Elizabeth Warren on Charlie Rose

Elizabeth Warren appeared on Charlie Rose last night.



Warren has lately appeared in many places (here's a new link to an unedited Planet Money full interview, and even "Tech Ticker"), which is encouraging, as she is talking of the most important situation/issue facing the country: the increasingly impossible situation of the middle-class squeeze. Unlike many prominent commentators though, Warren has real insight into some of the causes (another couple of fundamental causes and also solutions are a significant part of the book I've been writing). Instead of only being a raised voice or trying to present an economic ideology though, Warren gives non-ideological insight, and actually pinpoints some of the real causes.

So what happens when a clear, non-ideological mind like hers faces the labyrinth of money and influence and interests that is the TARP and the current situation? It's a fascinating moment in American history.

She cut through the fog to say the heart of the problem is indeed what's happening in the American family. This is true in that there were forces that pushed families into the choices they made, which in combination with choices banks and nations made (for instance the Chinese monetary policy of holding down their currency value) helped create this situation and outcome which is now threatening a world-wide depression.

I think she's right we have to address the problems faced by American families (specifically the problems of families with kids), of which there are several pieces, in order to be able to solve the big economic problems. For instance, banks' continuing troubles flow from continuing loan defaults (on mortgages and credit cards and auto loans, etc.) But the start and base source of loan defaults is from the middle class squeeze, which preceded the recession, and even if the recession eases will still keep banks in trouble and at risk, crimping normal lending.

Warren has superior insights versus many popular opinions. For instance, contrary to the popular perception of families buying fancy houses they could not afford is the bigger, far more widespread reality of a larger number of families that brought very average houses which were expensive and which they could not afford because they were competitively bidding up house prices in locations with good schools, which appear key to a successful life for their kids. Instead of getting sidetracked by the appearance that many "average" houses in newer areas are bigger than houses used to be, Warren cuts through the fog and pinpoints what's really happening: competitive bidding to be inside good school districts, whether in newer neighborhoods, or old. Small, 1950s era houses in the East have been bid up right along with the newer houses in the South.

That's an insight. Warren's insight.

That's a clear pinpointing of the real situation.

Fixing the big economic situation finally comes down to several specific problems, some complex, some quite simple. The insight is to be able to figure what really matters and what is more a side issue. There are even some simple problems that really matter, in addition to some complex problems (complex for instance are such as fixing banks or the situation of education and competition for schools). So in addition to talking about complex problems, Warren also talks sometime of simple problems. Credit card deregulation in the 70s and 80s for instance leading to the current unsustainable, theft-like practices. Sometimes to fix an engine you need to fix several things, and you have to fix them individually, even the smaller issues. So even with a major fix like a timing belt, you might still have to fix a relatively simple problem like a bad spark plug wire.

Warren has found some of the trouble other mechanics did not, and that makes repairs easier.

The Best of the Week

As a regular feature I'll be posting on the weekend a Best of the Week, which will occasionally be updated on Sundays also (if not posted on Sunday to begin with). Work is proceeding on the final draft of the book I've been working on (see my profile).

This week a couple of pieces stood out for drama:

Charlie Rose had an interview with Neel Kashkari (notes below):



some interesting moments (times):

9-11 minutes: house prices, loan modifications, what will end the "housing crisis"
17-23 minutes: the $700 billion, the crisis, the changes, the reasoning
24: "Nationalize (sic) the banks" vs. reality

...

And not to be over-shadowed, Adam Davidson, whom is usually fun to listen to, ended up going overboard on Elizabeth Warren, finally resorting to labels and pigeonholes. Of course, such don't fit so well. If Elizabeth Warren is "left", then the left is smaller than I thought, and we'll be needing a new label (or not) for what used to be "left". If you listen, here are a few economists Adam forgot when he said no economists agree that the problem of household debt is a central, primary problem on par with fixing banks (and I'm including any public/blog/interview statement to the effect that consumer/household debt is central and a main source of the problems banks face):

Ken Rogoff
Timothy Geithner
Nouriel Roubini

There are more (for instance Krugman has suggested this a few times lately), but these three could suffice. (Still if readers want to suggest more or offer links, I'll include them).

