“Trickle-down did not work. It got us into the mess we were in, in 2008 and 2009,” Mrs. Clinton said, referring to the idea that tax cuts on high-income households can spur economic growth. “Slashing taxes on the wealthy hasn’t worked. And a lot of really smart, wealthy people know that.” ~ Wall Street Journal, September 27, 2016 (“Donald Trump vs. Hillary Clinton on Tax Cuts for the Rich”)
The Blame Game. The term “trickle-down economics” is the liberal pols’ pejorative for the theory behind “supply-side economics”, which holds that stable economic growth, in large part, is driven by favorable tax policies, regulatory policies and monetary policies. In more prosaic terms, “a rising tide lifts all boats” – the boats don’t raise the tides.
Until Mrs. Clinton’s sound-bite, I’d never heard the Great Recession blamed on the healthy economy that preceded it. As most observers know, the singular reason our economy crashed was because those responsible for preventing such things took their eyes off the ball, failed to regulate – in spite of the warning signs – and our politicians in Washington failed to govern.
More specifically, the genesis of the housing and credit crisis, and the resulting recession, can be traced directly to the implosion of the securitization and credit industries in the early years of this decade. For those interested in an enlightening expose’ of this issue, read the book, “Inside Job”, or for a understandable and entertaining couple of hours, watch the recent Oscar winning documentary of the same name.
Although securitization of mortgages had been going on for several years, the process reached a fever pitch during the easy credit days, i.e. 2005 – 2007. Securitization is a fancy word for what Fannie and Freddie had been doing for years in the secondary market, i.e. purchasing mortgage loans from the originating lenders, pooling them into billion dollar behemoths, turning them into “investment grade” securities, and selling them to large pension funds and municipalities. For years the process was basically sound, in large part because these two Government Sponsored Enterprises, or “GSEs”, placed strict underwriting guidelines on the loans they would purchase – aka “conforming loans” – meaning that they conformed to Fannie’s and Freddie’s strict institutionalized standards.
But the big housing lenders such as Countrywide, and the Wall Street investment banks decided that they wanted to create a market for higher risk “non-conforming” loans, so they created the “private label” secondary market. Once the process got rolling, the banks’ business models did an abrupt left turn from what the marketplace had previously seen; there was now a market for risky loans, due to their attractive high yield returns. The result was that lenders began making loans with low or non-existent underwriting standards, such as the infamous, “No-Doc” or “Stated Income” loans.
Since lenders were no longer carrying their own loans, and merely packaging and selling them into the secondary market, there was no need to pre-qualify borrowers. During those days, if you could fog a mirror, you could get a loan. This was the era – in Alan Greenspan’s words – of “irrational exuberance.” Why none of these very bright people, from the Fed Chair to the Secretary of Treasury, on down, never saw this coming – or if they did, why they remained quiet – is a mystery. The most apparent, yet unstated explanation for this benign neglect was that there was no political stock in being a naysayer – things were going swimmingly, so why upset the applecart?
The economy was doing just fine during the pre-recession years – but Wall Street greed, and a regulatory laissez faire policy, combined to bring everything down. As soon as the drumbeat of reality began to sink it, with rumors of mass defaults of sub-prime loans – often within months of origination and sale – followed by the collapse of Bear Sterns and Lehman Bros., the private label secondary market stopped buying this securitized junk. Banks immediately began to raise the credit bar; borrowers couldn’t qualify for loans, homeowners couldn’t sell without buyers, and as the financial system seized up, growth stopped, jobs disappeared, and the tax base – i.e. local governments’ source of funding – dried up. The country was staring into the jaws of a financial Armageddon.
According to a New York Times, May 21, 2005 article (“Greenspan is Concerned About “Froth” in Housing”), the Fed Chair, Alan Greenspan, said of the profligate lending practices of the big banks and their easy money polices:
Without calling the overall national issue a bubble, it’s pretty clear that it’s an unsustainable underlying patternʼ, Mr. Greenspan told the Economic Club of New York at the Hilton New York hotel in Midtown. Mr. Greenspan emphasized that he sees no sign of a nationwide housing bubble, but he acknowledged concerns over “froth” in the market and pointed to a big increase in speculation in homes — particularly in second homes. As a result, he said, there are “a lot of local bubbles” around the country.
