 140 billion. Geithner has strongly opposed actions that might disrupt personal recapitalization, such as tight payments, taxes on financial transactions, and the abolition of major bank leaders. Geithner acknowledged that this strategy was unpopular in the community, wanting to reform more cruelly and punish bank leaders.
President Obama and key advisers introduced a series of long-term regulatory proposals in June 2009. The proposal addresses consumer protection, executive payments, financial bank pillows or capital requirements, expanded regulation of shadow banking systems and derivatives, and increases the authority for Federal Reserve to safely undermine important systemic institutions, among others.
Geithner testified before Congress on October 29, 2009. His testimony includes five elements which he claims to be essential to effective reform:
- Expanding the Federal Deposit Insurance Corporation (FDIC) resolution mechanism to include non-bank financial institutions;
- Make sure that the company is left to fail in an orderly manner and not "saved";
- Make sure the taxpayer is not in trouble for any loss, by making a loss to the company's investors and making a pool of money financed by the largest financial institution;
- Apply appropriate checks and balances to the FDIC and the Federal Reserve in this resolution process;
- Requires stronger capital and liquidity positions for financial firms and regulatory authorities.
The US Senate passed a regulatory reform law in May 2010, after the House passed a law in December 2009. This bill should now be reconciled. The New York Times has provided a comparative summary of the features of two bills, which address the various levels of principles mentioned by Secretary Geithner. The Dodd-Frank Wall Street Reform and Consumer Protection Act were signed into law in July 2010.
Solutions may be set in this category:
- Investor confidence or liquidity: Central banks have expanded their loans and money supply, to offset the decline in lending by private institutions and investors.
- Insolvent institutions or solvency: Some financial institutions face risks associated with their solvency, or ability to pay their obligations. Alternatives involve restructuring through bankruptcy, haircut bondholders, or government bailout (ie nationalization, receivers or asset purchases).
- Economic stimulus: The government has increased spending or tax cuts to offset a decline in consumer spending and business investment.
- Help homeowners: Banks adjust the terms of a mortgage loan to avoid foreclosure, with the aim of maximizing cash payments. The government offers financial incentives for lenders to help borrowers. Other alternatives include systematic refinancing of large amounts of mortgages and allowing mortgage debt to be "crammed" (reduced) in the homeowner's bankruptcy.
- Regulations: New or redesigned rules help stabilize the financial system in the long term to reduce or prevent future crises.
Maps Subprime mortgage crisis solutions debate
Liquidity
All big companies, even very profitable ones, borrow money to finance their operations. Theoretically, the low interest rate paid to the lender is offset by higher profits earned from investments made using borrowed funds. Corporations regularly borrow for a period of time and periodically "rollover" or repay the loan amount and get a new loan in the credit market, a general term for places where investors can provide funds through financial institutions to these companies. The term liquidity refers to the ability to borrow funds in the credit market or pay immediate liabilities with available cash. Before the crisis, many companies borrowed short-term in the liquid market to buy illiquid long-term assets such as mortgage-backed securities (MBSs), benefiting on the difference between lower short-term interest rates and higher long-term interest rates. Some are incapable of "rolling out" these short-term debt due to disruptions in the credit markets, forcing them to sell illiquid long-term assets at fire selling prices and suffer huge losses.
The Federal Reserve or Fed, in partnership with central banks around the world, has taken several steps to improve liquidity, basically stepping up to provide short-term funding to various institutional borrowers through programs such as the Term of Backed Securities Lending Facility Assets (TALF). Fed Chairman Ben Bernanke said in early 2008: "In general, the Federal Reserve's response has followed two paths: efforts to support market liquidity and function and pursue our macroeconomic goals through monetary policy." The Fed, a quasi-public agency, has a mandate to support liquidity as a "lender of last resort" but not solvency, which resides with government regulators and bankruptcy courts.
Lower interest rate
Arguments for low interest
Lower interest rates stimulate the economy by making loans cheaper. The Fed lowered its target for Federal funding rates from 5.25% to a 0-0.25% target range since September 18, 2007. Central banks around the world have also lowered interest rates.
Lower interest rates can also help banks "find a way out" of financial difficulties, because banks can borrow at very low interest rates from depositors and lend at higher rates for mortgages or credit cards. In other words, the "spread" between the cost of bank lending and income from an increase in lending. For example, a large US bank reported in February 2009 that the average cost to borrow from depositors was 0.91%, with a net interest margin of 4.83%. Benefits help banks rebuild equity or lost capital during a crisis.
Arguments against low interest rates
Another thing being equal, economic theory shows that lowering interest rates relative to other countries weakens the domestic currency. This is because capital flows to countries with higher interest rates (after deducting inflation and political risk premiums), cause the domestic currency to be sold in support of foreign currencies, a variation called carry trade. Further, there is a risk that the stimulus provided by lower interest rates can lead to demand-driven inflation once the economy grows again. Maintaining interest rates at low rates also impedes savings, while encouraging spending.
