Five Lies About the American Economy
The Obama team's favorite slices of fiscal baloney
The ongoing recession has raised a troubling question for otherwise resurgent Keynesian economists: How can the American economy keep getting worse under the intensive care of an interventionist economic team almost universally praised for its brilliance? The answer may be that the Obama administration is dealing with a fictional economy, one that bears little resemblance to the economy the rest of us inhabit. And when the difference between fact and fiction becomes too apparent, they just make stuff up. Herewith, five big lies the administration loves to tell and the mainstream media (with some notable exceptions) love to repeat:
1. Bold government action staved off a Depression, saving or creating 1.5 million jobs.
"Just remember," Treasury Secretary Tim Geithner said on November 1, 2009, "a year ago today, last year, you had markets around the world come to a stop. Economic activity just stopped, came to a standstill, like flipping a switch."
Geithner implies that the American business climate improved substantially in the first year of the Obama administration. In fact, nearly every indicator, from employment to freight transport to rents to retail sales to real estate, has headed steadily south. In some cases, such as unemployment, the numbers have been far worse than the Obama economic team's worst-case projections. In others, such as real estate, the weakness of the market is masked by expensive government support, including but not limited to the unkillable First-Time Homebuyer Credit, an assault on loan underwriting standards (see Lie No. 2) by the Federal Housing Authority and the government-run mortgage giants Fannie Mae and Freddie Mac, and the completely opaque $75 billion Home Affordable Modification Program (HAMP).
The $787 billion in stimulus spending authorized by the American Recovery and Reinvestment Act of 2009 is now best known for its inflated and unsupportable job creation numbers. At press time, Council of Economic Advisers Chairwoman Christina D. Romer (who, confusingly, made her academic reputation proving that fiscal stimulus did not help the U.S. economy during the Great Depression and World War II) was giving the stimulus credit for 1.5 million American jobs in 2009. All efforts at checking her claims, however, have turned up very different numbers. The Associated Press, the Boston Globe, the L.A. Weekly, and local papers around the country have failed to find actual jobs to match up with those being reported at Recovery.gov. The administration's only concession to this reality has been rhetorical: After claiming that hundreds of thousands of jobs had been "created" early in 2009, the Council of Economic Advisers turned to the phrase "saved or created" by mid-year. In December the Obama administration again changed its measure to jobs "funded" by the stimulus.
Of all the government interventions since the start of the real estate decline, only one—the rescue effort for too-big-to-fail Wall Street players, which predates Obama—has had a measurable effect. The Troubled Asset Relief Program, the Federal Reserve's promiscuous use of discount windows and dollar-destroying low interest rates, and the Treasury Department's open wallet for incompetent financial institutions have cumulatively ensured the survival of the biggest, failiest financial institutions, including such devourers of the commonweal as Citigroup, which managed to lose $7.6 billion in the fourth quarter of 2009 despite an infusion of tens of billions of taxpayer dollars over the year.
2. "No one wants banks making the kinds of risky loans that got us into this situation in the first place."
President Obama made this claim following a December meeting with big bank officials, then contradicted himself by urging bankers to take "third and fourth" looks at rejected business loan applications. But the administration has been even more enthusiastic about encouraging another type of credit: the precise risky loans that got us into this situation in the first place.
Mortgage lending standards have declined, and the amount of risky debt taxpayers are underwriting has rapidly increased, under Obama's guidance. A 2009 audit found that the Federal Housing Authority (FHA) was failing to vet lenders, ignoring missing borrower documentation, and declining to consider negative information prior to guaranteeing loans. More important, the FHA still guarantees mortgages with a minimum down payment of only 3.5 percent, despite abundant evidence that a borrower with low equity is more likely to default than any other type of borrower. (See Lie No. 3.) Defaults on government-approved loans continue to rise, as do redefaults on mortgages refinanced under HAMP.
Undaunted, the administration wants to give unpromising borrowers greater access to debt. At press time, the Treasury Department was considering allowing borrowers to get HAMP modifications by using only pay stubs, rather than tax records, to prove their financial status.
3. The economic crisis is a "subprime crisis."
"We believe the effect of the troubles in the subprime sector on the broader housing market will be limited," Federal Reserve Chairman Ben Bernanke said in May 2007, "and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."
