News of the fiscal fallout continues to paint a bleaker picture of the U.S. and global economies. On Saturday, leaders of G20 nations, the largest economies in the world, ended a two-day meeting where they discussed the global financial crisis and worked to figure out a way forward. But as President George W. Bush prepares to hand over power to President-elect Barack Obama, little was expected to get done at the meeting. Moreover, last week’s reorganization of the $700 billion economic bailout by Treasury Secretary Henry Paulson, a push by Congressional Democrats for an auto industry bailout, and a flurry of other issues compounded to make the economic situation seem more dire and complex.
BlackEnterprise.com spoke with Julian Morris, an economist and founder of London-based International Policy Network based with more of a free market approach, and Roderick Harrison, director at the Joint Center for Political and Economic Studies in Washington, D.C., who sees government intervention as necessary. Morris and Harrison discuss how the change in the bailout effort, a beleaguered auto industry, and additional government aid will affect each citizen, and what global governments plan to do about the crisis.
BlackEnterprise.com: Treasury Secretary Henry Paulson announced he was reorganizing the $700 billion financial sector rescue effort, instead focusing on credit cards, auto, and student loans. Why the shift?
Julian Morris: One reason could be that the original bailout was entirely misconceived.
A fundamental problem pertains to the prices the government would have paid for the “troubled assets.” If it had bought the troubled assets at market prices, it would have caused crippling mark to market adjustments across the market (the opposite of what was intended); on the other hand, paying elevated “hold to maturity” prices would be an unjustifiable use of taxpayer funds, given that such valuations would entail a fairly substantial (but difficult to quantify) premium to market prices.
Roderick Harrison: What he abandoned was the plan to buy through a “reverse auction†—-the troubled mortgage instruments that have threatened the survival of the banks and security firms that brought them heavily. The argument was that the great difficulty of knowing what might be on an institution’s books is what has prevented banks from lending to one another, causing the credit freeze. The strategy here is to give the banks sufficient reserves/funds so that they could begin lending again. This has already happened rather quickly —- about $300 billion has already been committed to financial institutions.
Where do the plans on purchasing toxic mortgages stand?
Harrison: This is what was shifted away from. The institutions will simply write these off as total losses and/or hold them in the hope that they will regain some of their value when the housing market recovers.
What provisions in the troubled asset relief program give Paulson the ability to do this?
Harrison: The program gave him broad powers to purchase assets without specifying particular mechanisms that he would have to use. He originally asked for total, unreviewable power, but the bill instead required that he report on and justify each decision. All of this is now moot since he has gone the loan/equity route instead.
With this shift, how will Americans directly benefit from the aid that’s part of the plan? For example, will people in default get assistance in repaying student loans or auto loans? Will states be able to apply for the funds and allocate to people who need help in those areas? How will it work?
Harrison: None of the current $700 billion will have any such direct applications. The money will all go to financial inst
itutions in the hopes that it will enable them to start lending again. Critics are worried that this has not yet led the banks to resume lending. They are instead sitting on the funds, building reserves to ride through the recession and/or purchasing ailing smaller banks. At best, if this works, it would help credit-worthy students, small businesses, and consumers get loans and credit again. It will do nothing to help those who are behind in or defaulting on their current loans.
Morris: The bailout plan, in more or less whatever form it takes, will be bad news for the majority of Americans. Some individuals will benefit — at a substantial cost to others. The main losers will be middle-class and working class Americans, who will suffer from a weaker economy and thus worse job prospects.
President-elect Barack Obama and key Democratic officials are pushing for an auto industry bailout, how would average Americans be affected if the auto industry doesn’t receive aid?
Morris: The Detroit-based auto industry is currently losing billions of dollars every month. By contrast, the auto industry in Alabama is holding up reasonably well considering the downturn in consumer sentiment. Bailing out the Detroit-based industry would undermine incentives to cut costs, improve efficiency, and develop vehicles that more people want to buy. It would temporarily keep some people in jobs, but at the expense of preventing others from keeping their jobs – and at the expense of new job creation.. The harsh reality is that Detroit automakers will have to reform and adapt to the changing world if they are going to survive in the long-term, regardless of whether they are bailed out this time. The sooner it begins to adapt, the more likely it will survive in the long-term.
Harrison: What is most likely is that any automaker that failed would
Will a collapse of the auto industry disproportionately impact African Americans?
Harrison: African Americans are a substantial percentage of the auto manufacturing labor force and would be hurt by layoffs. The troubled U.S. firms and their suppliers are concentrated in Detroit and Midwest states where unemployment is already among the highest in the nation. To give you an idea of the impact, Detroit already has the highest foreclosure rate of all metro areas in the nations, and African American workers and neighborhoods are among the hardest hit.
First there was the housing market meltdown, then the financial sector, now the auto industry is taking a hit and credit card companies stand closely behind, what other sectors look fragile?
Harrison: Construction has crumbled with the housing market. Consumer spending, which drive two-thirds of the economy, is diving, both as credit shrinks and as people try to save in the event of lay-offs or furloughs. People are cutting back on discretionary spending, which is hitting retailers. Transportation — shipping, trucking, air freight — is declining with few goods to transport domestically and internationally. State and local governments lose taxes and must shed workers. Healthcare is about the only industry that is still growing and that might continue to through a recession.
Morris: The outlook for the
whole economy is rather bleak, since mortgage and credit card debt has underpinned consumption for some time. But at some point the borrowing spree had to end. It’s not possible to shop on credit forever – at some point the bills must be paid.What should be Obama’s first steps in going forward in dealing with the economy as president?
Harrison: Jobs, jobs, jobs. When Sen. John McCain said the fundamentals of the economy were sound, we had already lost 750,000 jobs this calendar year. Now it’s nearly 1million. Nobody paid enough attention to this. The economy will, of necessity, keep sinking until these people are back at work and able to pay for their living expenses.
Also, infrastructure. Under the first stimulus package, the tax rebate check allowed individuals to go on for a few more months. If we put the money instead into putting people to work, i.e. rebuilding roads, the electric grid, green energy systems, schools, etc., we have something in a few years from now that will increase the efficiency of the economy and the quality of life.
Morris: The first step should be to create a more stable environment for entrepreneurs and businesses generally. That means ending the seemingly arbitrary interventions in the financial markets and allowing market participants to identify better ways of pricing risk. It means removing where possible distoritionary taxes and regulations that undermine entrepreneurial behavior.
I would advocate the introduction of a flat federal income tax and the elimination of the federal corporation tax. That would eliminate many of the tax scams that currently exist, incentivize entrepreneurial behavior, and enable individuals and families to save, invest and consume more of their hard earned cash – contributing to a stronger economy, with benefits for all.