Monetary policy and "credit easing"
Expanding the money supply is a way of encouraging banks to lend, thus stimulating the economy. The Fed can expand the money supply by buying Treasury securities through a process called open market operations that gives cash to member banks for loans. The Fed can also lend to various types of collateral to increase liquidity in the market, a process called credit easing. It is also called "expanding the Fed's balance sheet" as additional assets and obligations represented by these loans appear there. An overview of credit easing is available at: Cleveland Federal Reserve Bank-Credit Easing
The Fed has been active in its role as a "lender of last resort" to offset the decline in lending by deposit banks and the shadow banking system. The Fed has implemented various programs to expand the type of collateral that will be lent. These programs have various names such as Term Auction Facility and Time Asset Backed Securities Lending Facility. A total of $ 1.6 trillion in loans to banks was made for various types of collateral by November 2008. In March 2009, the Federal Open Market Committee (FOMC) decided to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $ 750 billion of mortgage backed securities (government-sponsored body), bringing the total purchase of this securities to $ 1.25 trillion this year, and to increase purchases of agency debt this year to $ 100 billion to a total of $ 200 billion. In addition, to help improve conditions in the private credit market, the Committee decided to purchase up to $ 300 billion of long-term securities during 2009. The Fed also announced that it expands the scope of the TALF program to enable loans against additional types of collateral.
Arguments for credit easing
According to Ben Bernanke, the Fed's expansion of the balance sheet means the Fed electronically creates money, which is necessary "... because our economy is very weak and inflation is very low.When the economy starts to recover, it will be the time that we need to loosen those programs, interest, reduce the money supply, and ensure that we have a recovery that does not involve inflation. "
Arguments against credit easing
Credit easing involves an increase in the money supply, which presents inflation risks that can weaken the dollar and make it less desirable as a reserve currency, which affects the ability of the US government to finance the budget deficit. The Fed is lending against increasingly risky and large collateral. The challenge of reducing the money supply in rhythm and the right amount will be unprecedented when the economy is on a strong footing. Furthermore, reducing the money supply when the economy starts to recover can put downward pressure on economic growth. In other words, increasing the money supply to dampen the decline will have a dampening effect on the subsequent increase. There is also the risk of inflation and currency devaluation. Critics argue that viable borrowers can still get credit and that credit easing (and government intervention more generally) is an attempt to maintain an unsustainable debt-based standard of living.
Solvency
Critics argue that due to the combination of high leverage and losses, the US banking system is effectively bankrupt (ie, negative equity or going as the crisis lasts), while banks fight that they have the cash needed to continue operating or "well capitalized. " As the crisis evolved into mid-2008, it became clear that rising losses on mortgage-backed securities in general, institutions that were systemically important reduced the total value of assets held by certain companies to a critical point roughly equal to the value of their obligations.
A little accounting theory is helpful for understanding this debate. This is the accounting identity (that is, the rule that must be true by definition) that the asset equals the sum of liabilities and equity. Equities are mainly ordinary or preferred shares and retained earnings of the company and are also referred to as capital. Financial statements that reflect this amount are called balance sheets. If a company is forced into a negative equity scenario, it is technically bankrupt from a balance sheet perspective. However, the company may have enough money to pay its short-term liabilities and continue operating. Bankruptcy occurs when a company is unable to pay its immediate obligations and seek legal protection to enable it to renegotiate its arrangements with its creditors or liquidate its assets. The relevant forms of accounting equations for this discussion are shown below:
- Assets = Equity Obligations
- Equity = Assets - Liabilities = Net worth or capital
- Financial leverage ratio = Asset/Equity
If an asset is equivalent to a liability, then the equity should be zero. While asset values ​​on the balance sheet are marked down to reflect expected losses, these institutions still owe to creditors the full amount of liabilities. To use a simple example, Company X uses $ 10 equity or authorized capital to borrow another $ 290 and invests $ 300 in various assets, which then drops 10% to $ 270. The company is leveraged 30: 1 ($ 300 asset/$ 10 equity = 30) and now has assets of $ 270, $ 290 liabilities and $ 210 negative equity . The leverage ratio is typical of a larger investment bank during 2007. With a 30: 1 leverage, it only takes a 3.33% loss to reduce the equity to zero.
Banks use various regulatory measures to illustrate their financial strength, such as capital tier 1. Such measures usually begin with equity and then add or subtract other actions. Banks and regulators have been criticized for being relatively "weaker" or less tangible in the size of regulatory capital. For example, a deferred tax asset (representing future tax savings if the company generates a profit) and intangible assets (eg, non-cash amounts such as goodwill or trademarks) have been included in the calculation of capital level 1 by some financial institutions. In other cases, banks are legally capable of removing liabilities from their balance sheets through structured investment means, which increases their ratio. Critics suggest using a measure of "real common equity", which removes non-cash assets from this action. In general, the general ratio of general equity to assets is lower (ie, more conservative) than the tier 1 ratio.
Nationalization
Nationalization usually involves the assumption of full or partial control over financial institutions as part of a bailout. Council and senior management replaced. Full nationalization means that current equity holders are fully abolished and bondholders may or may not receive "haircuts," which implies an impairment of the debt to them. Suppliers are generally fully paid by the government. Once the bank returns to health, it can be sold to the public for a one-time profit, or it can be held by the government as an income-generating asset, which may allow lower taxes to progress.
