Complacency Never Solved Anything: Housing, Finance, Recovery

The long run average in disposable income growth (96-11) = 2.8%, what we have now is 0.3%. The long term average for personal consumption (consumer spending) is about 1.8%.  [AngryBear]   So, when someone like economics writer Rebecca Wilder tells us not to be complacent about an economic recovery we should listen.  There certainly isn’t all that much to find comforting in this pronouncement from the SF Federal Reserve:

“Reports from the twelve Federal Reserve Districts indicate that overall economic activity continued to expand in September, although many Districts described the pace of growth as “modest” or “slight” and contacts generally noted weaker or less certain outlooks for business conditions. The reports suggest that consumer spending was up slightly in most Districts, with auto sales and tourism leading the way in several of them. Business spending increased somewhat, particularly for construction and mining equipment and auto dealer inventories, but many Districts noted restraint in hiring and capital spending plans.”

What’s Dragging Back A Full Recovery?

As with any complex topic the parts are interlocking and related to one another.  If one segment is lagging that will have ramifications for the total picture.  Looking at the segments should provide a larger vision of the problems we need to address.

Failure to address the fundamental problems in the housing sector.  First, it’s not just the foreclosure issue that is impinging on our capacity to recover — it’s also what we’ve lost along the way.

“Losses on owner-occupied housing have reduced consumers’ wealth by  more than $7 trillion over the last 5 years, and uncertainty about the future value of their homes, as well as the inability to refinance at reasonable rates, deters household outlays on durable goods.   The continuing weakness of the housing sector is a major source of risk for major U.S. financial institutions raising significantly the costs of the loans they offer.” [Summers, Reuters]

Secondly, those foreclosures place additional pressures on the housing markets, and it’s not just Nevada that is feeling the bind.  The following information describes what is happening in Georgia:

“In 2010, lenders repossessed 38,535 homes in Atlanta, a 21 percent jump from the previous year, RealtyTrac reported. Among the nation’s 20 largest metro areas, Atlanta ranked third nationally in foreclosure activity.

REOs accounted for 40.5 percent of all area sales last year, according to RealValuator. The median sales price of REOs was $79,900 in 2010, virtually unchanged from the year before.

Like many fast-growing communities hit by the real estate downtown, a backlog of distressed properties continues to hamper the Atlanta housing market. Bank-owned homes (REOs) sold for a median price of $71,000, down 18.1 percent from $80,400 in March 2010, the Realtor board reported.

At the same time, the median price of foreclosure properties sold at trustee sales was $121,000, down 2.6 percent from $124,192 a year ago.”

There’s a vicious cycle going on — foreclosures bring down values, lower values mean more homeowners underwater, more homeowners struggling creates less demand for durable goods.

Failure to address issues of income inequality and the interests of the middle class.  Our real estate report from Georgia is quick to point out that “distressed properties” are in the $150,000 range while in “more desirable neighborhoods with top rated schools” the market is doing much better. [Inman] The information about the widening gulf between income divisions has been readily available since 2007:

“…the increase in income inequality (both pre- and post-tax) as measured by the change in the shares of income going to different income classes, was greater from 2003 to 2005 than over any other two-year period covered by the CBO data. Over these years, an amazing $400 billion in pre-tax dollars was shifted from the bottom 95% of households to those in the top 5% (all income data in this report are inflation adjusted and in 2005 dollars). In other words, had income shares not shifted as they did, the income of each of the 109 million households in the bottom 95% would have been $3,660 higher in 2005.” [CBO, EPI] (emphasis added)

Did we gain anything from this widening gap?  Cornell University economics professor Robert H. Frank summed up the issue in his op-ed piece for the New York Times:

“There is no persuasive evidence that greater inequality bolsters economic growth or enhances anyone’s well-being. Yes, the rich can now buy bigger mansions and host more expensive parties. But this appears to have made them no happier. And in our winner-take-all economy, one effect of the growing inequality has been to lure our most talented graduates to the largely unproductive chase for financial bonanzas on Wall Street.

In short, the economist’s cost-benefit approach — itself long an important arrow in the moral philosopher’s quiver — has much to say about the effects of rising inequality. We need not reach agreement on all philosophical principles of fairness to recognize that it has imposed considerable harm across the income scale without generating significant offsetting benefits.” [NYT 2010]

What we can say with some justification is that the widening gap between income brackets in the United States has created depressed demand for goods and services, and  lowered the capacity of the middle class to continue to leverage its assets which are mostly in the form of home ownership.

Failure to curtail counter-productive activities in the financial markets which have little relationship to the real economy, but have severe consequences for it.  The financial sector, having made a royal mess of the U.S. financial markets during the Boom years, has yet to be fully restrained.

A partial explanation for the refusal of legislators to restrain some counter-productive behavior is the misapplication of the Moral Hazard argument.  For example, if homeowners are “bailed out” by judicially resolved mortgage refinancing they will be less responsible in their future economic decisions.  This, of course, assumes that homeowners behave like bankers, who have become used to privatizing their profits and socializing their risks. By contrast: “These are borrowers who were blowing through their savings struggling to stay current on their underwater mortgages, and were reaching out before default to work something out with their banks — responsible borrowers. ” [DailyFinance]

A second reason we’ve not seen more movement toward restraining the financial sector is the common misapprehension that it is the one sector of the economy which is doing well. “Three years later, the financial sector, despite coming under scrutiny for its role in the financial crisis, has returned to prominence, accounting for 29 percent — $57.7 billion — of U.S. profits during a record-breaking fourth quarter last year, notes the Wall Street Journal.”  [HuffPo] The question is: Doing Well For Whom?

