25 March 2009

Finances

For weeks (months?) now I have been reading and thinking about the financial crisis. I have no training or real knowledge about high finance, and so I always found coverage of the subject frustratingly difficult to understand. Certainly it's fairly easy to see that deregulation caused the issues, but how and why? How could it be prevented in the future and whose fault was it?

I believe I have a handle on it now, though. It seems as though much is made of "predatory lending practices" because they are the easiest aspect of the entire loan debacle to understand: everyone can grasp that a bank might offer a poorly-chosen loan to a bad risk in order to bring in a quick buck, because it's easily reducible to something in their experience. The white-collar version of loan sharking is not a hard thing to understand.

But inasmuch as I understand, the main problem was not these practices. Instead, it seems as though the problem was that deregulation during the late nineties created a loophole whereby insurance on these bad loans ("credit default swaps") could receive a top credit rating, making them a great risk in the eyes of investors and regulators. This was done through a complicated bit of chicanery called "boxing" where bad loans and good loans were grouped together to hide the risk. And because regulations require collateral on insurance for these loans on the basis of their risk, that meant that the big finance and insurance companies didn't have to put up very much collateral for what were really quite risky loans. This made it entirely okay to have very risky loans, which is what provided an incentive for that "predatory lending." After all, if people are willing to trade you cash for manure, you'd be out back scooping up the dung, too.

But a bad risk was still a bad risk, and so when the risky loans began to collapse as the overvaluation of housing ended (the "housing bubble"), the companies insuring them had to pay up. The problem there is that because they had magicked these bad loans to look like good ones, they didn't have to put up much collateral - and in fact, didn't have anywhere near the funds necessary to cover them. Boom: there goes massive financial entities, tumbling other dominoes on the way like Fannie and Freddie (government entities forced to help take some of the risk on these loans).

I'm sure that's an oversimplified way of looking at it, but inasmuch as I can tell it's pretty much the case. Great thanks is due to Balkinization, fivethirtyeight, the essays at Znet (particularly Dean Baker's), and Matt Taibbi's recent Rolling Stone essay on the subject for bringing revelation home.

Understanding the problem (at least rudimentally), I believe that there are some steps to be taken.  Lizzie mocks my arrogance for offering solutions to the crisis, but it sure seems as though there are precious few to be had beyond pumping money all over and shoring up those entities deemed "too big to fail."  And it always makes me feel better when I think I see a way to work through a problem.

First of all, a massive reduction in the payroll tax.  This is one of the least progressive taxes America has, and it's damn near just a penalty for having a job.  If you have a job, you get this tax.  Hertzberg at the New Yorker recently wrote a bit about the matter:
Where income taxes are concerned, even Republicans seldom argue that taxing added income over a quarter million dollars at, say, thirty-six per cent rather than thirty-three per cent is wrong because the affluent need more stuff. They argue that making the rich richer enables them to create jobs for the non-rich. More jobs: that’s a big argument for capital-gains and inheritance-tax cuts, too. But the payroll tax is a direct tax on work and workers—on jobs per se. If the power to tax is the power to destroy, then the payroll tax is, well, insane.
Further, a massive public works program would also be a great idea in the tradition of the New Deal.  This has been implemented in a slipshod manner in the stimulus bill and budget, but is larded with compromises and pork (not all earmarks are pork, even though bashing them is wildly popular).  A better way to implement it would be to construct a national direct-current backbone to transmit power from one sector of the country to another, and begin solar plant construction.  This would help address another vital need of the nation while also providing a huge boost to jobs in many sectors ranging from labor to technology.

In a longer-term view, a huge increase in oversight of the Federal Reserve (preferably with a nationally elected position) and diversification of global assets out of the traditional national currencies that hold debt (dollars, euros, yen, etc.) into something like the IMF's SDRs would help make the economic czars accountable and halt future volatility.  Currently we are putting all of our eggs in one shaky basket, and that's never a good thing.

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