Argument for nationalization or recapitalization
Permanent nationalization of certain financial functions may be an effective way to maintain financial system stability and prevent future crises. There is strong evidence that in the US, competition between mortgage securitizers contributes to the decline of the underwriting standards and the risks that led to the financial crisis of the late 2000s. The largest, most powerful entity - with the strongest bonds to government and the heaviest burden of regulation - generally comes from the safest and best performing mortgages. Furthermore, the period of greatest competition coincides with the period in which the worst lending came from. In addition, countries with a less competitive financial sector and greater government involvement in finance have proved far more stable and resilient than the United States in the late 2000s (decades).
Another advantage of nationalization is that it removes the inherent moral dangers in private ownership of the systemically important financial institutions. A systemically important financial institution is likely to receive a government bailout in case of failure. Unless these bailouts are structured as a government takeover, and losses are levied on bondholders and shareholders, investors have an incentive to take extreme risks, to capture increases during the boom period, and to impose losses on taxpayers in times of crisis. Permanent nationalization eliminates this dynamic by focusing all sides and negatives with taxpayers. Therefore, permanent nationalization can lead to lower and more rational levels of risk in the financial system.
Permanent nationalization also benefits government, a source of income - other than taxes - that can be used to cover losses from past bailouts or to build reserves for future bailouts. The political power of owners and top executives and board members of a systemically privileged financial institution can isolate them from taxes, insurance fees, and regulations aimed at controlling risk. Nationalization can be an effective way to curb this political force and open the door to reform.
Another advantage of nationalization is to provide governments with greater knowledge, understanding and capacity in financial markets, and can increase the government's ability to act effectively during times of crisis.
Economist Paul Krugman argued for the nationalization of the bank: "A better approach is to do what the government did with austerity and zombie lending in the late 1980s: it seized the dead banks, cleared the shareholders and then transferred their bad assets. a special institution, the Resolution Trust Corporation, pays quite a bit of bank debt to make them solvent, and sells fixed banks to new owners. "He advocates" an explicit, though temporary, takeover of the government "of bankrupt banks.
Economist Nouriel Roubini stated: "I'm afraid many banks [are] zombies, they have to shut down, the sooner the better... otherwise they'll take deposits and make other risky loans." He also writes: "Nationalization is the only option that will allow us to solve the problem of toxic assets on a regular basis and ultimately allow loans to continue." He recommends four steps:
- Determine which bank is bankrupt.
- Immediately nationalize the bankrupt institution or put them in the curator. The equity holders will be removed, and long-term debt holders will have claims only after the depositors and other short-term creditors have been repaid.
- Separate the nationalized bank assets into good and bad pools. Banks that carry only good assets will then be privatized.
- Bad assets will be merged into one company. Assets may be held to maturity or eventually sold with profits and risks imposed on taxpayers.
Harvard Professor Niall Ferguson argues: "The worst of all [the indebted] is the bank The best evidence we deny is the widespread belief that the crisis can be overcome by creating more debt... a de facto bank that does not go bankrupt needs to be restructured - a word preferably from the ancient "nationalization" of existing stockholders must face that they have lost their money.Unfortunately, they should remain vigilant against those who run their banks.The government will take control in return for a substantial recapitalization after the loss has been written meaningfully. "
Banks that go bankrupt from the perspective of the balance sheet (ie, liabilities exceeding assets, which means negative equity) can limit their lending. Furthermore, they have a greater risk of making financial bets at risk due to moral hazard (ie, whether they make money if the bet is successful or will be saved by the government, a dangerous position from the community's point of view). The unstable banking system also undermines economic confidence.
These factors (among other things) are why the bankrupt financial institution has historically been taken over by the regulator. Furthermore, loans to banks are difficult to increase assets and liabilities, not equity. Therefore capital is "tied" to bankruptcy bank balances and can not be used productively because it can be in a healthier financial institution. The Bank has taken significant steps to obtain additional capital from private sources. Furthermore, the US and other countries have injected capital (voluntarily or unwillingly) into larger financial institutions. Alan Greenspan estimates in March 2009 that US banks will need another $ 850 billion of capital, representing an increase of 3-4 percent in equity capital to asset ratio.
Following a model initiated by the British bank rescue package, the US government injected up to $ 350 billion in preferred stock or asset purchases as part of the $ 700 billion Emergency Economic Stabilization Act of 2008, also called the Troubled Asset Relief Program (TARP ).
Steven Pearlstein has advocated government guarantees for new preferred stocks, to encourage investors to provide private capital to banks.
For a summary of the US government's financial commitments and crisis-related investments, see CNN - The Bailout Scorecard.
For a summary of TARP funds granted to US banks as of December 2008, see Reuters-TARP Fund.
Arguments against nationalization or recapitalization
Nationalization abolishes current shareholders and may affect bondholders. This involves risk for taxpayers, who may or may not be able to recoup their investment. Governments may not be able to manage institutions better than current management. The threat of nationalization can make it difficult for banks to obtain funding from private sources.
Government intervention may not always be fair or transparent. Who gets the bailout and how much? A Congressional Surveillance Panel (COP) chaired by Harvard Professor Elizabeth Warren was created to monitor the implementation of the TARP program. COP issued its first report on December 10, 2008. In a related interview, Professor Warren indicated it was difficult to get a clear answer to his panel questions.
