As the World Economy slips into recession, opinions abound as to what action, if any, the United States government aught to take to prevent, mitigate, or otherwise minimize the negative impact that the recent economic turmoil has threatened to induce on the American people. Opinions vary wildly as to what action ought to be taken, but history provides the U.S. Government with a blueprint for aiding in the resolution of the current crisis. By selectively modeling aspects of Franklin Roosevelt’s New Deal, the U.S. Government can reduce the economic fallout caused by the current crisis.
Roosevelt’s New Deal, implemented in the 1930s during the great depression, focused on addressing three major elements of the economic situation in order of their time-criticality.(Schultz, 1999) These elements were relief, recovery and reform. The most immediate need in the economic crisis of the time was to reduce the unemployment rate, which had ballooned to nearly 25% nation-wide by 1932. (Schultz, 1999) In order to fix this immediate difficulty, Roosevelt instituted a number of jobs programs such as the Civilian Conservation Corps and the Works Projects Association. (Schultz, 1999) Both of these were federal jobs programs which served two key purposes: employing the unemployed, and completing much-needed work on the national infrastructure. (Schultz, 1999) The immediate needs of the current crisis are a bit different. The most pessimistic estimates put the potential unemployment rate at only eight percent. The two key “crisis” points facing the American economy today are mortgage foreclosures, and regional unemployment spikes. To mitigate these problems, Congress should mandate a freeze on foreclosure actions, and an audit of all potential foreclosures based on the unrealistic lending practices and repayment policies which precipitated the run on real estate. Once the government renegotiates these mortgages by fixing a fair, but reasonable interest rate, predicated on the true market value of the home, foreclosure rates will stabilize and be limited to those who could not afford the actual value of the homes to begin with. The second crisis point is potentially ruinous unemployment rates in areas that support the domestic auto industries. The “Big Three” automakers recently petitioned congress for a $25 billion-dollar bailout in order to continue functioning at status quo. (Strumpf, 2008) The problem with this proposal is that it is tantamount to a government-funded “make-work” jobs program, as domestic car sales do not meet the demand for the current labor force. The government in this situation has a unique opportunity to impose necessary change to the auto industry. The government could give the money to the auto industries contingent on their agreement to immediately retool domestic auto production to focus exclusively on hybrid and other alternate vehicles that are fuel efficient, stylish and affordable. (Strumpf, 2008) Concurrently, the government might impose a gasoline tax that would vary with oil prices and lock the price of gasoline at around $4.00 a gallon. This measure would force the American public to accept the reality of limited oil resources before it reaches crisis levels, and push the auto industry into highlighting alternative fuels and fuel efficiency, helping the nation transition away from fossil fuels.
The second phase of economic revitalization is recovery. (Schultz, 1999) This consists of middle-term regulations and fixes for fundamental problems with the economy. One of the major concerns is the instability of fossil fuel costs, particularly that of crude oil. (Weiner, 2006) There are two primary reasons for the instability of oil prices. (Weiner, 2006) One is the geopolitical situation in many oil-producing nations, whose governments are unstable, hostile or indifferent to the West. (Weiner, 2006) The second reason for the instability in crude oil prices is the reliance on speculation to determine the price. (Weiner, 2006) As recent events have illustrated, unrelated political and geopolitical circumstances can drive speculators to value oil at prices that far outstrip their “real” value. (Weiner, 2006) That overestimation translates directly to the gas pump, sending a ripple effect throughout the entire economic sector. (Weiner, 2006) Any product (i.e. nearly all of them) that requires shipping increases in price, while travel-oriented industries suffer, as consumer confidence and buying power is reduced. (Weiner, 2006)
The final phase of economic rehabilitation is reform. (Schultz, 1999) The current economic crisis was precipitated by a lack of enforcement of existing regulations of lending practices.( Engle & McCoy, 2007) These regulations were bypassed when lobbyists for lending institutions and other interests convinced SEC officials to legislate exceptions to lending guidelines. ( Engle & McCoy, 2007) In many cases, the motive was to simply increase the market for mortgage lenders, but these was also a movement to make housing more readily available by reducing income requirements among buyers. ( Engle & McCoy, 2007) This relaxation of rules allowed lenders to aggressively pursue, and contract thousands of poor-risk loans, often upon overvalued property with interest rates that rose dramatically after a short period of time. ( Engle & McCoy, 2007) These “bad loans” were packaged as derivatives, which added a margin value to them in the area of 20%. ( Engle & McCoy, 2007) As a result, commodities brokers and shareholders had literally billions of dollars in “paper assets” that never really existed in reality. ( Engle & McCoy, 2007) When the foreclosures began, after the high interest rates negotiated kicked in, banks discovered that the foreclosed assets had not nearly the market value that they expected. ( Engle & McCoy, 2007) This drastically decreased the value of the mortgages as commodities, which caused the derivatives, already overvalued at margin, to bottom out as well. ( Engle & McCoy, 2007) This precipitated the crisis that led to a 6000 point drop in the Dow Jones industrial average, and a shortage of liquid assets for short-term lending. These problems led to a slamming halt to commercial growth, and effectively stalled the economy. ( Engle & McCoy, 2007)
