What’s Next Q&A: The real effects of intervention

Veteran economics academic Edwin T. Burton, visiting professor at the University of Virginia, recently joined The Daily Progress editorial board to discuss economics and politics, recession and stimulus, and related issues.

The following is excerpted from that extensive discussion.

Q. What’s your take on the current economic situation?

A. John Taylor [in The Wall Street Journal] argues — and I’m making the same argument — that this was a bread-and-butter credit freeze-up that government essentially ignored. The freeze-up occurred in the summer of ’07. Federal Reserve Chairman Ben Bernanke and [former] Treasury Secretary Henry Paulson completely missed it.

You could see massive dislocation taking place and a huge amount of fear in the asset-backed securities market, which just didn’t trade anymore. And the asset-backed securities market is 20 percent of all the credit provided in the U.S. economy.

Yet the stock market soon traded at its all-time high. On Oct. 9, the stock market traded at 14,160 — in the face of the worst credit collapse in financial history. It was a complete disconnect. And it continued to be ignored until Martin Luther King Day.

And then Bernanke is sitting in front of the television set and sees the European markets collapsing. He calls an immediate meeting of the Federal Reserve.

And there was no change in the economy! Nothing!

Why did he take action? Because of the stock market. The stock market has driven behavior by policymakers from the beginning. They never cared about the credit markets.

Q. But then things seemed to get worse …

A. The first gong in ’08 was when Bear [Stearns] went under in March.

This is the first chance the government has to do something. What did it do?

I am convinced this is where they made the crucial mistake. I think they should have let Bear Stearns go. Bear Stearns was not a big player.

It’s not the first time Wall Street firms have fallen apart. In 1988, Drexel Burnham went broke ‘just like that.’ They were the most profitable Wall Street firm in 1988, and they went under in a day … without a ripple.

If Bear had been let go, the world wouldn’t have come to an end, but one good thing would have happened: The asset-backed securities that they had on their balance sheet would have been sold, and then you would have created a market for the asset-backed securities [although] it would have been a low market, a vulture market.

But what did the Fed do? It orchestrated acquisition by JP Morgan of Bear and it ring-fenced 300 million of Bear’s assets. That means they’re not going to sell them. So you can’t get the market trading again.

Every bit of Fed and Treasury policy throughout this has been to prohibit the market from trading. Every single bailout.

Well, they had an opportunity there. By the time you get around to Citigroup, you’ve got to be nervous. Citigroup is a real big operation, so just letting them go under would scare a lot of people. But Bear Stearns doesn’t scare anybody. Why not let Bear Stearns go?

Q. But the American people were scared. Why the disconnect?

A. There’s so much misinformation. For example, if I went out and polled the average American and asked him: What do you think commercial bank lending did in October, November, December? Think it fell off the cliff or went up?

The average guy watching the news would think it went down. It didn’t go down. And the numbers are readily available; go to the Federal Reserve Web site. It was up 2 1/2 fourth quarter over third quarter. The year as a whole, ’08, it was up 5 1/2 over ’07. Those numbers are readily available, and yet every single day in the media, you hear that bank lending has fallen apart. It’s just not even true.

Survey local banks, you get the same response. I remember in October Bernanke goes on television and says car loans won’t be available. So I call all over the area and say: Are car loans not available? [The dealers] said: There’s been no change in the car loan market. None.

Q. One of the things that’s common in the media now is the pretty universal description that almost all economists on all sides of aisle now believe that a giant stimulus to the economy is necessary, and fast. Where do you stand on that?

A. No. Oh, no. You’ll find that 300 economists signed a letter

against it, including many, many Nobel Prize winners.

For one thing, there will be no employment pickup. There’s essentially no job creation in this package. It doesn’t have any spending in it. The infrastructure spending in this package is 30 billion… .

This is not a stimulus package; it’s kind of a wish list, and [Pres-ident Barack Obama] is paying back his constituencies. The problem is the cost.

Nobody minds if you pay back your constituencies with 50 billion. But 900 billion, on top of TARP, on top of all these guarantees by the Fed — you’re pushing your credibility as a borrower.

I think Obama has blown it. The package that he could have gotten Republican support for would be a package that’s half true infrastructure spending, and fairly quickly — let’s build roads in Northern Virginia; people want that, for sure — and the other half, tax cut.

But if you don’t want to give it to “the rich,” make it a payroll tax cut. That’s certainly not going to benefit the rich. And payroll taxes are enormous.

It’s all about incentives. What you want to do is let people see there’s a bright future. And so if you say: We’re going to cut all the payroll taxes tomorrow in half, for the next five years, people are more likely to want to take jobs.

Same with business. Why not announce that three years from now we’re going to slice corporate income taxes in half for three years?

That way you have no immediate cuts in revenue, and people can say: Well, then, I think I’ll start a new business.

This, by the way, is not a Democratic disaster. It’s a Republican Party disaster. The Dem-ocrats didn’t do anything wrong in here, they just kind of went along with all these crazy policies [of the previous administration].

Q. Is there any good news?

A. Well, the National Business Review claims that the recession began in December of ’07. What kind of recession has 2 percent real growth, for quarter after quarter? The first half of ’08 was 2 percent real growth. That’s not a recession number.

There was increasing unemployment, but you still had unemployment in the 5 1/2 region. That’s not a recession number. You need double that to be talking about recession.

I don’t think this recession is all that serious. Quit referring to this as the Great Depression. You’ve got 7 1/2 percent unemployment.

Most countries in Europe would give their right arm to have an unemployment rate that low.

I mean, look at Virginia. You wouldn’t know that there was a recession. You’ve got 5.2 percent unemployment in the state, and it’s below 5 in [some areas].

Q. Virginia historically has a more stable economy. What about the rest of the country?

A. I’m on a board in New York, so I’m in New York all the time. People are so gloomy there, it’s unbelievable. But that is a depression, because their major business is on the rocks.

But it had to happen. Waving everything else aside, the excesses on Wall Street were stupid.

You have this whole culture that grew up somehow thinking that in two or three years that it’s natural to be make $300,000 a year [from a $50,000 skill set]. But it isn’t. No business can sustain itself doing that.

Q. Going forward, what could be done?

A. Well, if you do nothing at all, it looks like the economy is going to bottom out in the summer. January was an extremely positive month. It was one of the best months in history in investment-grade credit.

So there are all kinds of signs the credit market is easing, and good signs in the housing market. Even in South Florida you’re beginning to see a huge number of transactions, vulture transactions.

That’s what turns these markets around: People come in and buy something for $45,000 that sold last year for $200,000.

Even in this market, you’re beginning to see some good things happen. This market, for example, should bottom out by the summer, I would think, and most markets in the economy.

It’ll take a little longer for Vegas, a little longer for Phoenix.

Florida’s already beginning, in my opinion. Moody’s already predicted that the housing market will bottom in the summer, which is interesting. They’re the only ones predicting that other than me.

If they do nothing at all, there’s a very good chance that this is just a mild recession, somewhat less severe than the ’89-’91 and ’79-’81.

Problem is, when you do all these heroic things, you convince people that things are really bad.

It will recover, no matter what the policy. The question is the speed.

Now the government can help that if it puts incentives out there; or it can be neutral, in which case it will recover fine, or it can begin to throw a ton of roadblocks in the way.