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Analysis: Dr. Peter Morici says Paulson Regulatory Reform Plan falls short; Administration needs to fix ‘broken banks’
By Professor Peter Morici
Mar 31, 2008 - 2:41:56 AM
Peter Morici is an economist and professor at the Robert H. Smith School of Business at the University of Maryland. He is a recognized expert on international economics, industrial policy and macroeconomics. Prior to joining the university, he served as Chief Economist of the Office of Economics at the US International Trade Commission during the Clinton Administration.
Dr. Peter Morici on Sunday madebrief comments about some key holes in US Treasury Secretary Henry Paulson's financial sector regulatory reform proposal, as it relates to the causes of the current recession and the likelihood that the financial sector will cause similar future crises. Also below, is the transcript of an interview with Gannet News Service correspondent Pamela Brogan on the causes of the recession and remedies. It was released by Gannet on March 28.
Paulson Regulatory Reform Plan Falls Short
The regulatory framework proposed by Treasury Secretary Henry Paulson will not address fundamental problems in the banking sector that contributed significantly to the recession and that must be fixed to rescue the U.S. economy from recession and avoid future crises.
The banks and securities companies, essentially, created overly complex and risky securities when bundling subprime mortgages and other loans into bonds. The banks became engaged in bogus, off books operations and credit default swaps that proved less than worthy. Ultimately, the value of these bonds collapsed, as investors could not adequately evaluate those bonds and discount for their risks.
Now fixed income investors no longer trust the credibility of the banks and securities companies, and these firms can no longer bundle mortgages, consumer loans and business loans into bonds, giving rise to the current credit shortage.
Even with a lower fed funds rate and beefed up access to the discount window, banks lack the credibility to raise funds in the fixed income market to make loans adequate to power the economy out of recession.
The regulatory reform and reorganization proposed by Secretary Paulson would enhance the Federal Reserve's access to information about investment bank and securities companies activities, and subject many to stricter prudential financial standards; however, it does little to constrain the banks and securities from the kinds of abuses that gave rise to the current crisis. Nor does his plan provide adequate safeguard to avoid future credit crises and recessions from a recurrence of securitization abuses.
Further, Paulson's plan does not address the problem of the bond rating agencies. Rating services are paid by the banks and securities companies to rate the bonds created by those companies. This has proven a flawed model that Paulson seems unwilling to address.
Q&A: Administration needs to fix ‘broken banks'
By PAMELA BROGAN
Gannett News Service
March 28, 2008
WASHINGON — The nation's economy has hit a period of turbulence, marked by a mortgage crisis, a shrinking dollar and the recent collapse of Wall Street giant Bear Stearns. Now economists are worried about an onset of inflation.
To try to make sense of how we got into this mess, Gannett News Service turned to Peter Morici,a business professor at the University of Maryland and a former chief economist for the International Trade Administration during the Clinton administration, for answers.
Question: Some experts say the economy is the worst it has been since the 1930s. Do you agree? How bad is it?
Answer: It's not as bad as it has ever been since the 1930s. We are entering a recession of unknown depth and duration. Unlike other recessions, it has not been caused by inadequate demand or some external event like an oil embargo, but rather it's been caused by the worst housing bubble and breakdown since the depression, and a systemic breakdown among our New York banks. Our large banks have lost the confidence of the investment community and can no longer raise money. This recession has the potential to be the worst since the Great Depression, but that doesn't mean it will be.
Q: How did we get to this point?
A: The causes of the recession were twofold. One was the very large trade deficit, which was financed by Chinese and Middle Eastern investors, in part, buying lots of dollars and investing those dollars in the bond market, which then gave us low mortgage rates for a very long period of time, and (then) unwise lending practices by the banks.
All along the chain, from the agents who wrote the loans, to the appraisers, to the mortgage companies and regional banks, to the loan service companies, to the New York banks that bundled loans into bonds, to the bond rating agencies and the investors themselves, there were opportunities to cut corners. And each stop along the way, many corners were cut so that loans were made that should not have been made, and bonds were sold that didn't have the value that banks claimed they had.
Q: Is the Treasury Department and the Federal Reserve responding to the problems? What about Congress?
A:Treasury Secretary (Henry) Paulson has tried to provide limited assistance to homeowners, but he is requiring homeowners to bite the bullet and accept tough terms from the banks. On the other hand, (Federal Reserve head Ben) Bernanke has loaned $600 billion of Federal Reserve money to the banks and required no conditions even though the bankers themselves have been the most irresponsible players in this game. The Bush administration has been too slow to recognize the need for comprehensive assistance to homeowners who are in danger of losing their homes. And the Bush administration and the Federal Reserve have not taken assertive steps to fix the broken banks in New York. Congress moved too slowly to put in place a stimulus. It should have been sooner and larger.
Q: What would you like to see the government do?
A:We need something akin to the Resolution Trust Corporation from the savings and loan crisis to provide wide-reaching assistance to homeowners. We also need for Bernanke and Paulson to fix the New York banks. The New York banks have become obsessed with creating complex securities and bonds that yield high profits, not in making sound loans.
Q: Which of the presidential candidates has the best plan to turn around the economy?
A:None of them.My feeling is that the U.S. economy is beset by significant problems in the form of the trade deficit, our flawed energy policy and the breakdown of the New York banks. We need to get tough with China on its currency; we really need to legislate much more aggressive mileage standards for automobiles.
Q: What impact do high oil prices have on the economy?
A: What happens is that consumers spend more on gasoline and less on other stuff. When we buy gasoline, more of that (U.S. money) leaves the country in the form of oil imports, which taps off demand for U.S goods and services and slows the economy down.
Q: What about the declining value of the American dollar.
A: The dollar has declined too much against the Euro, because it hasn't been able to decline enough against the Chinese yuan. The Chinese intervene aggressively to keep their currency cheap (this makes Chinese products inexpensive in the U.S.). The dollar would find a very acceptable value if China more reasonably valued its currency. Since they have not responded to talks, we should impose a tax on the conversion of dollars into yuan to offset the subsidy that they have put in place.
Peter Morici,
Professor, Robert H. Smith School of Business, University of Maryland,