Notice these three don't fit in a common pigeonhole, unless it's "realist".

Ok, here's the link for that interview.

We hope Adam will re-balance. Sometimes a person has to make a mistake in order to find their own next step.

Update: After Adam's apology Monday, Planet Money posted the full unedited interview on Tuesday, which really is a lot more interesting.

...

One broad point I'd like to make: No one really knows the economic future. We have profound insights such as from Irving Fisher, but even standing on the high platforms of insights such as these don't afford a clear view through the fog of all the ever-changing decisions and efforts that together will sum and multiply and modify each other into true complexity.

One insight I can offer: ultimately our economy is a joint decision of all of us. We can indeed decide to move up, down, or in a new direction, and the mass decision of tens of millions moving together in response to the bully pulpit is no small matter. It could be decisive.

Poll: 70% Have Cut Back on "Luxuries", 40% on Necessities

Forty percent said they had cut spending on luxuries, and 10 percent said they had cut back on necessities; 31 percent said they had cut both. -- New York Times/CBS Poll

Of course, if 40% have cut back on luxuries, and another 31% on both luxuries and necessities, then 71% have cut back on luxuries.

But the stark number is the total of about 40% that have cut back on necessities.

This leaves open the question of whether eating out is considered a luxury or a necessity by respondents. But if eating out is a luxury for many now, then what necessities might be cut by as many as 40% of Americans? Variety of food eaten at home might be one necessity that could be cut back on. Auto maintenance might be another. Health care is certainly being cut back on by many.

We can only hope that the necessity of good nutrition is not being cut back too much by too many.

Americans took on an additional $5 trillion in mortgage debt from 2001 to 2007. Since roughly 51 million homes had mortgages at the end of 2008, this amounts to roughly $100,000 more mortgage debt owed on the average home than in 2001. Even at a favorable mortgage rate of 5.25% for instance, that $100,000 costs about $550/month in extra mortgage payments vs. payments levels of 2001, for an average home. Of course, some owe the same payment as in 2001 (not having moved or refinanced or taken money out), but many owe an extra amount considerably more than this average.

The interest cost of $5 trillion at 5.25% is some $260 billion per year.

That $260 billion per year (eased down a small bit with every foreclosure) is money that could have been spent in the economy on other goods and services, resulting in diverse and lasting employment for many millions of Americans.

This extra mortgage interest over just 3 years is about as large as the stimulus package.

This is what we are up against.

But there is one form of great relief and source of new strength for the U.S. economy in this dark reality.

With as many as 8 million foreclosures by 2012 (one estimate), possibly as much as $2 trillion of this debt burden could be removed from households (who become renters at typically much lower monthly costs).

Such a large amount of debt-relief (monthly living cost relief) would help the economy immensely.

We have a ways to go yet, as only 1.4 million foreclosures have accumulated since July 2007.

But Congress, which appears at times in thrall to vested interests or under the spell of clever lobbyists, does not appreciate the crucial economic stimulus foreclosure debt-relief brings to the U.S. economy. House prices return back to normal levels sooner due to foreclosures, allowing a recovery in buying (and eventually building) sooner.

We need a clearing, a chance for people to get out of homes far too expensive for them. We need these Americans back -- back in the economy -- able to live in a more economically participating way: with money to spend on more than only a gigantic mortgage payment (any payment more than around 1/3 of income). We have yet to see whether large numbers will benefit from Obama's foreclosure prevention plan to ease payments down to 31% of income. But many underwater home owners would often be better off, and the economy in turn, to let go of a home that is too expensive, lowering their monthly shelter costs even further, and have more money to spend on the other parts of life.

Such as the necessities.

Where We Are Now

I thought it would be good to give just a 2-minute, off-the-cuff sketch of Where We Are, without many explanations (see previous posts for these). Just a quick bunch of thoughts.

