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Nov 8, 2008

Stimulus Does Not Cure a Recession

Jobs change when people change what they want to buy or can afford

The U.S. is in recession, officially a decrease of Gross Domestic Product (GDP) over 6 months (two quarters). GDP is the total of all goods and services produced in the US. "Why is there a recession" is the same as asking "Why are we producing less, with less employment?"

Many people borrowed against the increasing value of their homes when home prices were going up. They "took money out of their house" in exchange for higher monthly payments. They didn't want to save this money, or else they would have let it stay in the value of the house. They spent it or invested it, buying (consuming) things like restaurant meals and cars, or buying stock in companies. A large amount was invested in building more houses, which supported manufacturers of housing materials.

Criminals in Mortgage Lending

Criminals did much of this borrowing, or shady mortgage brokers skimmed money from loans made to unwitting clients. They took advantage of No Documentation Loans, the most idiotic idea in 50 years. It was Fannie Mae, Freddie Mac, and Congress who gave the seal of approval to No Doc Loans by buying 20% of them. A lot of the money went to consumption, over many years, supporting increased production of consumer goods.

When criminals steal your savings or bank loans, they take money from one type of spending (equipment and business investment) and direct it toward another type of spending (dinners, vacations, and cars).

[edited] Raymond Zwego had been convicted of bank fraud and on probation when he decided to commit mortgage fraud, along with 8 accomplices. He purchased 61 Missouri properties, often by using fake buyers and paperwork. He acquired $16.9 million in mortgages, almost all of which went to foreclosure.
Florida is an example of inept regulation. (More below and at the original article.)
[edited] During 2000-2007, Florida regulators allowed at least 10,529 people with criminal records to process mortgages. 4,065 of them passed background checks despite committing crimes that state law specifically requires regulators to screen out, including fraud, bank robbery, racketeering and extortion.

People convicted in other states and in federal court were allowed to peddle loans. Regulators allowed at least 20 brokers to keep their licenses after committing mortgage fraud

A lot of money is lost because many loans will not be repaid. Falsified appraisals and falling prices leave many houses without enough value to pay off the loans against them and the cost of forclosure. The amount lost is about $500-$900 billion, which is 3-5% of our $18 trillion economy, with the losses concentrated in banks and financial companies. The extra houses built have oversupplied the market for housing, so houses have dropped in value, causing even larger declines for years in personal assets (overall savings).


This has suddenly and greatly changed what, and how much, people want to consume. People now want (or can afford) fewer houses, cars, and vacations. They want to save more now, just when the government is competing with them by printing money and lowering interest rates. Businesses want to produce and sell, but they don't know how much or what, so they lay off people and wait for price signals to guide them to future production.

The government is making things worse by propping up failing businesses having political connections. For example, it looks like General Motors should fail, so that its resources can be bought by people who are willing to bet on what to do next. Instead, the government may give their clueless management $25 billion more loans, removing resources from more productive uses.

The massive bailouts are misallocating resources. In very special cases, it makes sense to prop up a failing company. For example, we can't let the electric company go dark. Overall, the bailouts are a mistake. Moving resources from productive uses to failing uses kills jobs, even if the particular business or industry is propped up for a few years.


Stimulus packages are a mistake. A stimulus package produces a small extra demand for consumer items like TV's. This demand is small compared to total production, and is temporary and artificial. Companies can't tell what to produce after the stimulus is used up. They can't tell if demand is shifting or if it is only the stimulus acting.

A stimulus package is only a gift to the public, taken out of the savings and investment of the society (such as Social Security). It is like losing a job, then throwing a party to cheer up. It interferes with looking for the next job, and it uses up savings.

There are clues that stimulus packages are worthless. The last stimulus package didn't do anything lasting. It increased GDP for three months without stimulating or recovering from anything.

The Economic Growth Mirage
08/28/08 - CNNMoney.com [edited]

The economy declined in Q4 of 2007, grew at 0.9% in Q1 2008, and at 3.3% in Q2 2008. Economists say the gain may be temporary and warn of tougher times ahead. Temporary factors make the jump in the second quarter unusual, such as the $90 billion in economic stimulus checks that reached taxpayers during the quarter.

The National Bureau of Economic Research will report soon on Q2 results. David Wyss, chief economist with Standard and Poor's said "Mostly this report will say that when you give somebody an $1,800 check, he spends it".

Another clue is that the entire housing bubble was a giant stimulus. The good times raised people's ability to buy what they wanted, but they were spending borrowed money. This was just like borrowing on a credit card; it required higher mortgage payments to pay off the larger house debt. I suppose the plan was to sell the house, which isn't working out.

A funny note. After bipartisan agreement to hand out $150 billion in stimulus checks in March 2008, Democrats in congress publicly blamed President Bush for increasing the deficit by $150 billion. These Democrats knew that the money would have to be borrowed, adding to the deficit, in order to be handed out.