Purchase purchase of "Toxic" or "Legacy"
Another method of institutional recapitalization is for governments or private investors to purchase assets that are significantly reduced in value due to delinquency payments, whether associated with mortgages, credit cards, car loans, etc. A summary of the pros and its confrontations are included in: Brookings - The Administrations New Financial Rescue Plan and Brookings - Picking Among the Options
Arguments for the purchase of toxic assets
Removing complex and difficult-to-assess assets from banks' balance sheets throughout the system in exchange for cash is a big win for banks, provided they can provide an appropriate price for the asset. Furthermore, the financial transparency of financial institutions increases throughout the system, boosting confidence, as investors can be more confident about the valuation of these companies. Financially healthy companies are more likely to lend.
US Treasury Secretary Timothy Geithner announced plans during March 2009 to buy "inherited" or "toxic" assets from banks. The Government-Private Partnership Investment Program involves borrowing and government guarantees to encourage private investors to provide funds to buy toxic assets from banks. The press release states: "This approach is superior to good alternatives expecting banks to gradually work these assets out of their books or from governments buying assets directly.Just expect banks to work inherited assets from time to time at risk of extending financial crisis , as in the case of the Japanese experience. But if the government acts alone in the direct purchase of inheritance assets, the taxpayer will bear all the risks of the purchase - along with the additional risk that taxpayers will pay more if government employees fix prices for those assets.
Arguments against the purchase of toxic assets
The key question is what to pay for the asset. For example, banks can trust assets, such as mortgage backed securities with cash claims from an underlying mortgage, worth 50 cents, while it may only be able to find buyers on the open market for 30 cents. The bank has no incentive to sell assets at 30 cents. But if taxpayers pay 50 cents, they pay more than market value, an unpopular option for taxpayers and politicians in a bailout. To really help the banks, the taxpayers have to pay more than the value at which the bank carries the asset in its books, or more than 50 cents. Next, who will determine the price and how will the asset ownership be managed? Has the government entity formed to make this purchase have the expertise?
Economist Joseph Stiglitz criticized the plan proposed by US Treasury Secretary Timothy Geithner to buy toxic assets: "Paying a fair market value for the asset will not work.Only by paying more for the asset, the bank will be recapitalized adequately, but paying more for the asset simply shifts loss for the government. "In other words, Geithner's plan only works if and when the taxpayer loses big time." He states that the purchase of toxic assets represents "artificial capitalism", which means profits are privatized while losses are socialized.
Government-funded Asset Assistance Assistance Program (TARP) proposals are derailed because of these questions and the timeline involved in successful assessment, purchase, and management of the program is too long with the crisis to take place in September-October 2008.
Martin Wolf argues that the purchase of toxic assets may distract Congress from the urgent need to recapitalize banks and may make it more politically difficult to take the necessary action.
Research by JP Morgan and Wachovia shows that the value of toxic assets (technically CDO from ABS) issued during late 2005 to mid 2007 is worth between 5 cents and 32 cents in dollars. Around $ 305 billion of the $ 450 billion of assets created during the period is default. With another indicator (ABX), toxic assets are worth about 40 cents, depending on the exact vintage (period of origin).
Cardholders and counterparty haircuts
As of March 2009, bondholders in financial institutions receiving government bailouts have not been forced to take "haircuts" or a reduction in the principal amount and interest payments on their bonds. Partial repayment of debt to equity is quite common in Chapter 11 of the bankruptcy proceedings, since ordinary shareholders are destroyed and bondholders effectively become new owners. This is another way to increase equity capital in the bank, as the amount of liabilities on the balance sheet is reduced. For example, assume the bank has assets and liabilities of $ 100 and hence the equity is zero. In the process of bankruptcy or nationalization, bondholders may have their bond value reduced to $ 80. This creates a $ 20 equity immediately ($ 100-80 = $ 20).
A major aspect of the AIG scandal is that over $ 100 billion in taxpayer funds has been channeled through AIG to major global financial institutions (partners) who have received separate and significant bailouts in many cases. The amount paid to the partner is 100 cents. In other words, funds are given to AIG by the US government so that it can pay other companies, which basically make it a "bailout clearinghouse." Members of the US Congress demanded that AIG show whom it distributes the taxpayers' bailout funds and the extent to which these trading partners share in losses. The main institutions that receive additional bailouts channeled through AIG include "who" from major global institutions. This includes $ 12.9 billion paid to Goldman Sachs, which reported a profit of $ 2.3 billion for 2008. The list of amounts by country and opposing parties is here: Business Week - Counterparties and Payments List
Arguments for bondholders and counterparty haircuts
If the main problem is solvency of the bank, converting debt into equity through the haircut of bondholders presents an elegant solution to this problem. Not only does debt diminish along with interest payments, but equity increases simultaneously. Investors can then further believe that banks (and the wider financial system) are solvents, helping to dilute the credit market. Taxpayers do not have to contribute money and the government may be able to provide collateral in the short term to further support the trust of the recapitalization agency.
Economist Joseph Stiglitz testified that the bank bailout "... is really not a bailout fund from a company but from shareholders and especially bondholders." There is no reason that American taxpayers should do this. He writes that reducing the level of bank debt by turning debt into equity will increase confidence in the financial system. He believes that addressing bank solvency in this way will help to overcome the credit market liquidity problem.