After a 30-year, massive credit/debt boom aided by advertising, the ratio of American household indebtedness vs. income rose to levels similar to the peak in 1932 , and even doubled vs. incomes over 30 years. When the last easy-money extreme -- NINJA loans -- finally faltered, the bubble of credit began to reverse in late 2007, and house prices began their downward return towards normal. In response, people are trying to save for retirement since their houses and stocks are worth considerably less.

The change in consumer spending is likely to be semi-permanent (lasting, and only partially reversing), and that's for the people who have jobs. Meanwhile, jobs servicing the artificially high demand of the credit-bubble times are being lost, and that will be huge.

Rogoff and Reinhart's study of past financial bubbles shows it's likely that house prices will continue down for years more, and jobs losses are likely for years. The average GDP decline after such busts is 9%.

The Fed is acting more aggressively than ever before, yet how can extra credit availability matter when people everywhere simply choose to save? Consumers choose to save regardless, and businesses will choose to be conservative regardless of credit availability, since we all see the same reality. One way the Fed can do something meaningful is to manage to get mortgage rates under 5% and hold them there for a long time, thus freeing up more discretionary spending for many households after they refinance.

In short, one necessity to help prevent a Long Slump (near Depression-like) that lasts more than 3 years is by somehow creating effective incentives to start new kinds of industry and business to produce new kinds of products and services that people want and do not already have.

Obama may realize this in part, but it's not yet clear how well.

That's where we are.

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(Extra note: The Administration and Congress should not lowball the incentives for new business and job creation when they legislate. There is a tendency to work on the margin (for instance Obama's 2008 idea of a $3000 tax credit for new jobs). We will need something much more powerful, such as a 20% subsidy in the first year on the first $1 million of domestic investment and/or payroll increases that create jobs on net, paid a year later based on payroll continuation, and the percentage attenuating over 3 years, for instance. It's not at all hard to set up rules to prevent substitutions or other abuse of such a subsidy. I could do it in an hour, and so could many experienced businesspeople.)

Geithner Mentions "Unsustainable" Debt vs Income

We've learned to expect Tim Geithner to be precise and careful to only say what a Secretary of the Treasury should say. We expect to hear him making confidence- enhancing comments and laying out plans in a way that aims to bring more people on board with the administration.

But it's hopeful, and I think genuinely confidence-enhancing, when a Secretary of the Treasury clearly states how things truly are.

We need to have a clear picture of the real situation, in order to be able to do something effective about it.

So I'm encouraged to hear this 33 minutes into Geithner's interview on Charlie Rose:

Geithner: "...if you look at the amount the American people were borrowing, relative to income, you just had a huge, unsustainable rise in the basic debt obligations of the American people.....

"You know, uh, people borrowed and spent beyond their means..."

!

This is the basic reality we are dealing with.

All the other descriptions of our current situation that aren't centered on or in recognition of the fact of the credit bubble are either erroneous or beside the point. Even talking about wages is incomplete without an inclusion of the debt picture. Economics is not the entire picture of our lives, but so far as the economic and personal budget side of our lives goes, this is the most crucial fact.

I am reassured about Geithner's understanding of the situation -- that he can recognize and clearly state this central fact of unsustainable debt levels. Yes, we still have to wait to see just how willing the Fed and Treasury and Administration are to deal effectively with zombie banks, but at least there is no delusion about the real situation on the part of the Secretary of the Treasury. Since Geithner clearly understands the full picture (regardless of how he may estimate or misestimate the complexities of receivership), we can reasonably hope he'll correct mistakes and modify plans more quickly than without such an understanding.

Because the currently described plan has some flexibility -- for instance in just how much common stock taxpayers may end up holding in some banks in time -- we can plausibly imagine that the outcome would have some fairness for taxpayers in getting equity in banks (the potential for upside in return for their money). Until I see that we refuse to take a majority stake in Citigroup (for instance when certain guarantees cost us more as time passes), I am not going to presume that we won't "temporarily nationalize" (restructure, etc).

