Mortimer B. Zuckerman identifies the real significance of the enormously expanded Obama-era deficit. It is not only capable of putting a dent in Americans’ consuming lifestyles. It promises to change permanently American capabilities and America’s role in the world. Some of us believe the permanent transformation of the United States into another militarily impotent welfare state would fulfill both the domestic and foreign policy goals of the radical left’s agenda.

The majority of Western governments are running fiscal deficits of 10 percent or more relative to GDP, but it is increasingly clear that there will be no quick fixes, that big government and fiscal deficits will not bring us back to the status quo ante. Indeed, the tidal wave of red ink has meant that the leverage-led or debt-led growth model is dead.

Developed countries will be forced to deal with their debt on every level, from the personal to the corporate to the sovereign. Being able to borrow may have made people feel richer, but having to repay the debt is certainly making them feel poorer, particularly since the unfunded liabilities that many governments face from aging populations will have to be paid for by a shrinking band of workers. (Ecoutez, mes amis!)

Demography is destiny. As a result, there is a burgeoning consensus that we are witnessing an inevitable rise of the East and a decline of the West.

The prognosis for America is especially discouraging. We have relied too heavily on surplus savings from abroad on top of running massive current account deficits. Until recent times, we ran deficits of this order only when we were engaged in a titanic war; otherwise we sought to achieve budget balances over a complete business cycle. But now we are running annual deficits of $1.4 trillion, about 10 percent of the total economy. We have compounded the deficits we accumulated over the last decade, so they now reach 61 percent of GDP. Only once before has the ratio of federal debt to GDP come in above 60 percent. That was after World War II. And our federal debt ratio today doesn’t even take into account Social Security and Medicare. Total liabilities and unfunded promises for Medicare and Social Security were about $62 trillion at the end of the last fiscal year, tripling from the year 2000, according to the calculations of former Comptroller General David Walker. Sixty-two trillion dollars is $200,000 per person and $500,000-plus for the average household. As Walker put it, the problem with these trust funds is “you can’t trust them [and] they’re not funded.” Therefore, he asserts, we ought to count them as a liability, which would bring the debt-to-GDP ratio to 91 percent.

The present model of global growth had served excess Western consumption with inexpensive products from the East. The result is plain to see: The West has excessive debt, while China has excessive capacity and inadequate consumption, as well as high levels of savings and our debt.

The deficits we face are a dagger pointing at the heart of the American economy. They threaten that the United States will evolve into another aging welfare state, where fiscal expenditures shift from defense to social welfare, and America’s power in the world will shrink. It has clearly happened in Western Europe, which can no longer defend itself but relies on the United States.

Robert J. Samuelson warns that the United States has a very good chance of duplicating the Japanese experience. Like Japan, the US has an aging population and consequently a shrinking domestic market, problems producing affordable exports, and a tax and regulatory regime not encouraging to new start-ups.

It’s hard to remember now that in the 1980s Japan had the world’s most-admired economy. It would, people widely believed, achieve the highest living standards and pioneer the niftiest technologies. Nowadays, all we hear are warnings not to repeat Japan’s mistakes that resulted in a “lost decade” of economic growth. Japan’s cardinal sins, we’re told, were skimping on economic “stimulus” and permitting paralyzing “deflation” (falling prices). People postponed buying because they expected prices to go lower. That’s the conventional wisdom – and it’s wrong.

Just the opposite is true: Japan’s economic eclipse shows the limited power of economic stimulus and the exaggerated threat of modest deflation. There is no substitute for vigorous private-sector job creation and investment, and that’s been missing in Japan. This is a lesson we should heed.

Japan’s economic problems, like ours, originated in huge asset “bubbles.” From 1985 to 1989, Japan’s stock market tripled. Land prices in major cities tripled by 1991. The crash was brutal. By year-end 1992, stocks had dropped 57 percent from 1989. Land prices fell in 1992 and proceeded steadily downward; they are now at early 1980s’ levels. Wealth shrank. Banks – having lent on the collateral of inflated land values – weakened. Some became insolvent. The economy sputtered. It grew about 1.5 percent annually in the 1990s, down from 4.4 percent in the 1980s.

Despite massive stimulus, rapid growth hasn’t resumed two decades later.

from Rico via Theo.

Peter J. Wallison, at AEI, debunks the Baily-Eliott thesis, which attempts to deflect the responsibility for the housing market bubble from government social policies by dispersing shares of the responsibility to financial institutions for failing to manage risk, to insufficient regulatory oversight, to reckless and naive consumers, and even to the actions and inactions of “many outside the United States.”

Exculpating social engineering policies emplaced by the Clinton Administration was vital for the defense of the Progressive political agenda, and it was the Baily-Elliott interpretation of events that led to passage of the Dodd-Franks Act.