Fed Chairman Ben Bernanke argued in March 2009: "If federal agencies have such a tool on September 16, 2008, they could be used to put AIG into conservatories or curators, loosening it slowly, protecting policyholders, and applying haircuts to creditors. and the corresponding counterparties, the results will be much better than the situation we are facing right now. "
Harvard professor Niall Ferguson argues for a haircut of bondholders in insolvent banks: "Bondholders may have to accept either a debt swap for equity or 20 percent" haircut "(a reduction in the value of their bonds) - disappointment, no doubt, but none nothing compared to the loss when Lehman fell. "
Economist Jeffrey Sachs also argues for a haircut of bondholders: "A cheaper and fairer way would be to make shareholders and bank bondholders take hits rather than taxpayers.The Fed and other bank regulators would insist that bad loans are written on Para bondholders will take a haircut, but this loss has been rewarded to be a highly discounted bond price. "
Dr. John Hussman argues for a significant bondholder haircut: "Stabilizing financial institutions that go bankrupt through a curator if the bondholders of the institution do not want to swap the debt for equity.In almost all cases, the obligations of these companies to their own bondholders can fully absorb all losses without the need for public funds to retain bondholders... The total number of policy responses to this crisis is to defend bondholders from financial institutions that are under pressure at a public cost. "
Professor and writer Nassim Nicholas Taleb argued during July 2009 that deleveraging through forced conversion from debt to equity swaps to banks and homeowners was "the only solution." He supports more aggressive and system-wide action. He emphasized the complexity and fragility of the current system due to excessive debt levels and stated that the system was in the process of crashing. He believes every "green shoot" (ie, signs of recovery) should not distract from this response.
Arguments against bondholders and counterparty haircuts
Investors may refuse to provide funds to US agencies if bonds are subjected to arbitrary haircuts because of nationalization. Insurance companies and other investors who have many bonds issued by major financial institutions may suffer huge losses if they have to accept debt for equity swaps or other haircut forms.
The fear of losing someone's investment contributing to the recession will increase with every takeover.
Economic stimulus and fiscal policy
Between June 2007 and November 2008, America lost a total of $ 8.3 trillion in wealth between housing and stock market losses, contributing to a decline in consumer spending and business investment. The crisis has caused unemployment to rise and GDP declined at a significant annual rate during Q4 2008.
On February 13, 2008, former President George W. Bush signed a $ 168 billion economic stimulus package package, primarily an income tax rebate sent directly to taxpayers. Checks sent start week 28 April 2008.
On February 17, 2009, US President Barack Obama signed the American Recovery and Reinvestment Act 2009 (ARRA), a $ 800 billion stimulus package with a broad spectrum of spending and tax cuts.
Arguments for stimulus by spending
The Keynesian economy suggests spending deficits by governments to offset a decline in consumer spending and business investment could help boost economic activity. Economist Paul Krugman believes that the US stimulus should be around $ 1.3 trillion for 3 years, even greater than $ 800 billion passed into law by President Barack Obama, or about 4% of GDP every year for 2-3 years. Krugman argues for a strong stimulus to address the risk of depression and other deflation, where prices, wages, and economic growth go down in the self-strengthening cycle.
President Obama argued his reasons for ARRA and its spending priority in his speech on February 25, 2009, to a joint session of Congress. He argues that energy independence, health care reform, and education with significant investment or expenditure are increasing.
Economists Alan Blinder and Alan Auerbach both advocate short-term stimulus spending in June 2009 to help ensure the economy does not slip into a deeper recession, but then return fiscal discipline over the medium to long term.
Economists debate the relative benefits of vs. tax cuts. spending increases as an economic stimulus. Economists in President Obama's administration argue that spending on infrastructure such as roads and bridges has a higher impact on GDP and employment than tax cuts.
Economist Joseph Stiglitz explains that the stimulus can be seen as an investment and not just as an expenditure, if used appropriately: "Wise government investment yields far higher yields than the interest the government pays to its debt; in the long run, investments help reduce the deficit. "
Arguments against the stimulus by spending
Harvard Professor Niall Ferguson writes: "The oppressed reality is that the western world is suffering from a debt crisis of excess.Many of the governments are overtaken, as are many companies.More importantly, households are moaning under the unprecedented debt burden. Is the banks The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating more debt. "
Many economists recognize that the US faces a series of long-term funding challenges related to social security and health care. Fed Chairman Ben Bernanke said on October 4, 2006: "Our unsustainable rights program reform should be a priority." He added, "the need to reform earlier rather than later is very good." He discussed how lending to allow deficit spending increased national debt, raising questions of intergenerational equity, meaning the right of present generations to increase the burden of future generations.
Economist Peter Schiff argues that the US economy is rearranged at a lower rate and stimulus spending will not be effective and only raise the level of debt: "The GDP of America comprises more than 70% of consumer spending.For many years, most of that expenditure has been the function of voracious consumer loans through the extraction of home equity (averaging over $ 850 billion per year in 2005 and 2006, according to the Federal Reserve) and the expansion of credit cards and other consumer debt quickly.Now credit is scarce, undeniable that the GDP will go down, both left and right of the American political spectrum have shown a willingness to tolerate such contractions. "He further argues that the US budget assumption means certain rich countries must continue to fund an unlimited annual trillion dollar deficit, for the return of Treasury bonds 2-3%, without significant net exchange to fund the domes program tick, which he considered highly unlikely.