So we still have a possibility that Geithner's plan, or ongoing adjustments, could be a flexible and effective way of dealing with the banks that is good enough, within the context that there is no cheap or easy way out of this mess.

Bad Ideas Commonly Believed to be Facts are Preventing Real Solutions

Reality is, by nature, more complex than any human understanding can be. Thus judgements in which we can have real confidence are limited to prescribed situations within systems of rules or simplifying constraints we have imposed. For instance, we can say 5 + 6 = 11 with real confidence, or that experience has shown repeatedly that a household paying more than about 1/3 of income on housing often experiences financial stress or unsustainable finances.

When we try to judge actions in a more complex system such as an entire economy -- for instance whether letting Lehman fail worsened the economic situation months later compared to what we think would have happened if Lehman had been in part bailed out and handled like Bear Stearns -- we are forced to gauge or ignore large numbers of variables, some of which we cannot find in limited time, and then choose what complexities to simplify and what guesses to make.

When our financial system sank into crisis more deeply after Lehman failed, some plausible simplifications suggested that the failure of Lehman must have worsened the crisis.

After all, when a dramatic event immediately proceeds a great change, its reasonable (and common) to imagine the event caused or influenced the change.

We often hear in the news that a wilderness fire was caused by a careless campfire or cigarette. We sometimes hear that these caused fires even in wilderness areas dry from years of drought.

We ignore the fact that a soaking rain a day or two earlier would have caused that same bit of flame to lead to nothing much at all.

Even a lightning strike is sometimes said to have caused a fire, like an unlucky accident.

It's as if we want to believe that fire itself is unnatural and out of place in nature.

A more sophisticated and realistic view, though, developed with the wisdom of time and experience, is to understand that wildfires arise naturally in response to cycles of rain and drought -- that fire is inevitable, sooner or later.

Occasionally, instead of blaming an individual or a lightning bolt, we rise to the more meaningful assessment that drought itself is a cause of a major wilderness fire, and sometimes even can admit the growth of underbrush due to past firefighting is a cause. We can then -- once we have this increased honesty and clear vision -- take valuable actions made possible through our better understanding.

We plan for fires once we achieve this higher level of clarity and knowledge. We can begin to have controlled fires in response to lingering dry conditions, in order to preempt the inevitable in a way that saves the property and homes we have in the area.

Just thinking more clearly changes the situation and allows us to do what later we see as simply the obvious.

There is a prejudice in favor of old ideas, no matter how poor and erroneous they are.

But honesty and clarity and bringing in more knowledge usually pay off. They improve the bottom line and the public outcome.

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So, which factor intensified this financial and economic crisis -- letting Lehman fail...or continuing fallout of the unsustainable levels of debt and leverage and from stratospheric house prices leading to foreclosures?

In other words, if we had bailed out Lehman or sold it off as we did with Bear Stearns, would that have prevented any worsening of the financial "crisis" months later, as more and more mortgages went sour and revenue streams from mortgage-backed securities and their derivatives disappeared and foreclosures spiraled ever higher?

In other words, if we stopped one careless camper from starting a big fire....would that have guaranteed there would be no fire later?

If your common sense says no, I think you are on the right track.

Stopping one careless campfire in a dry woods does not prevent lightning from striking a month or two or three later.

Applying a similar sophistication of including more information in our estimations of complex situations helps to reveal several false or simplistic beliefs that are commonplace today.

I'd like to list a few of the oversimplifications that are obstructing our body politic from finding the best solutions to our economic predicament. We need to think more clearly in order to prevent another Great Depression.

So, here they are, in no particular order -- the worst popular beliefs of the day:

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1. Letting Lehman fail worsened the financial and economic situation.

