Fiscal Disaster at the Gates?
Some Say Yes, Some Say No.
Open the Gates to Find Out?

By Henry J. Stern
September 26, 2008

The world is spinning rapidly, and it cannot be stopped to let anyone off.

We wrote about the national fiscal crisis last Friday and Tuesday. Since then, the President addressed the nation, the leaders of Congress came to the White House, and the parties have negotiated.

At this point, it appears that Mr. Bush’s problems come more from his own party members in the House than from Democrats in either chamber. Candidate McCain could help if he brings about a resolution of the controversy, but should he gain political advantage from getting people in his own party to do what they should have done in the first place?

At this time, the issue is unresolved, but agreement may come in time for tonight's debate, over the weekend, next week, or not at all. People may be waiting to see if the Dow breaks 10,000 on the way down.

Last week we posed 24 questions as to what was happening and why, and we invited our readers to respond. We received many answers, which we posted on our blog. Unfortunately, our blog, or more accurately, message board, is harder to reach than it should be. If there is a pro bono webmaster around who could be helpful, please e-mail: starquest@nycivic.org.

One answer that seemed to be particularly informative came from Professor E. S. (Steve) Savas of Baruch College, who was Assistant Secretary of HUD in the Reagan administration. He is best known for his books advocating privatization of government services. I met him when he was First Deputy City Administrator during Mayor Lindsay’s second term, and I was an Assistant City Administrator. He is a wise man, although he has become more conservative over the years, a not uncommon phenomenon. It is offset politically by the number of idealistic young liberals coming out of our colleges and video arcades. Savas writes:

“The fundamental cause was the decades-old, bipartisan government policy of encouraging home ownership by people who can't afford to own their home or even to make a reasonable down payment. This policy culminated in President Clinton’s Community Reinvestment Act, which led to bald lying by loan applicants, mortgage-loan originators, and assessors in an environment of easy money created by the Federal Reserve Bank.

“With so much cheap money around, others also piled into housing as a sure-fire investment, and prices soared. Fannie Mae and Freddy Mac happily insured these risky mortgages, bundled them with sound mortgages, and swelled to gargantuan proportions. They were supported by members of Congress who received millions from them in campaign contributions, while the Clinton-appointed officials garnered large bonuses based in part on fraudulent earnings statements. Financial engineers devised opaque instruments to hedge and distribute the risk posed by the loans.

“The result was a monstrous housing bubble that inevitably burst and a series of financial disasters starting with the subprime-mortgage meltdown. Government accounting regulations (“mark to market”) hastily imposed after the Enron swindle guaranteed a downward spiral for AIG and others when there were no immediate buyers for their assets, although these were, in fact, quite valuable. That's what happened.”

Our View

We agree with a lot of what Prof. Savas has written, but it is not the entire story. The blame cannot fairly be placed on President Clinton. Mr. Bush has been President for seven and one half years, and his appointees have regulatory authority over the markets. They have not asked for new powers in this area. Their failure to act, or even to recognize a clearly impending disaster of titanic proportions, is a major cause of today's crisis and the collapse of financial institutions.

We should not yield, however, to the impulse to blame the government for everything. The errors in judgment by the principals of major and minor investment and commercial banks had a great deal to do with the destruction of wealth that followed.

Owning a home provides psychic income. “A man’s home is his castle” goes back to1644 and English jurist Sir Edward Coke. Individual home ownership consumes 650 to 1000 gallons of heating oil in a normal winter in the Northeast, so it is a highly inefficient way to keep people warm. Americans are used to phrases like “A chicken in every pot,” which was the Presidential campaign slogan of Herbert Hoover in 1928, along with “A car in every garage.” Although a pot only requires a kitchen, a garage suggests home ownership.

How do you provide homes for people who cannot afford them? Public housing was the answer from the 1930s on. Even conservative Senator Robert A. Taft of Ohio (a Presidential scion) joined with Senators Allen J. Ellender of Louisiana and Robert F. Wagner (the original) of New York to sponsor a Federal housing bill in 1949. Both Taft and Wagner had housing projects in Harlem and East Harlem named for them, but not Senator Ellender. Rule 10: I wonder why?

However, starting with the Jimmy Carter administration, government support for housing construction waned. Later, Reagan did not believe the government had any business building houses for individual citizens. Part of the problem was due to the fact that public housing projects were becoming minority ghettos, with increases in drug use, vandalism and crime. Large numbers of welfare recipients were placed in public housing, as well as single teen-age mothers, who could then open their own cases as clients apart from their mothers'. More stable families were driven from some projects by income limits.

Some Federally built housing had to be demolished because it was unsafe to inhabit and uneconomical to repair (starting with Pruitt-Igoe in St. Louis (built in 1954, torn down in 1972-74) The development contained 33 eleven-story buildings. Subsequently projects in Chicago, Atlanta and Newark were razed. Some were dynamited - like Las Vegas casinos. Katrina-damaged public housing is being now taken down in New Orleans, over the objections of preservationists. Abandonment of projects, however, did not happen in New York City, thanks to our Housing Authority, who fought the HUD and the Federal courts, in its effort to get drug dealers out of public housing.

Privately owned housing creates more stable communities than public housing. There are valid social reasons to encourage and to assist people of moderate income to own homes. But, luring people with bad credit - or no credit - to take out mortgages that carry adjustable rates or balloon payments is certainly not the solution.

As long as housing prices continued to rise, the banks could foreclose and resell the property to another sucker. When housing prices fell, however, the value of the mortgages fell even faster. As they were bundled together for resale, it was impossible to tell the good packages of mortgages from the bad. The whole market froze and disappeared, along with the triple-A auction rate securities that were widely sold as the equivalent of certificates of deposit.

This is one disaster that cannot be blamed on Osama bin Laden, Islamofascists, Chinese competitors, or any other external force. We did it to ourselves, under the eyes of regulators, starting with the great Alan Greenspan, who failed to see the consequences of what was happening before them.

Now we must pick up the pieces, which is what the bailout is trying to do. If it had come sooner, the price would have been lower. If we delay further, we do not know how costly it will be in the end. In malignancies, spontaneous remissions are rare. We would not rely on the problem resolving itself without intervention of some sort. Tincture of time is unlikely to restore lost billions. Our hope today is that the process will not be further impeded by Presidential politics, and that insolvent banks receive enough assistance to survive and continue to lend, but not be enriched as if they had no responsibility for this near-death experience.

You can call this series of dramatic fiscal events the “September surprise.” We wait to see what surprises October will bring.

P.S. Since the national debt is rising constantly, we thought the best way for you to keep up with it would be our linking to the national debt clock. As of 4:15 Friday afternoon, the sum is $9,851,398,609,458. In our last issue, we added three zeroes by mistake. We thank those readers who called the error to our attention.

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