Theme: Crisis

http://krugman.blogs.nytimes.com/2008/02/16/defining-the-macroeconomic-problem/KRUGMAN RECAPTURE: FROM FEBRUARY 2008 – ON THE CRISIS

http://krugman.blogs.nytimes.com/2008/02/16/defining-the-macroeconomic-problem/#comment-19177

1) In order to sustain that spending you seek, and support reorganizing both production and consumption, all these groups need impetus that it no longer appears policy can quickly reorient. Our tools seem to have exhausted their usefulness:

-Monetary Policy and Bureaucrats

-Traders (private sector)

-Institutions (commercial banks and insurance)

-Merchants (Distributors)

-Producers (theory, capital and production cycle)

-Ordinary Consumers and Their Daily Spending Habits

-Interpersonal Networks (intertemporal theories)

-Common Sense and Traditions (long wave theories)

2) I would like to understand why we don’t just put the onus back on the debt market by authorizing a new set of banks or bank divisions to issue home loans at some fractional value, and forcing the previous lending institutions to write off the debt, rather than letting people get forced out of homes and have their equity destroyed – especially if the problem was created by monetary policy in the fist place.

If the asset bubble will evaporate anyway, why pay the knowledge-cost and related stresses? Instead, why not simply force the issue and make consumers elated (and make them into spending consumers) because of it. What you do to refinance the write downs is paid one way or another – either by market losses or by buying out the bad debt. But this is the only method by which I can see we can affect the entire chain of human behavior quickly and positively without paying the dreadful cost of uncertainty over a period of four or five years. (Roughly what I am able to calculate it will take – not the two years I see others coming up with.)

The problem I see on the horizon is the limited innovation going on in the economy outside of healthcare, and even that is under threat. This coming period of contraction and consequent distraction is time we cannot afford to lose. We need to be competing and we need to channel money into innovation rather than home construction. (This is a lengthy topic in it’s own right.)

There must be some variant of this solution that would be sufficient. Imagine all homeowners reducing their mortgages by two thirds, or perhaps better said, simply refinancing DOWN and retaining their equity, as often as possible, and what that would do to the economy. (I cannot go into detail on a blog but this is a solvable process.) Raise interest rates and give ourselves room to control inflation rather than deflation, which is the only choice we really want to make.

I understand the natural objections but hiding this deflation inside of market processes will still yield the same result and the consequential shock will be very hard on the average person. Demographically, I am very concerned that if we don’t do something like this many people will simply not recover their financial lives. Ever. There are just too many people too late in life with too little savings, and the savings they have in their homes looks like it is rapidly going to evaporate. They cannot afford the double loss of equity and earning remaining lifetime earning potential as all this works out — time being the ultimate scarce capital we all have to work with.

Cheers

— Curt Doolittle