The financial and economic situation has progressively worsened because millions of homeowners can not afford to make the payments on their over-priced houses after the end of re-financing or equity withdrawal based on increasing prices, and are progressively, in an increasing accumulation of numbers, unable to pay. Lehman was only one of many inevitable results. ("If Lehman had been saved, at you and your children's expense, instead of at the expense of various investors, that would not have saved Washington Mutual (as an independent bank), IndyMac, Wachovia, Merrill Lynch, etc." -- more here)

What finally slowed the resulting inevitable financial crisis was only the massive blanket guarantees and money finally thrown by the Fed and Treasury into the banks. In effect, we have sprayed fire-slowing water across much of the entire dry financial wilderness in our area now. But there is a problem with the strategy -- significant stretches of forest are just temporarily dampened tinderboxes of essentially dry wood. We don't have the ability to truly make a heavy rain across the entire huge wilderness areas of dry forest. We need some controlled burns (aka some restructuring of some major banks and more widespread relief of impossible mortgage payments via foreclosure or write downs).

2. Foreclosures hurt everyone by driving down home prices in their neighborhoods.

Foreclosures are only making the inevitable more obvious.

House prices cannot be sustained at huge premiums above local rents and local incomes, because creative financing will eventually come to an end.

House prices inevitably will continue to come down after a housing speculation fever is gone, until they settle back to to their more normal price levels vs incomes and rents, which for the US will be similar to prices of circa 2000 or 2001 in many areas (based on Case-Shiller national prices), no matter what we do.

House prices will decline back to normal no matter what we do.

3. Increasing taxes on the richest Americans will hurt economic growth.

American economic history contradicts this idea several times, making it appear random. Once tax rates on the highest incomes come down below about 1/2 (50%), further reductions don't always correlate with better economic outcomes.

Be honest: if you were earning $300,000 or $500,000 a year, would you really work less because your marginal tax rate was 40% instead of 35%? The idea the 2011 rise in marginal rates will hurt the economy contradicts common sense as well as the actual history of economic growth in the U.S. Reducing taxes on the highest earners mattered when confiscatory rates well over 50% came down significantly. In contrast, Bush's 2003 tax cuts to lower top income tax rates from about 40% down to 35% and cut investment capital gains taxes even for the wealthiest can even be claimed to have backfired, correlating with less job and wage growth vs other periods which had higher tax rates. I think the most accurate conclusion is simply that once the top income tax rates are under 50% and top capital gains taxes under 30%, it does not matter much what they are, one way or the other, expect in terms of the benefits of balancing the federal budget and allowing the good forms of public investment to be funded.

4. Federal spending/investment is mostly wasteful and private investment is always better.

Some forms of public investment (federal spending) -- such as education, school lunch programs, and aid to families with children -- have huge payoffs, making us all wealthier in terms of future economic growth. It's common sense that spending a modest bit of the national wealth improving education and nutrition of our young will result in more productive capacity vs a situation where a large fraction of our population is handicapped for the long run by malnourishment and under-education. To consider interesting questions like public investment "crowding out" private investment see this.


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What we need in America is less "debate" between simplistic extremes, and instead a more intelligent process of bringing in more information to refine our popular ideas.

Less conflict, and more refinement.

Cooperative refinement of ideas will win out over loud argument any day and any year and in any era.

There Were Signs of Distress

There were signs of distress about the economy: 60 [Sixty!] percent of respondents said that they were very or somewhat concerned about being able to pay their home costs, and 39 percent said that the decline in home prices had affected them personally.

Slightly over half said that their household income provided them with just enough money to pay their bills.

-- NYTimes

These numbers are surprisingly high -- even though we knew many American families were under an economic squeeze. Would you have thought that 60% were concerned about being able to continue paying all the costs of their home? This alarming number makes sense though if you consider that about 1/2 of American households have "just enough money to pay their bills" as the poll reveals.

This is a dramatic confirmation of the one key fact that underlies our economic woes.

Every time a nation has a housing price bubble -- when house prices rise well over the limit of about three times annual household income (of the household when purchasing the home), then the crushing burden of making this proportionally high mortgage payment *every month*, over time, gradually destroys so many household budgets that a large portion of the population progresses deeply into debt....

