Monday, September 29, 2008

Spending

I'm still not an economist, yet I continue to be amazed by what must be either the economic illiteracy or deliberate obfuscation of the McCain/Palin campaign. The all-purpose answer to the question of how we got into, and how we should get out of, the current crisis, is government spending: The government spent too much in the past and should spend less in the future. Sen. McCain has said something like this over and over again, including in Friday's debate, and Gov. Palin, to the extent that she said anything that could be said to have propositional content, seemed to reaffirm the point in her Katie Couric interview.

Let's begin with the low-hanging fruit. If someone were committed to the proposition that government spending is bad for the economy, wouldn't he or she be strenuously opposed to the bailout? Indeed, wouldn't he or she be opposed to all of the proposed alternatives to the bailout that involve large expenditures of government funds? I suppose one could support the bailout---or at least not oppose it---if one thought the government would end up making a profit, but that seems unlikely here, and in any event, one hears absolutely nothing from McCain or Palin about why, if government (non-military) spending is generally bad, this time it's even a necessary evil.

Now the slightly higher fruit: Within the last couple of weeks, McCain has sometimes suggested that the underlying cause of the current crisis was "greed" on Wall Street, notwithstanding the fact that as a free marketeer, he was supposed to believe that through the magic of the market, private greed leads to public good. Perhaps because McCain is not convincing attacking greed, he has also stuck with his other explanation: government spending has gotten out of control. During Friday's debate, he cited government spending over and over again as the cause of our problems, including, specifically, the current financial crisis. To wit: "And the reason, one of the major reasons why we're in the difficulties we are in today is because spending got out of control."

Huh? There are plenty of reasons why one might think that wasteful government spending is a bad idea, but surely it was either irrelevant to, or actually worked against, the causes of the financial crisis. The housing bubble facilitated the sub-prime mortgage crisis because, with home prices rising, lenders didn't worry about borrowers' ability to repay: If the borrower defaulted, no biggie; the house is worth more anyway; and borrowers falling behind in their payments could simply flip the houses for a profit. What, if anything, was the effect of federal deficit spending on the housing bubble? Probably to make it a little less bubbly than it might have been. When the government spends more money than it collects in taxes, it must borrow money. That government demand for credit in turn raises the cost of credit, i.e., drives interest rates up, which makes home purchasing somewhat less attractive. So, without excessive government spending, we probably would have had even lower interest rates, and an even larger bubble.

There is a possible counter-story here: Low interest rates were the product of a deliberate Fed policy of economic stimulus that wouldn't have been necessary but for the drag that government spending had on the economy. There's no really good evidence that the Bush deficits dragged the economy in this way; a Keynesian would say just the opposite. But to the extent that one buys this counter-story, then the blame for keeping interest rates falls on the architect of the Fed policy, Alan Greenspan. And McCain, while listening most to Phil Gramm on economic matters, has frequently cited Greenspan as his great sage. So the counter-story is an even bigger mess for McCain.

To be clear, I'm not saying that the Bush deficits have been good for the economy. What I am saying is that tracing their effects requires at least some rudimentary understanding of supply and demand. If McCain has such an understanding, he has not explained how his single-minded focus on government spending as the root of all evil fits in with it.

Posted by Mike Dorf

17 comments:

egarber said...

That government demand for credit in turn raises the cost of credit, i.e., drives interest rates up, which makes home purchasing somewhat less attractive. So, without excessive government spending, we probably would have had even lower interest rates, and an even larger bubble.

I read somewhere that the bailout may drive up rates -- erasing the easing that would come with a general improvement in confidence. If the government has to spend 700B, it's gonna have to borrow it, thus flooding the market with treasuries. Assuming foreign investors even want to own more American debt, this supply glut will drive prices down, and yields (interest rates) up. Plus, the crowding out of private investment puts upward pressure on interest rates.

On another note -- maybe you or Neil can write about this -- I'm starting to get annoyed with conservatives blaming the whole crisis on Fannie and Freddie. The narrative is that F and F were reckless and the whole mess starts and ends there. The political reason for the argument is pretty obvious: it gives conservatives a way to say that in the end, it was "big government" that caused the problems (given the quasi public status of F & F).

But from what I've seen, that simply doesn't hold up.

1. For one, during the run-up, F&F's share of the total securitization market dropped to historically low levels. The entities only executed about 40 percent or so of the total securitization. The remaining 60 was through purely private underwriting efforts.

2. F&F stayed away from subprime loans almost altogether. I've heard conservative commentators say just the opposite. F&F focused on prime (and maybe some Alt A loans); the really toxic stuff was put in motion by the investment banks.

Where am I wrong here? I'm certainly not an economist OR a lawyer :), but these seem to be basic facts to me -- and nobody in the media is correcting it.

Neil H. Buchanan said...

Mike stole a bit of my thunder, as I am planning to post something tomorrow about McCain's comments about spending. Still, there's so much wrong with McCain's comments that I'll still have plenty to say.

One small point in agreement with egarber: Fannie and Freddie did NOT engage in subprime lending. By definition, subprime loans are those too toxic to have met Fannie and Freddie's standards.

Tam Ho said...

Giving toxic loans is perfectly fine, so long as it is done under the umbrella of job creation. Duh.

Paul said...

http://www.creditslips.org/creditslips/2008/09/is-the-crisis-r.html

That is the sort of thing that makes sense to me. I don't have (and won't be installing) Real Audio, so I am relying on the summary to which I linked.

For those uninterested in following links, my summary of the summary is that Rogoff thinks the promise of a bailout is the actual source of the problem.

The logic is compelling to me and can be summed up from this quote:

"why do business with Warren Buffett who will negotiate a tough deal, if you believe that the government will ride in soon with cheaper cash?"

I would love to see some of the smarter people on here that none-the-less believe in the "crisis" tell me where Rogoff has it wrong.

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