Last November, two highly respected Brookings Institution scholars, Martin Neil Baily and Douglas J. Elliott, published a paper entitled “Telling the Narrative of the Financial Crisis: Not Just a Housing Bubble.”

Baily and Elliott make a strong case for explaining the financial crisis as the result of a general decline in risk aversion because of the effect of the great moderation—the period from 1982 to 2007 when it seemed that we understood the causes of financial crises and had found a way to avoid or mitigate them. The evidence for a general weakening in risk aversion coming out of this period is plausible. But the Baily-Elliott narrative assumes that the 1997–2007 housing bubble was also caused by this factor, and that seems implausible. The extraordinary lengths to which the government went to force private-sector lending that would not otherwise have occurred—through affordable-housing requirements for Fannie and Freddie as well as demands on FHA and on the banks under CRA—shows that the housing bubble that ended in 2007 was not a natural occurrence or the result of mere risk aversion. If it had been, there would have been no need for these government programs.

The housing bubble that finally burst in 2007 was driven by a U.S. government social policy that was intended to increase homeownership in the United States and was thus not subject to the usual limits on the length and size of asset bubbles. As such, it was far larger and lasted far longer than any other bubble in modern times, and, when it deflated, the vast number of poor-quality mortgages it contained defaulted at unprecedented rates. This drove down U.S. housing values and caused the weakening of financial institutions around the world that we know as the financial crisis.

Market participants were certainly taking risks as the bubble grew, and it may well be, as Baily and Elliott posit, that this private risk taking was greater than in the past. But the facts show that the bubble was inflated by a government social policy that created a vast number of subprime and Alt-A mortgages that would not otherwise have existed. And the risks associated with this policy—which could produce losses of more than $400 billion at Fannie and Freddie alone—were being taken by only one unwitting group: the taxpayers.

Read the whole thing.

Hat tip to Scott Drum.

Via JammieWearingFool.

Mark Halperin, in Time, describes just how bad the Chosen One’s situation has become.

Barack Obama is being politically crushed in a vise. From above, by elite opinion about his competence. From below, by mass anger and anxiety over unemployment. And it is too late for him to do anything about this predicament until after November’s elections.

With the exception of core Obama Administration loyalists, most politically engaged elites have reached the same conclusions: the White House is in over its head, isolated, insular, arrogant and clueless about how to get along with or persuade members of Congress, the media, the business community or working-class voters. This view is held by Fox News pundits, executives and anchors at the major old-media outlets, reporters who cover the White House, Democratic and Republican congressional leaders and governors, many Democratic business people and lawyers who raised big money for Obama in 2008, and even some members of the Administration just beyond the inner circle.

Most living Americans, including now approaching geezerhood Baby Boomers, have never seen anything like the current economic hard times. When I go out out of doors, I sometimes feel a bit surprised that the world is actually in color, not in black and white, and no one is dressed in 1930s styles.

But, on the whole, most of us have been facing current adversities with grim good humor. It’s our turn, we tend to reflect. We’ve had it good for so long. Sooner or later, government was bound to screw things up seriously.

But, we shrugged, we can survive. Our parents did. And the world has changed. We have vastly more education, more skepticism and sophistication. The peasant mentality that permitted the Great Depression to drag on for over a decade as the result of one socialist monkey wrench after another thrown into the engine of the economy and the Smoot Hawley Tariff just can’t happen today.

We’ve learned a lot. The policy errors of the New Deal have been exposed and its economics debunked. Today’s American population will not sit passively by and let Washington drive the economy into the ground year after year after year. The democrats will get slaughtered in 2010 and our Kenyan Caliban will be sent packing in 2012. A conservative Republican will take office in 2013 and the land will heal.

But, I have just read two news items in the Wall Street Journal which give me pause.

1) Despite the fact that the newspapers are full of foreclosure auction notices, and we all know people moving and abandoning homes to the banks, we tend inevitably to think that real estate disaster is well along and that we can look forward to the end of all that within an endurable interval.

We may be wrong.

This WSJ article from yesterday ends, I think, with whistling in the dark.

Housing markets began to stabilize early last year as low prices and government interventions broke the downward spiral. Policy makers spurred demand for homes by holding down mortgage rates, offering tax credits for buyers, and extending low-down-payment loans through the Federal Housing Administration.

The government also attacked the supply problem. Regulators relaxed mark-to-market accounting rules, giving banks more flexibility in valuing certain real-estate assets and removing some of the impetus for banks to quickly foreclose. Meanwhile, the Obama administration put in place an ambitious program to modify mortgages.

The Home Affordable Modification Program has fallen short of its goals. So far, fewer than 500,000 loans have been modified, below the target of three million to four million. Yet the program served as a “closet moratorium” on foreclosures that stanched the flow of bank-owned homes to the market, said Ronald Temple, portfolio manager at Lazard Asset Management.