Deeper and deeper into debt, until....

Until the easy credit ends when the house prices finally stop shooting upward.

Then, as households are forced to pull back on their credit-fueled spending, it becomes clear that the level of economic interaction (making and purchasing) throughout the whole economy cannot be maintained.

And then, like a flexible latticework bridge with more and more pieces being pulled out of the structure, the economy begins to creak and sag. The sagging can threaten to become a major slump downward.

Outright depression is only held off by the efforts of governments.

This is how a house price bubble is one of the most destructive things that can happen to a nation. It gradually removes more and more actual (non-credit) discretionary spending power from the economy as housing costs escalate and eat more and more of available income (as gradually more people begin paying larger mortgage payments). Then, finally, as the bubble stops expanding and easy credit ends, there is a sudden drop in credit-fueled discretionary spending. So the demand for goods and services suddenly drops off to a lower level. It's like the bubble forces a hard fall.

It happened to Japan.

And now it has happened to many nations at once: the US, Ireland, Spain, the UK, Sweden, Australia, and those are not all. The fallout is not going to be easy to work past.

It would be reasonable to expect the economic difficulties of the world to last for a long while, in part because the adjustment itself -- production and wages being adjusted downward to a significantly lower level of demand (less purchases of goods and services by consumers) -- is a circular process, and even the aid of government for lending and credit makes the adjustment slow.

A slow adjustment implies a long time of economic weakness and uncertainty.

As I see it, the only thing that can speed a real recovery (instead of a painful stagnation) from a house-price bubble is exactly to achieve house prices falling all the way back down to their normal long term average levels in ratio to household incomes, and to have households that can't really easily afford their mortgage payments get out of them.

When homes are generally affordable in most places again, then the nation can recover.

It is exactly house prices falling back to where they have to be in terms of incomes that allows house prices to finally stabilize, and confidence to return.

Ironically, foreclosures, so often spoken against by our politicians, can aid many families in two important ways.

First, foreclosures help to push house prices down more quickly, so that the inevitable and necessary fall in prices ends sooner. After prices are low enough and buyers increase, confidence spreads and people feel their wealth will increase instead of falling. As an added benefit, the lower prices allow young families to afford their first home.

The subsequent turnaround from this lower house price point allows a general recovery.

Second, for many or most families that "lose" a house in foreclosure, the family budget becomes much easier when freed from especially large housing costs. They have room to breathe.

They have escaped the crushing monthly payment that not only stressed their finances and sometimes their relationships and even their health --they have also escaped the monthly burden that robbed them of a chance to save money for the future.

For many families, a foreclosure is a reprieve, and a chance to move towards a healthy monthly budget, with some savings for the future.

A family that has a mortgage modified so that instead of a crushing 40-50% of their income going to mortgage payments they are set to pay only 38%, for instance (one program under Bush), is *not* so lucky a family as we might think at first.

38% of the monthly income paid on the housing payment is still a crushing burden, even if the crushing squeeze it creates over time is slower. Slowly being crushed is not better than rapidly being crushed. In fact it is worse. Seemingly 38% can be just afforded, until....until the car needs one too many repairs or the medical co-payments add up a little too much....

A lucky family is one that escapes from any crushing 35% or 40% or 45% of income going to their housing payment and moves into a cheaper place with a payment of 28% or less of their monthly income.

But it is not widely understood by many people or many in Congress that paying over 30% of your monthly income for your housing payment leads to financial stress and even harms the general economy.

We have a ways to go yet, as few in Congress seem to understand that high house prices damage our economy.

High house prices damage America, Congressmen and Congresswomen, Senators.

They prevent us from having much of an economy, once the bubble illusion of wealth -- which is actually based on ever-higher mortgage debt -- comes to an end.

When we spend almost all our money just paying for the house, the insurance, the car and the health care, how can we afford to go out to eat or pay someone to mow the lawn or buy more gifts or the other myriads things that are the output of...

...the output of our jobs?