When commenting on the G20 summit, economist John B. Taylor said: "The financial crisis is caused and prolonged primarily by government excesses in fiscal and monetary policy, and the continuing strength as far as the eye sees will not end the crisis or prevent any further. i> ".
The leading Republican Party strongly criticized President Obama's 2010 budget, which includes $ 900 billion or a larger annual increase in national debt until 2019 (Schedule S-9).
A large amount of real wealth is destroyed during the boom (the realization of which fact is the cause). As a result, the private sector needs to rebuild what is missing. Government spending during this period diverted resources from the redevelopment and extended the recession. Conservatives argue it would be better to cut government spending. This will reduce the input costs used by businesses that will allow them to expand and hire more workers.
Arguments for stimulus by tax cuts
Conservatives and supply-side economists argue that the best stimulus is to lower marginal tax rates. This will allow businesses to expand investments that are truly productive and cure the economy. They noted that this worked when President Kennedy and Reagan slashed taxes.
Arguments against stimulus by tax cuts
There is a significant debate among economists about the type of fiscal stimulus (eg, Expenditure, investment, or tax deduction) that produces the largest "bang for the buck", technically called a fiscal multiplier. For example, a $ 100 billion stimulus that generates $ 150 billion of additional economic growth (GDP) would have a 1.5 multiplier. Since the US Federal Government has historically collected about 18% of GDP in tax revenues, a multiplier of about 5.56 (1 divided by 18%) will be needed to prevent an increase in the deficit of all types of stimulus. Technically, the larger the multiplier, the less impact on the deficit because additional economic activity is taxed.
Various economic studies place a fiscal multiplier of the stimulus between zero and 2.5. In testimony before the Financial Crisis Commission of Investigation, economist Mark Zandi reported that infrastructure investments provide high multipliers as part of the American Recovery and Reinvestment Act, while spending gives moderate to high multipliers and tax cuts have the lowest multipliers. The conclusions by category are:
- Withholding tax: 0.32-1.30
- Spending: 1.13-1.74
- Investment: 1.57
During May 2009 the White House Economic Advisory Council estimated that the elements of the American Recovery and Reinvestment outlay would have a multiplier of between 1.0 and 1.5, while tax cuts would have multipliers between 0 and 1. The report states that this conclusion "... broadly similar to those implied by the Federal Reserve's FRB/US model and a prominent private predictor model, such as Macroeconomic Advisor. "
The supply-side economists argue that tax rate cuts have enough multipliers to actually increase government revenue (ie, greater than 5.5). However, this was disputed by research from the Congressional Budget Office, Harvard University, and the US Treasury. The Center for Budget and Policy Priorities (CBPP) summarizes the various studies conducted by economists across the political spectrum that indicate tax cuts do not pay for themselves and increase deficits.
To summarize the above research, investment and infrastructure spending are more effective stimulus measures than tax cuts, due to higher multipliers. However, all types of stimulus spending increase the deficit.
Government bailout
Arguments for bailout
Governments may intervene because of the belief that agencies are "too big to fail" or "too interconnected to fail", meaning that letting them enter bankruptcy will create or increase systemic risk, which means disruptions to credit markets and the real economy.
The widespread failure of banks is believed to have caused the Great Depression, and since World War II, almost every government - including the US in the 1980s, 1990s, and 2000s (decades) - has chosen to save its financial sector in times of crisis. Whatever the negative consequences of the bailout, the consequences of not financing the financial system - economic collapse, the protracted contraction of GDP, and high unemployment - may be even worse.
For these reasons, even ideologically ideological political leaders opposing bailouts have generally supported them in times of crisis. In a dramatic meeting on September 18, 2008, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke met with key lawmakers to propose a $ 700 billion emergency bailout of the banking system. Bernanke reportedly told them: "If we do not do this, we may not have an economy on Monday." The Emergency Economic Stabilization Act, also called the Troubled Asset Assistance Program (TARP), was signed into law on October 3, 2008.
Ben Bernanke also described the reason for the AIG bailout as "a difficult but necessary step to protect our economy and stabilize our financial system." AIG has $ 952 billion in liabilities in accordance with its 2007 annual report; its bankruptcy will make the payment of this obligation uncertain. Banks, cities, and insurers can suffer significant financial losses, with unforeseen and potentially significant consequences. In the context of a dramatic business failure and takeover in September 2008, he did not want to allow other major bankruptcies such as Lehman Brothers, which had caused money market funds and caused a crisis of confidence that brought interbank loans to a standstill.
Arguments against bailout
- Lower standard business signals for giant corporations by providing incentives to risk
- Creating moral dangers through the safety net guarantee
- Instill a corporate governance style in which businesses use state power to forcibly take money from taxpayers.
- Promote centralized bureaucracy by allowing government forces to choose bailout terms
- Embedding a socialist style of government in which the government creates and maintains control over business.
