Why We Don’t Recover - Washington persists in postponing the bad-debt reckoning, strangling...

Washington persists in postponing the bad-debt reckoning, strangling consumption and killing jobs.

Four years ago this fall, President George W. Bush’s Treasury department tried to create a “Super Structured Investment Vehicle” to buy up some troublesome financial instruments that few people at the time had heard of. The “Super SIV” marked the start of a financial-crisis strategy that Washington continues to pursue: pretending that bad debt is worth more than it is. This now bipartisan strategy has taken a massive toll, the latest evidence of which is the news that the country created only 18,000 jobs in June—less than 1 percent of the 14 million jobs that Americans need.

The Treasury thought—or pretended to think—that it was dodging a bullet with the Super SIV. Through the vehicle, big, healthy banks, such as Bank of America, would get together and pool $75 billion in private funds to buy up the arcane securities and derivatives that were giving the financial system a headache and thus beginning to affect the broader economy. “With Wall Street firms having almost no luck finding buyers for mortgage-backed securities and derivatives, [Treasury Secretary Hank] Paulson wanted to see what could be done to relieve the bottleneck,” the New York Times reported back then. “Treasury is very serious about getting some solution in place to take away the fear hanging over the markets,” JPMorgan analyst Alex Roever told the paper. “It is a very challenging thing to do. There are so many parties involved and they all don’t agree.”

Indeed. The Super SIV didn’t work. The notion that $75 billion could have solved a multitrillion-dollar problem sounds ridiculous today; even at the time, it was a desperate move. Nearly half a year later, though, Washington took the same approach to Bear Stearns’s failure. In March 2008, rather than let Bear’s “toxic securities” fall to real market prices, the Federal Reserve stepped in, scooped them up, and parked them near its own books, so that nobody had to admit that those mortgage-related assets weren’t worth much. Six months after that, we got TARP—the Troubled Asset Relief Program. At $700 billion, TARP had nearly ten times the firepower of the original Super SIV. But it was supposed to do the same thing: buy banks’ bad mortgage securities. That would remove the uncertainty that was freezing up credit markets so that normal lending and borrowing could get the economy going again.

After intense debate, now dramatized in HBO’s film Too Big to Fail, Treasury realized that the shiploads of money couldn’t obliterate a stubborn fact: figuring out what those toxic assets were worth was complicated and would take a long time. Banks, for example, supported by Fed chief Ben Bernanke, argued that the Treasury should value the securities at long-term prices, not at “fire-sale” prices. But how could anyone figure out what the long-term prices were? Those prices depended on how steeply the housing market would decline over the next few years and on how many homeowners would default. If it turned out that the securities were worth more than the government thought, the banks would suffer unnecessarily. If it turned out that they were worth less, the taxpayers would take the bath. Because dealing with the toxic assets was so difficult, Washington decided to avoid the problem altogether. Paulson did an about-face, using TARP to inject capital directly into banks so that they could continue to obscure securities’ values.

Right before the Treasury created the Super SIV, the Fed’s own holdings totaled $869 billion. Today, that number has tripled to nearly $3.2 trillion. Essentially, the Fed has become the financial system’s Super-Super-SIV. An institution that is supposed to confine its holdings to plain old U.S. Treasury bonds now owns $918 billion worth of mortgage-backed securities. The Fed also holds $64 billion in investments in “support for specific institutions,” including what’s left of the Bear Stearns toxic assets and AIG’s mortgage-related mess. The Fed says that it values(PDF) these things at “fair value,” but that’s a canard. It’s like dropping an elephant into a half-filled swimming pool and announcing that the pool is now full of water. The financial system knows that the Fed has to get out of the pool eventually, and when it does, the water level—the prices of these toxic assets—will drop.

That’s what started to happen just a few weeks ago, when the Fed gingerly tried to declare victory. Because the central bank figured that markets were returning to health, it decided to sell some of its AIG-related securities. After the Fed made its move, an index that tracks this type of securities plummeted, after having doubled in the previous two years. The Fed panicked and made an unusual announcement that it wouldn’t try for sales again any time soon. The index then rose by double-digit percentage points.