Borrow More to Spend Your Way Out?

The bad times are now very bad. The entire society must adjust to what people want now and can earn now. Spending during the bubble directed businesses to hire people and produce things which people could afford then. The recession is part of reorganizing to employ people and produce the different things that they can afford now. It is made worse because people were spending their savings, thinking that they were spending unending increases in house values.

Every month, some companies shrink or fail and others expand or start up. There are always local recessions as demand shifts to better or different products and companies. A nationwide recession is rare, but it can't be improved by forced spending from savings (or future savings). This delays the shift to producing what people can afford now.

The government can borrow money from future national savings (future taxes) and give the money away. This is a contination of the past bubble and credit mistake, not a way to a comfortable future.

Trust Those Who Built the Country

Only the market, thousands of productive people and businesses, can now apply organization and judgment to produce the right things in an efficient way. The government can borrow more money, but it doesn't have a clue. It can't even regulate effectively to keep us safe from fraud.

If the government wants to be kind, it should support limited unemployment payments and let companies rise and fall according to demand. It should not feed losing companies and starve future productive winners.


 Ex-convicts were active in mortgage fraud
2008 - MiamiHerald.com by Jack Dolan, Rob Barry, Matthew Haggman
[edited]  The Miami Herald discovered that regulators in the State of Florida allowed thousands of mortgage professionals to have criminal records, costing consumers millions.

During 2000-2007, Florida regulators allowed at least 10,529 people with criminal records to process mortgages. 4,065 of them cleared background checks despite committing crimes that state law specifically forbids, including fraud, bank robbery, racketeering, and extortion. Florida regulators have refused to do background checks on more than half of mortgage brokers, despite pleas from industry leaders to screen them.

Despite a growing epidemic of mortgage fraud in Florida, the highest level of all the states, the number of license revocations declined over the last five years, leaving borrowers at the mercy of predatory brokers.

The Florida Office of Financial Regulation ignored a 2006 state law requiring nationwide criminal background checks on applicants. People convicted in other states and in federal court were allowed to peddle loans. Regulators allowed at least 20 brokers to keep their licenses even after committing mortgage fraud, the one crime that seemed sure to get them banned.

U.S. Sen. Mel Martinez (R-Fl) said "I knew we had a problem. I had no idea how bad."

Don Saxon, commissioner of the Florida Office of Financial Regulation, said he didn't know why his staff issued licenses to bank robbers and racketeers, but would look into the cases cited by The Miami Herald. He said "You're asking me to get into the heads of the people who made those choices. Certainly we are not proud of the fact that these people have gone on to do bad things."

OFR officials said there is no single standard they use to decide who gets a license. The criminal background check is just one of many factors. Terry Straub, director of OFR Division of Finance said "We look at all the facets around, you know, whatever file, and we predicate on the fact that everybody deserves another chance".

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Why Spending Stimulus Plans Fail
11/14/08 - WSJ.com by Brian Riedl [edited]

What Congress gives to some it takes away from others.

Government stimulus bills are based on the idea that feeding new money into the economy will increase demand and production. But, every dollar it injects into the economy must first be taxed or borrowed out of the economy. Value is merely redistributed from one group of people to another. No new spending power is created.

If Congress funds new spending with taxes, it is redistributing existing income. If the money is borrowed from American investors, those investors will have that much less to invest or spend in the private economy. If the money is borrowed from foreigners, the balance of payments must still balance. That means reducing net exports through exchange-rate adjustments, thereby leaving net spending on the economy unchanged.

Fixing "our crumbling infrastructure" has become a new plan for creating jobs. But, before the government can spend $1 billion hiring road builders and purchasing asphalt, it must first tax or borrow $1 billion from other sectors of the economy, which then lose a similar number of jobs.

In other words, highway spending merely transfers jobs and income from one part of the economy to another. As economist Ronald Utt has explained, "The only way that $1 billion of new highway spending can create 47,576 new jobs is if the $1 billion appears out of nowhere as if it were manna from heaven."

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Spending did not end the Great Depression
Reduced spending and lowered tax rates did it.

[edited] What happened in 1945 at the end of WWII? FDR was convinced the only way to employ the 12 million returning soldiers was another New Deal program, but he died before he could impose his plan. The new President Truman proposed it, along with national health care.

Both the Congress and Senate had Democratic majorities. They said "No" to the whole New Deal revival: no federal program for health care, no full-employment act, only limited federal housing, and no increase in minimum wage or Social Security benefits.

Instead, Congress reduced taxes across the board. Top marginal corporate tax rates effectively went from 90% to 38% after 1945.

By the late 1940s, a revived economy was generating more annual federal revenue than the US had received during the higher tax rates of the war years. Price controls ended by the end of 1946. The US began running budget surpluses.

Unemployment had remained double-digit throughout the whole New Deal. One year after the end of New Deal policies and the return of economic freedom, it was under 4% despite the return of a huge number of soldiers.

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