On November 24, 2008, Republican member Ron Paul (R-TX) wrote, "In dismissing a failed company, they seize money from members of the productive economy and give it to the failed." By defending the company with an outdated or unsustainable business model, governments prevent their resources from being liquidated and available to other companies that can put them into better, more productive use.The crucial element of a healthy free market, is that both success and failure should be allowed to happen when they are accepted. "But with a bailout , the rewards are reversed - the results of successful entities are awarded to failures. How this should be good for our economy is beyond me.... It will not work. It can be work... It's clear to most Americans that we need to reject corporate cronyism, and allow the natural rules and incentives of free markets to choose winners and losers in our economy, not bureaucrats and politicians' desires. "
Nicole Gelinas, a writer affiliated with the Manhattan Institute think tank, wrote in March 2009: "In place of a heartbreaking but consistent and tested process [bankruptcy] undermines the failing company, what have we chosen? The world of investors who can never be sure, at of the future, that if they put their money into a failing company they can rely on a reliable process to get back some of their funds.Instead, they may find themselves under the government's turning power from whining forward for reading the mood of a volatile public... In saving the vestiges of a failing company from a free market failure, Washington might sacrifice public confidence that the government can ensure that free markets are fair and impartial: years into an exhausting and arbitrary bailout era , it is not clear that our policy is destroying the system to interrupt turn it off will work. "
Bailout funds can be expensive for taxpayers. In 2002, the World Bank reported that state bailouts spent an average of 13% of GDP. Based on US GDP of $ 14 trillion in 2008, this would be about $ 1.8 trillion.
Help home owner
Government-administered and government-run voluntary programs were implemented during 2007-2009 to help homeowners with mortgage assistance by case, to reduce the foreclosure crisis that hit the US. Examples include Housing and the 2008 Economic Recovery Act, Current Alliance Hope, and Home Owner Frame and Stability. All of these operate under the "one by one" or "case by case" credit modification paradigm, as opposed to automatic or systemic loan modification. They usually offer incentives to various parties involved to help homeowners in their homes.
There are four main variables that can be adjusted to lower monthly payments and help homeowners: 1) Reduce interest rates; 2) Reduce the principal amount of the loan; 3) Extend the term of the mortgage, such as from 30 to 40 years; and 4) Convert variable variable ARM rate to fixed rate.
Arguments for systematic refinancing
The Economist describes this problem in a way: "No part of the financial crisis has received so much attention, with so little to show for it, as a tidal wave of house foreclosures sweeping America.Government programs have been ineffective, and private efforts are not much better. " Up to 9 million homes can enter foreclosures over the period 2009-2011, compared to one million in regular years.
Critics argue that the method of loan modification per case is ineffective, with too few homeowners being assisted relative to the number of foreclosures and with nearly 40% of the assisted homeowners returning to misbehaving within 8 months.
On February 18, 2009, economists Nouriel Roubini and Mark Zandi recommended a 20-30% reduction in the overall "systemic" (systemic) mortgage balance. Lowering mortgage balances will help lower monthly payments and also handle about 20 million homeowners who may have financial incentives to enter voluntary foreclosures because they are "under water" (ie, mortgage balances are greater than home values).
Roubini further argues that mortgage balances can be reduced in return for lenders who receive a warrant granting them the right to some future home award, which essentially exchanges mortgage debt for equities. This is analogous to the concept of the haircut of the bondholders discussed above.
Harvard Professor Niall Ferguson writes: "... we need... the general conversion of American mortgages to lower interest rates and longer maturity.The idea of ​​turning a mortgage into a puritanical legal right is a breach of contract sanctity, but there are times when the public interest requires us to respect the rule of law in the breach.Often during the 19th century governments changed the terms of the bonds they issued through a process known as "conversion." A coupon of 5 percent coupon will only be redeemable with a 3 percent coupon, to account for market prices and falling prices, such procedures are rarely stigmatized as a standard.Today, in the same way, we need a regular conversion of adjustable mortgage rates to take account of a fundamentally changing financial environment. "
The State Foreclosure Prevention Working Group, a coalition of state public prosecutors and bank regulators from 11 states, reported in April 2008 that loan servicers were unable to keep up with the number of foreclosures. 70% of subprime mortgage holders do not get the help they need. Nearly two-thirds of the loan exercises require more than six weeks to be completed under the current "case-by-case" review method. To slow the growth of foreclosures, the Group has recommended more automated credit modification methods that can be applied to large blocks of troubled borrowers.
In December 2008, the US FDIC reported that more than half of the modified mortgages during the first half of 2008 were in arrears again, in most cases because payments were not reduced or mortgage debt was not forgiven. This is further evidence that loan modification per case is not effective as a policy tool.
A report released in April 2009 by the Office of the Currency Finance Supervisor and the Thrift Supervisory Office showed that less than half of the loan modifications during 2008 reduced homeowners' payments by more than 10%. Almost one of four loan modifications during the fourth quarter of 2008 really increase monthly payments. Nine months after the modification, 26% of loans where monthly payments are reduced by 10% or more into arrears, compared to 50% where the amount of payments has not changed. The US Financial Supervisor states: "... Ã, a modification strategy that generates unchanged monthly payments or rises running the risk of a very high re-default rate."
