Liberal Economists' Blind Spots

Derek Thompson of the Atlantic asked, "How did 2011 go so wrong?"  He could not understand why the year started out so well, with all of the economic indicators pointing toward a recovery, yet 6 months later we are stalling.

Well, he came pretty close to the answer himself:  Housing.  He himself said that investment (for the top 10% of Americans mostly) plus housing constitutes the savings for American households.  Therefore the housing collapse, which we are still sorting through, dampens the demand.  And then, at the very end, Thompson concluded, well, "The hardest thing for Washington to understand is that not every economic question can be solved in Washington."

What Thompson has conveniently forgotten is that we are still sorting through the housing wreckage because of the Bush/Obama administration's housing policy.  At the beginning of the crisis in 2008/9, the presidents concluded that a "soft landing" is our top goal.  Therefore, they slowed down the foreclosure process.  The banks themselves, fearful of exposing their own liabilities and thus going out of business, went along.  The TARP program allowed the administration to dictate foreclosure policy and pace for awhile.  The Making Home Affordable program of mortgage modification gave many people the false hope of staying in their homes, and thus exhausting their savings trying to save that sinking ship of their houses.  The search for foreclosure scapegoats ended up at the robo-signing title agents, which does not change the material facts behind the foreclosure cases, but simply delaying the process.

The federal government has succeeded in their economic policy of soft landing housing.  The economic cost of that priority is the current malaise we're going through.  We have yet to find the bottom of the housing market.  There is still a huge shadow inventory in the foreclosure pipeline.  The administration's TARP funding prevented the banks from running out of cash, yet the banks' safety net allowed the banks to hold onto their foreclosed inventory, hoping that the housing prices will come back up before they run out of cash, thus allowing them to still make a profit.  So consumers' savings are tied up in their houses.  Too many people have exhausted their savings trying to stay in their untenable houses.  The rest are waiting for the market to recover before realizing their real estate savings.  The real estate market is sucking the liquidity out of the market, preventing a consumer demand-driven economic recovery.

See, in a "normal" recession, housing market starts crashing.  People start losing jobs and have to stop paying mortgages.  They either arrange a short-sale or foreclosure.  The banks start accumulating properties instead of the revenue streams of mortgage payments.  Thus banks quickly runs into their own liquidity crises.  Even though the rational banker wants to hold onto the properties as long as possible, to recover the investment, the liquidity crises forces him to offload properties.  The glut of housing supply is quickly realized, allowing the real estate market to discover the bottom quickly.  At this time, the people with cash move in.  They buy the cheap houses with their savings, releasing the cash into the economy.  The discovery of the bottom allows business owners to start planning for the recovery.  The additional cash in the economy greases both demand and investment.  Voila, recovery.

An additional factor is that, as people lose their jobs and got foreclosed on, they move to greener pastures.  The liberated labor move to where jobs are, satisfying the labor needs and increasing the monetary velocity of these growth areas.  The result feeds back into the overall recovery and we get onto the peaks again.

Whereas, because of the delay in the foreclosure process, we have too many people holding on in the Rust Belt (And California), instead of moving to the Sun Belt where the jobs are.  This exacerbates the unemployment problem, and decreases the monetary velocity in the Sun Belt. [With less labor in the Sun Belt, employers have to bid up wages.  People with higher income have lower velocity.  Thus, lower monetary velocity for everybody, and slowing down recovery.]

So yes, the government can do plenty to improve the economy.  They can start by encouraging people to move to where the jobs are, and speed up the foreclosure process.

Oh, and we are starting to see the voices saying that a default on Treasuries is better than austerity measures.  If that happens, we are going to drag the world economy down with us.  The only thing standing in the way is the Republican House.  Let's hope that they hold the line.