Interesting and very important article on Huffington Post today, contrasting the views of CEA chair Romer with those of Treasury Secretary Geithner regarding the essential features of the financial crisis, and thus illuminating the potential conflicts and difficulties over crafting a successful solution(s). It also includes some interesting comments from economist Jamie Galbraith, that we think are spot on:
Economist James Galbraith, who has been critical of the administration’s rescue effort as insufficient, said in an e-mail that "the recognition that the fundamental decline (collapse) in asset prices is the problem firmly contradicts the administration’s line that credit is ‘blocked’ and can be made to ‘flow.’ The asset price (read: housing price) problem undercuts that completely, not so much by establishing insolvency of the banks, but by establishing the lack of credit-worthiness of the borrowers. Whether Christina Romer recognizes this is an interesting question."
Consider that many of those troubled financial assets were created in an environment of 30-50x leverage (or more) in important parts of the system, historically low domestic savings, and ‘twin deficits’ that may finally have reached a tipping point. In an environment of massive deleveraging, increasing saving, and collapsing global trade, the average credit worthiness of existing borrowers is surely not likely to rise in the short run – thus the huge run up in the number of banks tightening lending standards. Against that back drop, an ‘economically hawkish’ Congress was seated in 2007, and an even more ‘hawkish’ federal government in 2009, which may well have made the solvency issue worse at the margin.
As we pointed out in 2008, there’s only one way for strapped debtors to improve their long term solvency – as opposed to covering short term pressures via asset sales – and that’s via rising incomes. Expenses can be cut to a point, an approach that the relative performance of discount to high end retailers indicates is well underway. But incomes will tend to rise only in response to incentives. Beyond providing short term life support to the financial system, a policy mix aimed at expanding real incomes broadly would be the best choice for getting us through this crisis. That’s something that Japanese policy makers never got right, and their economy continues to struggle as a result; and at the moment, our policy makers appear to be making similar mistakes.