The inability of homeowners to pay their mortgages that cause mortgage-backed securities to be "toxic" in the bank balance sheets. To use the analogy, it is a matter of "upstream" from defaulting homeowners who create toxic assets and bankruptcy banking "downstream." By helping homeowners "upstream" at the core of the problem, banks will be helped "downstream," helping both parties with the same set of funds. However, the main government assistance until April 2009 was to the bank, only helping the "downstream" side of both.
Economist Dean Baker argued to systematically convert a mortgage into a rental arrangement for a homeowner at risk of foreclosure, with a very reduced monthly payment amount. Homeowners will be allowed to stay home for a substantial period (for example, 5-10 years). Rent will be at 50-70% of the current mortgage amount. Homeowners will be given this option, indirectly forcing banks to be more aggressive in their refinancing decisions.
Arguments against systematic refinancing
Historically, loans came from banks and held by them. However, mortgages originating over the past few years have been increasingly packaged and sold to investors through a complex instrument called mortgage-backed securities (MBSs) or secured debt bonds (CDO's). Contracts involved between banks and investors may not allow systematic refinancing, as each loan must be individually approved by the investor or their delegate. Banks are concerned that they may face a lawsuit if they unilaterally and systematically convert a large number of mortgages into more affordable terms. Such assistance can also further damage the financial condition of banks, although many have written down the value of MBS assets and many of the impacts will be absorbed by investors outside the banking system.
Deciding on a contract would potentially lead to higher interest rates, as investors demanded higher compensation to risk that their contract could be subject to a homeowner bailout or government mandated grant.
Like other government interventions, homeowner assistance will create a moral danger - why should a potential homeowner pay an advance or limit himself to a house he can buy, if the government will free him when he gets into trouble?
Conflict of interest
The various conflicts of interest are debated as contributing to this crisis:
- Private credit rating agencies are compensated for debt securities ratings by securities issuers, who are concerned to see the most positively applied ratings. Critics argue for alternative funding mechanisms.
- There is a "revolving door" between the main financial institution, the Treasury Department, and the Treasury bailout program. For example, former CEO of Goldman Sachs is Henry Paulson, who became Treasury Secretary of President George W. Bush.
- There are "revolving doors" between major financial institutions and the Securities and Exchange Commission (SEC), which should monitor them.
A precedent is the Sarbanes-Oxley Act of 2002, which applies a "cooling period" between auditors and the firms they audit. The law prohibits auditors from auditing public companies if the top CEO or financial management works for audit firms over the past year.
Lobby
Banks in US lobbying politicians extensively, based on a report in November 2009 from employees of the International Monetary Fund (IMF) who wrote independently of the organization. The study concludes that: "the prevention of future crises may require a weakening of the financial industry's political influence or closer monitoring of lobbying activities to better understand the incentives behind it."
The Boston Globe reported during that January-June 2009, the four largest US banks spent this amount ($ million) to lobby, despite receiving taxpayer bailouts: Citigroup $ 3.1; JP Morgan Chase $ 3.1; Bank of America $ 1.5; and Wells Fargo $ 1.4.
Before the crisis, the most aggressive lobbying banks were also involved in the most risky practices. This suggests that governments are generally a force for caution and conservatism, while private industry lobbying for the ability to take greater risks.
After the Financial Crisis, the financial services industry stepped up an aggressive public relations campaign and lobby designed to show that government policy rather than corporate policy led to a financial crisis. These arguments were made the most aggressive by Peter Wallison of the American Enterprise Institute, former Wall Street lawyer, Republican political leader, and longtime supporter of financial deregulation and privatization.
Rule
President Barack Obama and key advisers introduced a series of regulatory proposals in June 2009. The proposal addresses consumer protection, executive payments, financial bank pillows or capital requirements, expanded regulation of shadow and derivative banking systems, and increases the authority for the Federal Reserve to safely undermine institutions - important systemic institutions, among others.
Systemic risk regulator
The purpose of a systemic risk regulator is to address the failure of a fairly scalable entity that irregular failure threatens the financial system. Such regulators will be designed to address entity failures such as Lehman Brothers and AIG more effectively.
Arguments for systemic risk regulator
Fed Chairman Ben Bernanke stated there was a need for "well-defined procedures and authorities to deal with potential failures of a systemically important non-bank financial institution." He also argued in March 2009: "... I will note that AIG offers two clear lessons for upcoming discussions at Congress and elsewhere on regulatory reform.First, AIG highlights the urgent need for a new resolution procedure for nonbank financial systemically important.If a federal agency has such a tool on September 16, they may be used to place AIG into the conservatories or curators, loosen it slowly, protect policyholders, and impose a haircut on the creditor and the corresponding partner. better than the situation we are facing now, secondly, AIG's situation highlights the need for strong and effective consolidation oversight of all the systemically important financial firms AIG builds a concentrated exposure to the subprime mortgage market largely from its functional view The regulator A more effective oversight may have been identify and memb the remarkable risk taker locale at AIG-FP. changes can scalably reduce the likelihood of future systemic risk episodes like those we face at AIG. "
Economists Nouriel Roubini and Lasse Pederson recommended in January 2009 that capital requirements for financial institutions are proportional to the systemic risks they propose, based on assessments by regulators. S
Source of the article : Wikipedia
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