The blame game will reinforce sluggish economic growth and deflation risk

The SEC fraud charges against Goldman Sachs appear to be part of a politically motivated anti-Wall Street and anti-capitalist Administration attack. The specifics of this particular case appear to favor Goldman rather than the SEC. The seeming objective is to shift voter anger away from Washington and to reinforce the effort to enact punitive and restrictive anti-financial institution legislation. This is an all too typical post-crisis legislative response. After every crisis some legislative remedy is enacted to which Washington can point as forestalling a repetition of the event, whether there is any merit to the claim or not. Unfortunately, as in the past, many will be taken in. And worse, it will do damage to the economy and deflect attention from the real causes of the the financial meltdown and ensuing economic distress.

It is difficult to cite a participant or sector that is not at least partly responsible for the our financial fiasco. That includes the political, regulatory, financial, and consumer sectors.

Congress went on a deregulatory binge. But, more important than that,they encouraged efforts to increase home ownership at the expense of prudent lending. They approved an expansion of mortgage lending to marginal or financially challanged borrowers (to put it charitably),and a vast enlargement of subsidized Fannie Mae and Freddie Mac. Borrowers with a downpayment of 5% or even less and with inadequate income were encouraged to buy homes. It must be recognized that Congresses' main priority is to be reelected using promises of how taxpayer money will be spent to achieve that objective. Spending far beyond our country's means and running huge Federal budget deficits is no barrier if that is what it take to be reelected. Knowing that, Congress created the Federal Reserve and other regulatory authorities to exercise politically unpopular restraint at the appropriate time and take the political heat for that unpopular move in place of Congress and the President. One Fed Chairman aptly described the Fed's job as taking the punchbowl away as soon as the party got going.

Unfortunately,the principal regulatory authorities did not take the punchbowl away. They actually spiked the punch with ever more hard liquor. At the very least, it is clear that they were asleep at the switch as financial institutions took on excessive risk with leveraged funds. Worse, lenders were allowed to sell imprudent loans with no further financial liability. These financial engineering innovations eroded the basic home mortgage lending practices that had effectively kept home mortgage lending safe as well as correcting the short-term mortgage lending problems that contributed to widespread real estate distrees in the Great Depression of the 1930s. Thirty-year fixed-rate self-amortized mortgages for 80% or less of conservative market value appraisals to borrowers with mortgage payments of 25% of income had become a mainstay of home-mortgage lending. That template of conforming mortgage loans gave way to to all sorts of abominations, from loans of up to 125% of excessively appraised value, to borrowers with no income, for terms of a few years at variable rates. It is no wonder that such mortgages, approved or encouraged by housing authorities, regulators, Congress and the Federal government, were the first to get into trouble. The ensuing home-asset bubble, as with other asset bubbles, was left by the Fed and other authorities to balloon with little or no effort at appropriate retraint. Fed Chairman Greenspan appeared to believe that the financial system and economy was self-correcting. That is exactly the wrong belief for a regulator.

The basic tenant of good lending is to know your borrower. That principle also was forgotten. Dubious mortgages were packaged into pools and sold as bonds with triple A ratings. Where is the resposibility and culpability of the rating agencies for mislabling "liars" mortgage loans as AAA bonds. Those often worthless bonds were sold to pension funds around the globle without recourse to the original lenders, appraisers, packagers, rating agencies, regulators, etc. Why was that allowed? It is not enough to say that few if any knew that home prices could decline.

There is enough blame to go around. That includes the current Administration, that made the solutions to the problem of the previous Admistration their own.
Where is the massive effort to keep homeowners in their homes? The efforts in that direction has so far proven feeble and inadequate at best.When the FDIC was first chatered thre was a moritorium on foreclosures for owner occupied homes. That should the minimum first step. If there were jobs there would be an increase in the demand for homes and an end to the price declines. TAX INCREASES WILL REDUCE JOBS, NOT HELP CREATE THEM.

It is a mistake to assume that the economy is now so safely on the road to recovery that there are no risks to adopting an anti-business, anti-finance stance in the expectation that such a tack will win votes for Democratic candidates in November. There is a grave risk that the effort will actually backfire.

There are signs that the economy is mending. But, those signs are tentative and all too often suspect. And they may not last beyond the stimulus. The course of the economy could remain sluggish at best, or it could even threaten to slide back into recession.

Housing has gained a temporary and meager lift from the home buyer tax credit. Car sales benefited from Toyota's steep price cutting in the wake of its woes and competitors partially matching price incentives. The tax refunds have been spent, boosting retail sales. But it is difficult to see how that pace can be maintained with slight increases in income growth and cuts in borrowing. There has been a modest improvement in employment by some measures and a worsening by others. The 162,000 increase in March nonfarm payrolls is largely due to special factors, including census workers, a tax incentive boost in construction and a rise in temporary jobs. There were still 15 million officially unemployed in March for a 9.7%unemployment rate. But 9.1 million were working part time because they could not find the full-time employment they sought. There were also 1 million discouraged workers who gave up looking for employment because there are no jobs to be found. That is up 309,000 from a year ago. The broadest unemployment rate,U-6, rose to 16.9%seasonally adjusted in March, up from 16.8% in February and 16.5% in January.

Inflation is quiet and will remain so. Deflation remains a risk, especially if and when the seeming signs of economic recovery fade with the end of the stimulus.

Home foreclosures are still rising, placing downward pressure on home prices. Some at the Fed argue that it is that phenomenon that is primarily responsible for slow overall inflation while price pressures are beginning to build in some sectors. However wiser heads are likely to continue to prevail, keeping Fed policy accomodative for an extended period. There is far too much idle excess productive capacity and far too much unemployment and underemployment for significat price and wage pressures to be sustained. That promises to not only keep bond yields low, but to eventually drive them lower.

Even with concerns over state and local budget deficits, tax-exempt yields have been declining. But, there are still 5% tax-exempt yields available. The liberty bonds in New York, backed by both Goldman Sachs and its new office building, are but one example. Yes, Goldman Sachs is still a buy, both its stock and bonds. Treasuries are also still a safe haven. There are financial problems that have yet to fully emerge, including commercial real estate and credit unions, and others that have not yet run their course.


Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731

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