Further Thoughts on My Treasury Meeting
By John Lounsbury.
In a previous article reviewing my attendance at a small discussion group meeting with Treasury Secretary Geithner and other senior Treasury Officials, I left out one very important topic that was covered. I also failed to effectively summarize my overall impressions. First, let’s cover the omitted topic.
Treasury officials several times emphasized that they recognize there are still many more potential foreclosures to come. I conclude that they are not delusional about the magnitude of the remaining tenure of the housing bubble and its aftermath. I took the occasion to try to explore Treasury’s thinking. One thing Treasury folks mentioned was a responsibility to support efforts to ensure that citizens can get adequate housing. I found that very curious but let it pass because I had a larger objective, which I was able to get to shortly thereafter. But, before getting there, let me just say that I think a more appropriate statement would have been that policy should not interfere with citizens’ ability to get satisfactory housing rather than support those activities. Semantics? Perhaps. But, to me the distinction is important.
The important point that we eventually reached involved the underlying strategy of HAMP and other foreclosure prevention programs implemented by the Federal government. The Treasury statements indicate they clearly had an objective of spreading the time line for foreclosure over a longer time frame than would have otherwise occurred. I offered a paraphrased summary statement to find if I had understood policy correctly. There is no transcript but it I offered something like this:
Policy was directed at deferring what might have been 5 million (an arbitrary number for discussion purposes) foreclosure completions in 12-18 months to 5 million foreclosures over 36 or 42 or 48 or 54 months. This was done to lessen the economic shock of massive action. Do I have the essence of the policy?
The response was something like:
and also avoid some foreclosures that would otherwise have occurred.
Then add to my previous statement that policy possibly reduces the number of foreclosures ultimately experienced by 5 or 10%, if successful. In other words, 5 million foreclosures might be reduced to 4.5 million or 10 million foreclosures might be reduced to 9 million, if the foreclosure prevention programs achieved a high level of success.
I think there was affirmative response, but I admit there was not an aha! moment. At least I am confident that my summary was not contradicted, so I will continue to feel I understand policy.
The housing discussion crystallized again for me the overall policy direction that started with the previous administration and has continued with the current one. I have joined many others in using the term “kick the can down the road”. That is in fact the formal policy. It is nowhere written in bright lights, but that is the fundamental basis of policy.
With housing, the policy has been to diffuse a foreclosure problem over a longer timeframe to reduce economic shock. With finance, the policy has been to create a “workout” time line for large banks to “earn” their way out of balance sheet problems.
The problem with this approach is, of course, that the Federal deficit basically funds the “earnings” of the banks. The FED provides new money that the banks can borrow at near 0% and the banks then buy Treasuries that pay higher interest rates. The “earnings” that the banks get from this “carry trade” process is achieved by the further indebtedness of the citizenry through the increased national debt.
This is not a growth policy. Treasury guys stated that the long term potential for the economy might be near 2.5% real growth, but that we are experiencing (going to experience?) a post stimulus slow down. Treasury does not appear to be delusional about the sluggish growth prospects for the economy. The question of a recessionary double dip was not broached, but I don’t think any opportunity was lost – Treasury would not have ventured into that realm had we attempted it, in my opinion.
Extend and pretend is official policy from what I can gather from this experience at Treasury. Pretending may not be fatal if fantasy does not become permanent. However, there is an opportunity cost. Either Prof. Cowen or Prof. Tabarrok (or both) raised the question of why leverage for restructuring of the financial system had not been exercised when the crisis peaked. I did not hear an answer. The answer perhaps resides with the timing – the end of one administration and the start of a new one. We will never know if more structural reform might have occurred if the crisis had come a year earlier or a year later. I am skeptical that would have made a significant difference, but we will never know.
For an excellent discussion of what might have been, read Barry Ritholtz’s excellent article. But if we now concentrate on what should be done from now on we must limit compulsive obsession with “coulda, woulda, shoulda” and focus forward. We must learn from history but not be preoccupied by it.
Going forward we need to “wean the sucklings from the federal teat”. I am not in the camp that wants to do that abruptly, but I am also not in the camp that wants the Bailout Nation, documented so well by Ritholtz in his excellent book of the same title, to be continued. It is time to spend less effort bailing and more effort repairing the boat.
When we recognize the size of this financial crisis, it is amazing that we have not suffered more. As I wrote last year (here and here), even when we adjust for inflation and normalize to population, this crisis is orders of magnitude larger than anything else in the past in financial terms, including the Great Depression. As much as we criticize actions taken, there are lots of worse conditions we could be in right now. The size of the financial system catastrophe is of historic proportions and we are still alive.
To anyone reading this who feels there should not be all the pain we have and will have, I submit that there is no painless way forward. What we can all strive for is a result that makes the pain ultimately worth it.
And that is about as optimistic as I can get at this point.