There is only one sale, a US-wide national sale - 10 per cent off everything.
Laurence Kotlikoff, Boston university economics professor, social security whizz and part-time columnist, has a plan to solve the financial crisis. A battle plan. A plan, involving a sale.
The daddy of the “consumption smoothing” theory even says solving the problem is easy, a grand sale being the first step to jump-starting consumer spending.
He notes in his Bloomberg column:
To stimulate spending, Uncle Sam should get the states to begin a six-month, 10 percent sale on retail purchases. The federal government would pay the states to cut their sales taxes by enough to generate a revenue loss equal to 10 percent of state consumption. States with low or no sales taxes would subsidize purchases.
His justification? A deep and prolonged recession will cost $2tn in lost output. A sale would cost $500bn.
But, the battle goes on. Step two - to buy up toxic subprime assets at dirt-cheap prices.
Treasury Secretary Paulson has decided not to buy them through a government-run auction. But there are other purchasing and swap mechanisms available.
Once the banks are free of toxic waste, Kotlikoff says it will be easier to boost their collateral.
Banks hold some $3.5 trillion in AAA-rated loans, including top- tranche mortgage-backed securities, but they are no longer accepted as security. Uncle Sam should resurrect this collateral by insuring these loans against default. Banks would pay the premiums for this insurance with preferred stock.
But there’s more… Step three. Reviving trust in main street’s ability to pay off its debts. The solution? Government default insurance on the bonds of top-rated companies (err, isn’t that turning corporates into effective GSEs?).
Banks that buy this insurance would face no risk lending to these companies. The alternative is lending directly to businesses.
The government guarantee, of course, worked out very well for Freddie and Fannie. Kotlikoff’s view - that by guaranteeing AAA-rated private-sector loans the government would be insuring against systemic risk.
But there’s more… He says the government should also prop up the equity market by actively investing in the futures market itself - it is, after all, already buying shares of banks and securities.
In buying futures, the U.S. gets no voting rights and can’t interfere with business decisions.
But don’t call him a socialist. His battle plan only focuses on ‘rearranging the financial furniture’ during the current panic. Once the panic is over (due to the effectiveness of the plan), the US would be obliged to sell back all those assets bought. If all goes well, as it should, there could even be profits in store for all - to be distributed via lower taxes, of course. Explaining his vision he says:
In the current crisis, the government is borrowing to invest, not spend. But over the past 50 years the U.S. has borrowed to spend, not invest. It has taken money from younger generations to spend on Social Security, Medicaid and Medicare benefits, while promising to pay the young much larger benefits of their own when they retire. Thanks to this off-the-books pyramid scheme, the U.S. is short $70 trillion, in present value, to pay for future spending not covered by future taxes.
Not stopping there Kotlikoff goes on to offer solutions for other perpetual America problems too. Health care could be resolved via an annual voucher system. The Social Security problem, meanwhile, could be resolved by freezing the current system and having the state, and the state alone, invest all contributions into a global-weighted index of stocks, bonds and real-estate trusts.
Brave views, clearly. Worth remembering though is Kotlikoff’s own potential contribution to the crisis as a proponent of ‘consumption smoothing’ in the first place.
The idea here is that people should aim to maximise the utility of their lives (quality of life) by smoothing consumption over a lifetime. Not squandering your youth to benefit old age, or squander money when young to impoverish your old age. The ideal is a flat lifetime consumption profile.
To achieve it, borrowing against future earnings during early study and early working life, when income is low, is perfectly acceptable. But while the theory warns of the inefficiencies of saving too much, saving in later life is essential for the model’s success.
However, could this justification for borrowing in early life have helped spur the current crisis? Just perhaps. Worth noting this particular passage from a paper entitled ‘Imperfect Information and the Housing Finance Crisis’ by the Joint Center for Housing Studies, Harvard University penned by Golding, Green and McManus in February 2008:
Those who do not have liquid wealth often optimize by using home equity to purchase a consumer durable, such as a car, because such a financing mechanism lowers the cost of capital and allows for consumption smoothing. As subprime mortgages have taken a beating in the media recently, commentators have forgotten that they allow households to obtain consumer finance far more cheaply than other methods of funding: in particular, a subprime fixed-rate mortgage may well be less expensive for consumers than those for a subprime automobile loan. Tapping home equity to purchase a durable also has only a gradual effect on household balance sheets, as the asset one buys through home equity is a depreciating, rather than immediate, expense.
Related Link:
Economic War Calls for Full Plan of Battle: Laurence Kotlikoff - Bloomberg