If by “doing well” we merely mean is it profitable? Yes, it is a profitable sector. However, we need to raise the next question: Is the financial sector adequately performing its classic economic function of allocating capital from areas of surplus to areas of shortage?  Not. So. Much.

What about lending to small businesses? The FRSBF Economic Newsletter for October 2011 reports:

“Banks have pared their small business loan portfolios by over $47 billion since the pre-recession peak in 2007, with outstanding loans continuing to dwindle. In contrast, indirect evidence suggests that portfolios of loans to larger businesses have started growing again. The trends for small business loans are important because these enterprises play a vital role in the U.S. economy. Nonfarm businesses with fewer than 500 employees account for about half of private-sector output and employ more than half of private-sector workers. Moreover, relatively new businesses, most of which are small, generate a large share of new jobs.”

Yes, indeed, those loan trends are important — especially for the actual small businesses in the U.S. which “generate a large share of new jobs.”  But if loans to major corporations are “growing,” while outstanding loans to small companies are “dwindling,” then how do we generate those new jobs?  This certainly doesn’t reassure anyone that banks are allocating capital to those elements in the economy which might actually spur some employment and overall economic growth.

The banks have made no secret of their opposition to the Dodd-Frank Act reforms in the financial sector, especially in regard to the Volcker Rule which limits proprietary trading.  Volcker explained to the Senate Banking Committee in 2010:

“What we can do, what we should do, is recognize that curbing the proprietary interests of commercial banks is in the interest of fair and open competition as well as protecting the provision of essential financial services. Recurrent pressures, volatility and uncertainties are inherent in our market-oriented, profit-seeking financial system. By appropriately defining the business of commercial banks, and by providing for the complementary resolution authority to deal with an impending failure of very large capital market institutions, we can go a long way toward promoting the combination of competition, innovation, and underlying stability that we seek.”  [pdf]

In opposition to Mr. Volcker’s call for a measure to promote stability and competition while avoiding unproductive volatility in the markets, the financialists whined that the Fed rules for defining proprietary trading were 174 pages long! [DealBkr] Evidently, the opponents haven’t been reading fine print mutual fund annual reports lately, which require multitudinous pages of size 6 font to tell investors whether they made any money or not.

What To Do?

It’s one thing to delineate problems, another to specify solutions.  However, there’s nothing in the Solutions Department that hasn’t been offered time and again — usually to be rebuffed by the Banking industry.

HousingAllow judicial resolutions of mortgage modification agreements.  No, this will not launch us down the ravine toward Personal Irresponsibility.  What it will do is to allow an enforceable resolution of issues regarding principal payment and interest terms.  Yes, someone in the pipeline may take a “haircut,” but it is unconscionable to hold that the homeowner take all the responsibility while the banking sector “socializes” the losses.

Encourage public-private sector coordinated efforts to modify mortgages which do not require a judicial resolution.   The HAMP program was never adequately funded, and lacked authority to resolve all mortgage issues, but it was a start.  [HuffPo]  House Republican objections centered on the program’s lack of progress — which was perfectly predictable given the emphasis placed on unenthusiastic banking sector cooperation, and the lack of enforcement options available to the government.  The most common GOP objection as the House voted to dismantle the program was that it “was government interference in the private sector,” as if the private sector had nothing to do with creating the problems in the first place.

Provide assistance for those communities which are contending with high levels of foreclosure such that the impact is felt in law enforcement, loss of tax revenues, and in the need for increasing programs in social services.  Unstable housing leads to unstable communities, and since Atlanta, Georgia and Las Vegas, Nevada didn’t create the exotic financial products that eventually blew the housing market to smithereens, they can hardly be held responsible for cleaning up after the Wall Street Meltdown.

Income:  Reining in some of the more egregious practices on Wall Street would serve to reduce income disparity.  When the financial sector returns to its traditional function of channeling capital toward INVESTMENT rather than SPECULATION then we ought to see increased commercial activity, increased corporate investment in production — as opposed to mergers and acquisitions — and higher levels of employment.   To this end, the provisions of the Dodd-Frank Act should be enhanced, and certainly not repealed.  Taxation proposals should reverse the trend of shifting more of the overall burden from the upper 1% onto the remaining 99%.

Financial sector reform:  At the risk of repetition — the primary function of our financial sector should be to channel capital from surplus to shortage, from investors to industry.  While speculation has always played a role in financial transactions, when “capital gains” become more lucrative than “real economic growth” it’s time to apply the brakes on the runaway Financialist’s train.   When high speed electronic transactions cause Flash Crashes, a tax on transactions should slow the phenomena.   When shareholders have more than a marginal effect on management, then we ought to expect more long term planning and less emphasis on short term quarterly earnings reports.

There is, indeed, much to be done, and nothing will happen if we become complacent.

 

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