To understand how Bernanke could be so wrong on something so important (see Lie No. 4), note that the real estate bust was not a problem with self-identified "subprime" loans (mortgages that are made to borrowers with bad credit and not backed by Fannie Mae and Freddie Mac). In fact, the rapid expansion in subprime lending was a late phenomenon that occurred in the last 18 months of a decade-long real estate bubble. Subprime defaults are actually slightly below their worst-ever historic records, and the explosion of subprime defaults that began in 2005 was accompanied or slightly preceded by a statistically equal explosion in prime defaults.
How is this possible? The period going back to the mid-1990s has seen a massive increase in mortgages that look prime (and are backed by Fannie and Freddie) but in fact feature dangerously low down payments, tricky interest-only and adjustable rate mechanisms, and other inadvisable debt schemes. Late in 2008, Fannie Mae admitted in a footnote that its portfolio had for years been stuffed with alt-A, negative amortization loans, and other junk debt.
Statistically speaking, the only reliable gauge of default probability is how much equity the borrower has as a share of debt. Fannie, Freddie, the Department of Housing and Urban Development, the Federal Housing Administration, and all other federal real estate concerns have been working since the 1990s to increase the loan-to-value ratio of mortgages. They have succeeded: Americans now own a smaller percentage of their homes than at any other time in history.
4. Ben Bernanke is a heroic leader.
"The man next to me, Ben Bernanke, has led the Fed through one of the worst financial crises that this nation and the world has ever faced," Obama said when nominating Bernanke for a second term as Fed chairman. "As an expert on the causes of the Great Depression, I'm sure Ben never imagined that he would be part of a team responsible for preventing another. But because of his background, his temperament, his courage, and his creativity, that's exactly what he has helped to achieve."
Seconding that emotion, Time anointed Bernanke its 2009 Person of the Year, swooning over the Fed chairman's cranial power, his "tired eyes," and such bold action as lowering interest rates to zero and paying banks to keep deposits in the Fed's vaults—none of which has translated into noticeable economic health during the last two years. (See Lie No. 5.) "He wishes Americans understood that he helped save the irresponsible giants of Wall Street only to protect ordinary folks on Main Street," Time wrote.
Alas, no sooner had the year turned than Bernanke's reality distortion field began to fail. His reappointment, though inevitable, turned out to be a bigger challenge than expected, with a left-right Senate coalition rising up to make hay out of Bernanke's abundantly documented record of wrong bets and absurd predictions. Had Bernanke limited himself to defending fictions about his own career, he might have stayed out of trouble. Yet he continues to maintain, in one of many examples, that former Fed Chairman Alan Greenspan's artificially low interest rates in the early part of Decade Zero did not contribute to the real estate bubble. The hapless banking chief's performance may have been summed up best by the financial blogger Mish Shedlock: "Bernanke did not get a single thing right."
5. The worst is behind us.
"Here is what I know," Larry Summers, Obama's top economic adviser, told ABC in December. "We were talking about Depression; we were talking about the financial system collapsing. Today, everybody agrees that the recession is over, and the question is what the pace of the expansion is going to be."
Shortly after Summers made that comment, third-quarter GDP numbers were revised downward substantially. (They have traveled from 3.5 percent to 2.8 percent to 2.2 percent so far.) Former Fed Chairman Paul Volcker told Der Spiegel in December 2009, "You know, people get very technical about these things. We had a quarter of increased growth, but I don't think we are out of the woods." In January regional unemployment rates, which had shown some signs of improvement, began moving up again. The unwinding of consumer and homeowner credit continues. Christmas spending turned out to be only slightly higher (around 1 percent, according to MasterCard's Spending-Pulse unit) in 2009 than in 2008—when, according to Summers and others, the United States was flirting with depression and financial collapse. The only good news: a return to GDP growth in the second half of 2009, based largely on inventory investment and nonresidential fixed investment, not a return to demand or underlying growth.
But the truly dire evidence is in real estate, the market that drove both the bubble and the bust. A record 7.6 percent of U.S. homeowners are at least 30 days late on payments, according to Equifax, and delinquencies continue to rise at an increasing pace. About 1.2 million loans out there are in limbo: The borrower is in serious default, but the bank has not started the foreclosure process. Another 1.5 million are in the early stages of the foreclosure process, but the banks haven't yet taken possession of the homes. By a conservative estimate, there may be 3 million to 4 million foreclosed homes coming onto the market in the next few years. This is the inevitable, and salubrious, reaction to many years of real estate inflation, and it will continue to happen no matter how hard the government pretends it can control economic outcomes. See Lie No. 1.
Contributing Editor Tim Cavanaugh (bigtimcavanaugh@gmail.com) writes from Los Angeles.