The result: The share of distressed sales fell by November to 25% of home sales, and prices stabilized. After rising in the winter, the distressed share fell to 22% in June, before bouncing to 30% in July.

The problem is that these measures are wearing off. Demand plunged this summer after tax credits expired, and unsold homes are piling up. More foreclosures could move onto the market as borrowers fall out of the loan-modification program.

“We see the perfect storm brewing with rising supply and falling demand,” said Ivy Zelman, chief executive of research firm Zelman & Associates and one of the first to warn of trouble five years ago. She estimated that distressed sales could account for half of the market by year-end if traditional sales didn’t rebound.

The market does have some tailwinds: Housing starts are at all-time lows. Banks have hired more staff to manage problem loans and government entities such as Fannie Mae and Freddie Mac that own a growing share of foreclosures are less likely to deluge the market.

The next leg down in prices “isn’t going to be the foreclosure-induced freefall where you just had inventory coming out the wazoo, and it was going to be sold one way or the other,” said Glenn Kelman, chief executive of Redfin Corp., a real-estate brokerage.

Prices also have come down so much already they have less distance to fall. During the housing boom, prices inflated much faster than incomes rose, thanks to speculation and lax lending. The ratio of home prices to annual incomes reached 1.6 at the end of June, which is below the ratio of 1.88 from 1989 to 2003, according to Moody’s Analytics.

By those metrics, prices are actually undervalued in markets that have already seen huge declines, such as Las Vegas, Phoenix and Los Angeles. But Moody’s data show that prices remain “significantly overvalued” elsewhere, including Boston; New York; Seattle; Orange County, Calif., and Charlotte, N.C. Markets in both camps face supply imbalances that will pressure prices for years.

What I see is houses being offered for sale at significantly lower prices which are not selling, and a huge, absolutely enormous backlog of not-yet-foreclosed, not yet fallen out of the Home Affordable Mortgage Program houses yet to hit the market.

Who would be crazy enough to buy at any price in the current, totally unpredictable circumstances?

It is easy to find experts venturing predictions that home prices may fall another 10%. Why not another 30%, another 50%, or even 90%?

The market is flooded with homes. An enormous number more are somewhere in the pipeline headed for distress sale. Money is tight. People are still out of work, still losing jobs. Mortgage rates are low, but it is very difficult to get a mortgage. And, in the final analysis, who is going to buy now? Who will not believe that the market is still going down?

How low can we go? No one knows. People my age have lived through a period in which government policies lifted home prices into the stratosphere by arranging for 30 year financing for everyone. When I was a boy, working class families bought $5000-$12,000 houses, paying cash or arranging for two or three years of seller financing. The same kind of homes were selling for as much as $500,000 near Eastern cities a few years ago, and for $1,000,000 or $1,200,000 near San Francisco.

There is a very long way down between the prices of homes decades ago and recent prices. And deleveraging is just not happening. That backlog of unliquidated defaulted properties is sitting there, still unprocessed, like a ticking bomb.

2) Then, I read in the same WSJ of internationally-designed new banking rules intended to reduce risk by reducing liquidity and dramatically raising banks’ capitalization requirements.

The focus of the agreement is on the amount of “capital” banks are forced to hold. Capital is what banks use to absorb losses. Regulators and analysts typically believe that banks with more capital have a lower risk of failure or insolvency.

Regulators agreed to require banks to hold a specific level of a basic type of capital known as “common equity.” Common equity is considered the most effective type of capital because it is used to directly absorb losses. Officials agreed large, internationally active banks will have to hold levels of common equity equal to at least 7% of their assets, much higher than the roughly 2% international standard or 4% standard for large U.S. banks.

Who said governments in our time would not undertake “reforms” that reduce credit, constrict economic growth, and preclude recovery?

Remember Japan? Back in the late 1980s, everyone was afraid that Japan was going to replace the United States as the world’s leading economic power. Then along came recession, and Japan responded with the same kind of policies we see being applied right here today. Japan is still in recession, and nobody has been afraid of Japanese economic performance in years and years.

We have been saying to ourselves that housing prices may drop another 10% and that the real beginnings of the recovery may take another year, or maybe two, to arrive. We could be wrong.

Edward J. Pinto at AEI has a paper providing a thorough history and analysis of exactly how federal housing policies created the current financial crisis.

