Dean Baker: The Meltdown Lowdown

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from The American Prospect:



The Meltdown Lowdown

This week in economic news: McCain advocates balancing the budget with magic, Greenspan is either a liar or a fool, and government lenders sag under the weight of bad mortgages.

Dean Baker | July 10, 2008 | web only



McCain Comes Out for a Balanced Budget (With Tax Cuts)

John McCain would like to claim the legacy of the last popular Republican president, Ronald Reagan. He took a big step toward that goal on Monday when he explained his plans to balance the budget by 2013. Just like Reagan, Sen. McCain claims he can cut taxes, increase defense spending, and balance the budget. For his next trick, he will juggle 27 flaming bowling balls, while standing on one foot on the back of a charging bull, blindfolded.

Those keeping score will remember that the deficit exploded in the Reagan years. It was 2.6 percent of gross domestic product in the last Carter budget but exploded to 6 percent of GDP -- the largest deficit of the post-World War II era -- by 1983. The debt to GDP ratio rose from 32.6 percent at the end of 1981 to 53.1 percent after the last Reagan budget in 1989. Prior to Reagan, the debt to GDP ratio had been falling consistently since World War II under both Democratic and Republican presidents.

If McCain thinks that promising tax cuts, higher defense spending, and a balanced budget is "straight talk," what would he consider lying?

What If They Are Telling the Truth?

When a high-powered official makes some really harebrained statement about the economy, I always assume that it is for political purposes and that he or she really knows what's going on.

For example, Alan Greenspan told The Washington Post recently that he first became aware of the explosion in sub-prime mortgage debt in January of 2006, his last month as Fed chairman. But the growth in sub-prime lending was not a trade secret -- by 2006 it was a widely noted development among people following the housing market and the economy.

In the same vein, Jose Manuel Barroso, the European Commission president, complained last week about the weak dollar at the same time he defended the European Central Bank's (ECB) recent interest-rate hike.

Presumably, one of the main reasons that the ECB raised interest rates was to strengthen the euro (and thereby weaken the dollar) in an effort to fight inflation. The higher value of the euro against the dollar and other currencies makes U.S. goods cheaper in Europe, causing Europeans to buy more imports and fewer domestically produced goods. (Cheaper imports also lower prices more generally in the euro zone, another way to reduce inflationary pressure.) The lower dollar also raises the price of European exports, causing people in the United States to buy fewer of them. Higher imports and lower exports will have the effect of slowing growth in the European economies, thereby throwing workers out of work and decreasing their bargaining power, which is how central banks fight inflation.

Therefore, it doesn't make sense to both support the rate hike by the ECB and complain about a weak dollar, although the higher interest rate also slows the European economy through other mechanisms. If Barroso didn't want a weak dollar, then he should be opposed to the rate hike.

Anyhow, when prominent figures like Greenspan and Mr. Barroso make statements that really don't make any sense, I have always assumed that they were doing it out of some political calculation. But what if these people are actually being honest and really don't have a clue? Let's hope they are just liars.

Fannie Mae and Freddie Mac Are Going Down. Who Could Have Known?

The stocks of Fannie Mae and Freddie Mac both fell by more than 15 percent on Monday. These giant companies were established by the federal government to facilitate homeownership through the creation of a secondary mortgage market. The secondary mortgage market allowed the banks or savings and loans that made mortgages to resell them, which meant that they could get more capital to issue new mortgages. This effectively transformed mortgage markets from local to national or international markets. In the last quarter, Fannie and Freddie, along with the Federal Housing Authority and the Department of Veterans Affairs, either issued or backed 80 percent of new mortgages. Essentially, as the private mortgage-financing system collapsed, the quasi-public system has risen to fill the gap. .......(more)

The complete piece is at: http://www.prospect.org/cs/articles?article=the_meltdown_lowdown_071008