The burgeoning economic crisis in the country is an easy road to the White House for Democrats. But there is increasing likelihood that the economic downturn is not going to be shallow or mild, and that necessary steps to resolve the crisis may disappoint some key constituencies.
My diary last November wondered why the candidates were missing in action on the kitchen table economy. No longer a problem. But the full scale of the economic situation has not come into full view for either the candidates or their constituencies. There are multiple risks — big risks — political and economic risks — of doing the wrong thing, congratulating the Fed for doing the wrong thing, not maneuvering so as to enable the right thing to get to the table, and ultimately of being branded as inept because the problem was not solved.
The big three risks are:
- The responsibility for the economic crisis has not been clearly assigned to Bush, Greenspan and the unregulated banking sector. Bipartisanship may turn out to be co-ownership.
- Democratic fingerprints are all over a stimulus plan that likely will not work.
- The political will will not be forthcoming to do what needs to be done to prevent a hard landing and a long Japanese-style malaise to follow. Democrats will sooner or later be viewed as inadequate, paving the way for a return to the Right Wing policies that have failed so well in the current circumstance.
The economic problem was put well by Robert Kuttner in an interview with Amy Goodman last month, and earlier in an article in the American Prospect of which Kuttner is co-founder.
What is the problem?
Briefly, this recession is being generated by a credit crunch, a collapsing housing sector, and rising energy and commodity prices. These are not going away with any spending stimulus and are not susceptible to lower Fed interest rates.
In the credit crunch, banks have lost their capital in their so-called innovation of mortgages. Mortgages were turned into securities which were further engineered to create an inverted pyramid of debt. This sort of nonsense was popular for corporate debt and commercial property debt as well, but that is still behind the curtain.
At the bottom of the pyramid, near fraudulent loans were sold to people who could not afford them. In the next layer, millions of prime borrowers were persuaded to buy houses for their asset value; that is at higher prices were justified because the price was sure to go up. In the next layer banks and mortgage originators moved these mortgages into securities that got AAA ratings. These securities then became the collateral for further debt obligations; these were tranched (French for sliced) into pieces and sold on. In the end, the buyers of securities did were far removed from the mortgages, and the terms of securities were so complex that neither buyers nor sellers knew what they had bought or sold.
This is the root of the credit crunch, and is why major U.S. banks are going around the world, hat in hand. It is also why the Fed has become innovative itself, lending billions in its "special auction facility," and taking as collateral very shaky paper.
The second leg of the recession is the actual collapse of the housing market and the deflation of housing prices. This has bankrupted home builders and will end up idling millions of construction workers, but more importantly it is subtracting trillions of dollars of net worth from homeowners. Foreclosures are half the problem. The other half is the declining home equity. The housing bubble is working in reverse. As prices go down, people are beginning to carry mortgages that are greater than the values of their homes, and the temptation is to walk away — send the keys to the bank in so-called "jingle mail." This puts further downward pressure on home values and continues the process.
Well-intentioned attempts to keep people in their homes and work out terms at prices that are still too high may just kick the can down the road. Here is the seed of the Japanese-style malaise, continuing sluggish growth and near deflation for decades. Aside from its effect on the economy of the middle class, we cannot afford to get bogged down as we enter the period of real challenge on energy and the environment.
The third leg of the recession is energy and commodity price increases. Oil and gasoline prices are going up, but so is wheat, corn, food of all kinds, metals and natural gas. At the same time, and at least partly for the same reason, the dollar is slipping. It is our contention that speculation is moving from real estate into commodities and currencies. This is the inflation part of the impending Stagflation.
Tomorrow: Economics meets Politics