But in 2008, as the crash was unfolding on the national stage, he was, to say the least, “contrite”, while appearing before the House Committee on Oversight and Government Reform:
You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others,’ said Representative Henry A. Waxman of California, chairman of the committee. ‘Do you feel that your ideology pushed you to make decisions that you wish you had not made?
Mr. Greenspan conceded: ‘Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.’
But on Thursday, almost three years after stepping down as chairman of the Federal Reserve, a humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.
Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief, he told the House Committee on Oversight and Government Reform.’[1]
Until Hilary Clinton’s sound-bite during the Monday, September 26 debate, the cause of the 2008-2009 recession had never been attributed to “trickle-down economics”. To now say so is akin to blaming hurricanes on butterflies in South America; there is no correlation.
Riddle Me This, Batman. So how is it that over the past eight years, we’ve managed to pull out of the death spiral of unemployment, economic stagnation, falling incomes, and collapsing home prices? Regardless of one’s political perspective, it’s hard to argue with the numbers. One has only to look at post-recession communities such as Bend, Oregon over the past several years. Once the poster-child for short sales, with its exodus of U-Haul trailers headed to the mid-west, all that has reversed:
When describing the Bend-Redmond economy over the past decade, it is best to envision a roller coaster ride with wild peaks and valleys. The housing boom from 2004 to 2007 brought with it jobs, increased home prices, and rapid population growth. The bubble burst in late 2007, which decimated the local economy. Home values dropped by just under 50 percent. Nearly 14,000 jobs were shed from the local economy, a decline of more than 20 percent. During the depths of the recession over 16 percent of the labor force was unemployed. Seemingly out of nowhere we turned a corner and the rollercoaster started taking us back up. The past three years have produced some of the fastest job growth, home value appreciation, and population growth ever seen in the Bend-Redmond metropolitan area. Labor Trends, Damon Runberg, Regional Economist, State of Oregon Employment Department, April 2016
And Portland, on a much larger scale, has experienced the same turn-around, in spades:
As if people need another reason to move to Oregon, the state’s economy became an economic dynamo in 2015, according to a new Bloomberg analysis.
“Oregon is the picture of economic health,” the report states.
In fact, Oregon, the nation’s 27th-largest state, had the best performing economy in the nation based on employment, home prices, personal income, tax revenue, mortgage delinquency and publicly traded equity of its companies during the first three quarters of the year, according to Bloomberg.[2]
So where has the momentum been coming from; bottom up or top down? If the former, one would think families had flocked to Bend and Portland first, and the jobs and growth followed. Of course, that has not been the case. Rather, the pre-recession economic climate had to be resuscitated. We had to get out of the death spiral of foreclosures, layoffs, and business closings. How did that occur? There are several examples:
- The federal bankruptcy laws allowed businesses and individuals an opportunity for a fresh start.
- The federal and state governments quickly suspended the income tax on debt relief, thus allowing homeowners to avoid the imposition of a tax when lenders forgave their home mortgage debt on short sales and foreclosures.
- The interest rates for the past several years have been, to say the least, “accommodative” both to business and homeowners.
- The FHA has relaxed its lending requirements and cost of mortgage insurance, thus creating an affordable source of money for homebuyers with credit issues following the recession.
- The federal government enacted HAMP, HARP, and a number of other programs designed to keep homes out of foreclosure.
- Oregon enacted laws requiring that lenders offer a face-to-face meeting with defaulting borrowers, to explore better alternatives than foreclosure.
In short, our post-recession boom was due to the government being more accommodative in the exercise of regulatory power and taxes, rather than less. The result is that business has been allowed to flourish, and consumers and jobs are returning. As with the law of gravity, to be effective, sound economic policy must “trickle down”.
Post-Script. This article is not about the election of either of the two major candidates. I regard them with equal disdain. Voting for either one is a choice between drawing from two very short straws. ~PCQ
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[1] New York Times (“Greenspan Concedes Error on Regulation”) Oct. 23, 2008.
[2] “Oregon Is the Picture of Economic Health”, bloomberg.com, February 9, 2016.
