What About The Little Guy?

As the financial meltdown continues apace, one thing we're bound to be seeing a lot of are articles like this one, inviting readers to join the pity party for the real victims -- all those former Master-of-the-Universe investment bankers whose investment portfolios have taken such a rude hit of late, and who are now forced to make such heartrending decisions as the following:

Who can they let go from the staff? Most would rather do without the nanny than without the cleaner. With any luck the cleaner likes children anyway and will help out in a pinch. If there is a cook, she goes before the nanny. The cleaner also knows how to roast a chicken and wash up. Forget the garden altogether - expect to see a lot of weeds as the crisis worsens - although the unemployed may take some comfort in doing the gardening themselves.

Oh noes!

Even more tragic are the breathless reports informing readers that "one tumbling titan after another" is being forced to give up his high-end mistress. "I can't afford her anymore!" they plaintively wail.

To which I say -- cry me a river, bitchez! You were the geniuses who engineered this fiasco, in spite of credible warnings that a financial disaster of epic proportions was in the making. If these dudes are, in effect, being killed by their own swords -- being economically wiped out by the insanely complex and wildly unsound investment strategies and financial instruments that they themselves invented, refined, and foisted on the rest of the world -- well, that would be poetic justice now, wouldn't it?

But they aren't the only ones who will be hurting, of course. My brother, a middle manager at Merrill Lynch with a mortgage to pay and a wife and three kids to support, is very worried about his job. And he's one of the lucky ones, given that the acquisition of Merrill Lynch by Bank of America has at least allowed that firm to survive.

And there's no question that the turmoil on Wall Street will be reflected on Main Street, as credit becomes harder to come by for businesses and individuals alike, and the entire economy contracts as a result.

As we've seen thus far, when it comes to the suffering of their buddies on Wall Street, Bush, Paulson, and company have been the milk of human kindness itself, engineering lavish, taxpayer-funded bailouts for Bear Sterns, Fannie, Freddie, and AIG. But when it comes to the suffering of middle Americans, that same milk abruptly turns dry, sour, and very curdled indeed. We've seen precious little help, for example, for individuals overwhelmed by debt and in danger of losing their homes. Yet, according to economist Noriel Roubini, the most effective way to deal with the current crisis would be a program that brings relief to distressed homeowners in danger of defaulting on their mortgages.

As you may know, Roubini is the "Dr. Doom" who was one of the few economists who saw the writing on the wall and predicted the current crisis. He studied of economic crises that took place in the 90s in places like Asia, Mexico, Brazil, and Russia, and saw that all those economies shared common weaknesses:

On the eve of the crises that befell them, he noticed, most had huge current-account deficits (meaning, basically, that they spent far more than they made), and they typically financed these deficits by borrowing from abroad in ways that exposed them to the national equivalent of bank runs. Most of these countries also had poorly regulated banking systems plagued by excessive borrowing and reckless lending. Corporate governance was often weak, with cronyism in abundance.

After analyzing the markets that collapsed in the '90s, Roubini set out to determine which country's economy would be the next to succumb to the same pressures. His surprising answer: the United States'.

At the time, Roubini's Cassandra-like warnings about the U.S. economy fell on deaf ears, but now they look all too prescient. As one of the few people who forecast the disaster that is now hitting U.S. markets like a tsunami, he has surely earned the right to be taken very seriously indeed.

And this is what he's saying: of all the fiscal tools available, "government purchase of distressed mortgages to provide debt relief to households " would be "the most important and effective to resolve this severe financial and economic crisis." Here's why: the root of the problem, he says, is that households are carrying too much debt. The actions taken so far to resolve the crisis -- tax rebates for households, and bail-outs of institutions like AIG and Freddie Mac, will not solve the problem, for the following reasons:

First, you cannot grow yourself out of a debt problem: when debt to disposable income is too high increasing the denominator with tax rebates is ineffective and only temporary; i.e. you need to reduce the nominator (the debt). Second, rescuing distressed institutions without reducing the debt problem of the borrowers does not resolve the fundamental insolvency of the debtor that limits its ability to consume and spend and thus drags the economy into a more severe economic contraction.

Since government purchase of mortgages at a discount would leave many distressed banks even more undercapitalized than they were in the first place, we may also need to create a public institution that would recapitalize those banks (an RFC-like agency, if you will). For more details about how a mortgage relief and public recapitalization program might work, read the whole post.

One point Roubini strongly emphasizes is that it's important for lawmakers to enact this kind of program as soon as possible. If we wait for a new president, the situation will only continue to rapidly deteriorate. Not only will this make a solution even more costly than it already is, but it will make what is already bound to be a severe recession even worse. Unless policymakers act soon, he warns, we may be facing a multi-year recession "like the one that afflicted Japan for a decade after the bursting of its real estate and equity bubble."

Now there's a scary thought.