The major cause of the financial crisis in the U.S. was the collapse of housing and mortgage markets resulting from an accumulation of an unprecedented number of weak and risky Non-Traditional Mortgages (NTMs). These NTMs began to default en mass beginning in 2006, triggering the collapse of the worldwide market for mortgage backed securities (MBS) and in turn triggering the instability and insolvency of financial institutions that we call the financial crisis. Government policies forced a systematic industry-wide loosening of underwriting standards in an effort to promote affordable housing. This paper documents how policies over a period of decades were responsible for causing a material increase in homeowner leverage through the use of low or no down payments, increased debt ratios, no loan amortization, low credit scores and other weakened underwriting standards associated with NTMs. These policies were legislated by Congress, promoted by HUD and other regulators responsible for their enforcement, and broadly adopted by Fannie Mae and Freddie Mac (the GSEs) and the much of the rest mortgage finance industry by the early 2000s. Federal policies also promoted the growth of overleveraged
loan funding institutions, led by the GSEs, along with highly leveraged private mortgage backed securities and structured finance transactions. HUD’s policy of continually and disproportionately increasing the GSEs’ goals for low- and very-low income borrowers led to further loosening of lending standards causing most industry participants to reach further down the demand curve and originate even more NTMs. As prices rose at a faster pace, an affordability gap developed, leading to further increases in leverage and home prices. Once the price boom slowed, loan defaults on NTMs quickly increased leading to a freeze-up of the private MBS market. A broad collapse of home prices followed.

Fox News interviews Democratic pollster Patrick Caddell on the results of a Democracy Corps poll indicating that 64% of Americans think the country is headed in the wrong direction.

5:59 video

The democratic party is fracturing… the democratic party has essentially been hijacked by an educated… over-educated, elite group who basically don’t care about the people who constitute the democratic party. … It is a much graver constitutional crisis. We have a situation where we have 21% of the people who believe that the government is operating with the consent of the governed, from the Declaration of Independence. 21! 68% say no. 57% of the people in a CNN poll said a few months ago said they believe the federal government is becoming a direct and immediate threat to their own freedom. Now, I’m telling you, that is pre-revolutionary. What’s happening is, this sense of pushing people. We’re going to shove this down your throat. We’re going to shove this. We know better. The issue is very simple: who is sovereign in this country? the people or the political class? … We are heading for a tidal wave kin November, the likes of which I don’t even know the dimensions yet. It’s still forming.

Hat tip to Ace via Bird Dog.

The Washington Examiner says it’s time for democrats in Washington to quit kidding themselves. Their economic policies don’t work.

[T]he stimulus bill has proven to be an extraordinary waste of borrowed money that has failed to create jobs, generate economic growth or do much of anything other than line the pockets of White House political allies. That and give $308 million in subsidies to BP before the Gulf oil spill disaster, and subsidize a study on what happens when monkeys snort coke.

As [Christina] Romer [chairwoman of the White House Council of Economic Advisers, who retired on Friday] fades back to her teaching post at Berkeley, Obama is adding to the economic misery by creating an environment of regulatory uncertainty. The Wall Street reform law Obama recently signed potentially requires 533 new regulations, 60 studies and 93 reports, according to the U.S. Chamber of Commerce. Obama’s Environmental Protection Agency has 29 active rulemakings, and there are 100 new rules on the Labor Department’s agenda and 26 at the Transportation Department.

Add Obama’s determination to raise everybody’s taxes by allowing the Bush cuts from 2001 and 2003 to expire Jan. 1, 2011, and it’s easy to why banks, businesses and consumers are hoarding trillions of dollars that could otherwise spur economic growth. And we haven’t even addressed the destructive effect on economic growth of Obama’s nationalization of major portions of the economy, including the banks, health care and the auto industry.

The economy is stalling, unemployment seems stuck at European levels of idleness, the federal deficit and the national debt are at historic highs, public confidence in Congress is at its lowest-ever level and big majorities of Mainstream Americans say Obama has the country on the wrong path. Obamanomics has failed miserably and it’s time for everybody in this town to admit it so we can move on.

Nero plays the lyre while Rome burns

One assumes that, as is traditional, the bride’s parents were paying for the wedding. The Clintons, of course, haven’t got a dime that hasn’t come from leveraging the power and fame associated with politics. Their kind of politics consists of exchanging favors and money taken directly from the public purse for personal advantage. We have currently something on the order of 20% real unemployment in this country, and close to 10% of all the home mortgages in the country are currently in default. The latest wave of recession stories talk about the depletion of the life-time savings of middle class Americans, who are emptying their retirement accounts in order to stay afloat. The economic catastrophe is directly connected to mortgage lending policies enacted during the administration of William Jefferson Clinton. So, although I tend to have little sympathy for class warfare, I think that white trash thieves and looters feasting and celebrating their daughter’s nuptials on a stupendous scale in a grand, inner sanctum of the American aristocracy at a time in which ordinary Americans are experiencing long unprecedented and major financial distress does have precisely the aspect of Neronian irony that this Doug Ross piece notes.

There really are two Americas: the Democrat ruling class and everyone else.”