These are not signs of a healthy financial market. Those toxic assets are still there, and they’re spreading their poison into the rest of the economy. Private businesses have no idea what will happen when the Fed pulls away all its support—or what will happen if the Fed doesn’t pull away its support. So companies hoard cash rather than create jobs. People, too, hoard cash. Stuck with the bubble’s hangover of private debt, they have no idea how they’re going to pay for their kids’ education or their own retirements. Even employed people without much debt are terrified that they’ll lose their jobs and won’t get new ones—so they don’t spend money, further depressing consumer spending and killing more jobs.

The politicians we elect have three choices—the same choices they had four years ago. They can admit that this debt isn’t worth much and allow the financial sector to bear the consequences. They can hope that the Fed tries to use inflation to raise the price of everything else, making the debt seem a lighter burden in comparison. Or they can maintain their silence, letting the financial sector take another half-decade or more to make enough money on new ventures so that it can finally admit what it should have admitted back in the fall of 2007: bad debt is never good. At least the Fed acknowledges this strategy: it says that it’s using “time” to manage toxic securities and “minimize disruption to the financial markets.” But prolonging government control of financial markets just prolongs investors’ uncertainty.

If Congress and President Obama, as well as the candidates who would like to succeed the president in 2013, maintain their silence, people should at least understand that the lousy jobs numbers are no mystery. They are the result of a policy that Washington has willfully chosen. As the Fed notes, the cost of this policy isn’t measured in dollars but in something more precious: time. Washington’s refusal to confront the debt problem is costing millions the most productive years of their lives.

Nicole Gelinas, a City Journal contributing editor and the Searle Freedom Trust Fellow at the Manhattan Institute, is a Chartered Financial Analyst and the author of After the Fall: Saving Capitalism from Wall Street—and Washington.

Ah been sayin’ ya jes gotta take yer lumps for goin’ on 3 year now, ‘n’ ain’t nobody lissinen.

Mah poor lil brain jes thinkin’ ya gots to go belly up when yer broke, then ya moves on to the next town ‘n’ starts over.

But ize jes a hill billy. Hain’t nobuddy lissinen’ no Hill Billy.

First comes financial crisis; then comes sovereign debt crisis; then comes financial repression (where government looks for ways to force institutions to hold their bonds. Banks are forced to hold government bonds, for 'liquidity' and pension funds are forced to hold government bonds, for 'safety'). Then comes bailing the banks out all over again. New bad debt on top of old bad debt!

It's all a part of Zer0 The Clown's plan to destroy America.

And then just think of our policy regarding the national debt...

Not one penny of US debt has been repaid for 51 years. The last time the US debt actually decreased on a year-over-year basis was 1960.

So are the Repubicans running any ads on TV exposing this snake-oil crackpot for what he really is?

This reminds me of a collectibles craze....the Government has been effectively using our money to prop up the “idiot children of the well-connected” version of the Beanie Baby market.

I was vilified years ago when this first started, for suggesting that everything inherently has a “free market value”...I didn’t understand the lack of liquidity, or the market conditions, etc. etc...they said. B.S.

They were junk then, they are junk now. And, just like a “collectibles craze” when essentially useless items become wildly overvalued, the people who were last in should have been left holding the bag.

I think we should start a bailout program for the collectors of 70’s Franklin Mint Plates.

It might be further postponed because of a contagious, international currency problem.

EU: Italy stares into the abyss
http://www.freerepublic.com/focus/f-news/2747149/posts

all this boils down to one thing...this recession has not been allowed to run it’s course...interference from the fed and fubo has resulted in extending this thing and making it worse...think hoover/roosevelt....

Yep. They keep on kicking the can down the road and the problem gets larger and deeper. Like ignoring a bad tooth.
In time, the grown ups will get back in charge and will make the necessary moves to get our country back on sound financial footing.
When the day of reckoning comes, duck. It will be ugly.

oh yeah....the white collar recession hit several years ago...then the investor class got hit...then the blue collar got hit....only 2 groups left, government workers and welfare class...when they get hit, watch out ( but they are next )

They can admit that this debt isn’t worth much and allow the financial sector to bear the consequences.

That would mean that elite people who have lots of friends in Congress and the White House would have to take huge cuts in their net value. Apparently that’s not allowed any more.

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