Policy Court

Opinion of the Court, delivered by David Lamb, signed by William Leich:

It’s what you might call a “perfect storm.”  In the midst of the worst recession in seven decades, America is also experiencing the most acute shovel shortage in its history.  At least that’s what some might have concluded in the seven weeks after President Obama signed the American Recovery and Reinvestment Act (ARRA)—a bill funding $787 billion of welfare provisions and “shovel-ready” infrastructure projects—and before any such construction projects began.

During those seven weeks, three things happened.  Unemployment jumped ten percent, GDP growth fell to lowest rate since the Great Depression, and, most troubling, Americans rediscovered the power of rhetoric; that “shovel-ready” was a euphemism, and a dangerously shortsighted one at that.  That getting the “shovels” was the hard part.

The truth is that any federal initiative involving states, including the ARRA which gives states money to finance construction projects, takes months to get money in the hands of Americans.  And that’s the root of economists’ debate over how to best legislate fiscal stimulus.

Since people tend to spend a larger fraction of money when its in the form of a reliable monthly paycheck rather than a onetime bonus, hiring new workers to complete projects should, at least in pure economic theory, provide a larger stimulus than distributing the same amount of money as tax rebates.  However the length of time it takes governments to plan projects, hire workers, and begin work may negate the stimulus advantage of employment programs.  After all, $200 billion in stimulus when the economy is risking recession will probably better excite growth than will $400 billion in stimulus two months later, when the economy has already entered recession.

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Opinion of the court, delivered by David Lamb, signed by William Leich
If you have ever been to an airport, contracted a computer virus, or taken a look at the Social Security system, you know that security often isn’t secure.  And even though Wall Street bankers call subprime mortgages “securitized,” they know that the difference between “securitization” and securitization is a matter of bears and bulls—and not the type found in the zoo.

The subprime mortgage crisis that became the financial crisis that became the recession that became the Great Recession wasn’t a consequence of market failure or misguided risk-taking.  Rather it was the result of individuals—bankers and homeowners—behaving like individuals at the expense of the broader economy: exploiting bankruptcy laws that mitigated their own risk, not by removing it, but by imposing it on third-parties.

Subprime mortgages are called “secure” because their loan value is designed not to exceed the value of the property.  This means that if a homeowner becomes delinquent on a mortgage, the lending party can foreclose on the home and recover the loan’s entire value.  As long as real estate prices are static, banks don’t carry significant risk writing mortgages without down payments.

The problem is that this system depends on home values not falling below mortgage values.  When they do—when delinquent borrowers owe more than their houses were worth—creditors can be stuck with a deficit: their collateral—the house—is worth less than their credit—the mortgage—which means foreclosure doesn’t bring all of their money back.

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