Reform measures to assure that such problems do not occur again in the future relate directly to this course. The relationship between congress, special interests, and regulatory bureaucracy is at the heart of the dysfunction in the U.S. economy. Congress passes laws establishing regulatory agencies or guidelines, such as the FDIC, and the SEC. It becomes the role of the executive branch to staff these agencies and administer enforcement of these regulations and run the agencies. The individuals appointed to do so are besieged by special interest groups, who promise material gifts (i.e. bribes) or lay out convincing arguments to have certain regulations ignored, altered, or minimized for the benefit of the interests who guide them. These same special interest lobbyist convince members of congress to build the legislation with sufficient loopholes to allow the regulatory agencies to counteract the measures, and still be within the letter of the law. The only thing that has kept the interest groups from seizing complete control of the function of government is the fact that many of these groups have contravening interests. For every group favoring a particular trend, another interest is dedicated to stopping it. In the case of the economic crisis, this dynamic was upset in that no interest stood in opposition to the bad lending practices. They were seen as a win-win. No interest group is against expanding markets for mortgages and allowing more people to buy homes. What the situation lacked was a responsible agency to consider the negative consequences associated with economic growth whose foundation was “potential value” of commodities. As it happened in 1929, when people and institutions decided to “cash in” through foreclosure, it became apparent that the theoretical value of much of the financial market was, in fact, an illusion.
Annotated Bibliography
1. Citation: Schultz, S. (1999) “Liberalism at High Noon: The New Deal” Retrieved November 25th, 2008 from University of Wisconsin Department of History website: http://us.history.wisc.edu/hist102/lectures/lecture19.html
Annotation:
This item is a written representation of a history lecture given by a professor at a Big Ten University. The subject of the course is United States History: Post-Civil War. The format of this item is a detailed outline with links to images and other supplementary material. Highly organized, and entertainingly presented, this item gives a solid overview of the elements of Franklin Roosevelt’s New Deal, and the problems it attempted to correct. As the title suggests, the presenter of this item does have political bias, but does an effective job separating fact from opinion. The author is quite clear when presenting a point that is subject to disagreement. Overall, a good summary of the measures and intent of the New Deal. This was necessary because I framed my solution to the current economic crisis with relation to Franklin Roosevelt’s New Deal.
2. Citation: Engel, K. & McCoy, P. (2007) “Turning A Blind Eye: Wall Street Finance Of Predatory Lending.” Fordham Law Review,75. Pg. 2039-2100, March 2007.
Annotation: This law review article takes a detailed look at the causes of the current mortgage crisis. It focuses on the lack of regulation of what the authors describe as “predatory lending practices”, which in turn led to the granting of thousands of subprime mortgages. The authors go on to outline how brokers on Wall Street securitized mortgages in large bundles without determining which, of any, of the mortgages therein were completed using the predatory mechanisms of Adjustable-Rate mortgages. The authors continue to describe the cascading effects that these securities had in the market, as the ARM mortgages, by their very existence undercut the value of the securities. I used this article to describe the regulatory issues and the mortgage crisis that precipitated the current economic crisis.
3. Strumpf, D. (2008) “Ghosn: Auto Industry Consolidation Likely.” Retrieved November 25th, 2008 from Manufacturing Management News Now Website:
http://www.manufacturing.net/News-Ghosn-Auto-Industry-Consolidation-Likely.aspx
Annotation: This is an AP news item posted November 19th, 2008 on a website geared toward management in the manufacturing industries. It concerns the statements of Nissan’s CEO, Carlos Ghosn, who has publically speculated about the possible consolidation of the “big three” automakers. Ghosn states that he anticipates a major consolidation of these manufacturing entities in the near future. The remainder of the article consists of a consise review of the state of the American auto industry. The author gives estimate on potential unemployment and discusses the recent attempt by the executives of the “big three” to acquire a bailout package from congress. This article provided me with information about the state of the auto industry, and potential consequences of its collapse.
4. Citation: Weiner, R., (2006) “Do Birds of a Feather Flock Together? Speculator Herding in the World Oil Market” Retrieved November 25th, 2008 from Resources for the Future Website: http://www.rff.org/rff/Documents/RFF-DP-06-31.pdf
Abstract: This is the written assessment of an analysis of data designed to determine whether the fluctuations and increases in the price of crude oil can be associated with the actions of commodities brokers or speculators. As is typical of descriptions of experimental design, Weber outlines his reasoning, hypothesis, methodology, analysis, results and conclusion is a scholarly manner. He concluded that while it was likely that individual speculators caused any significant shifts in prices, but commodities brokers did trend the prices artificially higher by attempting to speculate based on regional geopolitical factors.
