BoA, QE2, EU: What To Do?

Welcome to Politics Bites, where every afternoon at It's A Free Country, we bring you the unmissable quotes from the morning's political conversations on WNYC. Today on the Brian Lehrer Show, Nicole Gelinas, contributing editor of the Manhattan Institute's City Journal and author of After the Fall: Saving Capitalism from Wall Street and Washington, and Simon Johnson, former chief economist of the International Monetary Fund and co-founder of the blog The Baseline Scenario, discuss some of the big economic stories in today's news.

The Fed's program known as QE2 is coming to an end — did it work? Bank of America is planning to pay $14 billion back to investors who lost money on mortgage deals gone bad — is it enough? And what's going on in Greece, exactly?

Bank of America

Bank of America and Countrywide, which Bank of America owns, settled with some of their biggest mortgage securities clients. This could have a huge impact on stabilizing American banks and the housing market. The settlement between Bank of America and investors who claim they were defrauded into buying mortgage-backed securities is a big step, but Simon Johnson said it does not mean that the bank is admitting to wrong-doing.

I don’t think their admitting anything but I think that they are conceding that very big mistakes were made and it’s a major reversal for Brian Moynihan, the CEO of Bank of America, who previously said he would be engaging in hand-to-hand combat with investors to prevent having to make this kind of payout.

Many economists predict that this kind of settlement may be the thing that is required for a real sustained recovery to take place — that the banks resolving the real value of homes in America will get credit moving again in the housing market and elsewhere, and thus get the broader economy flowing again. Nicole Gelinas said that may be true but that it should have happened a long time ago.

We are still half a decade into the housing crisis and we’re still talking about the value of mortgage securities. The actual mortgages that are in these securities are still cocooned through many many layers from reality.

Gelinas said the mortgages still have not been written down to any realistic level. While the government has encouraged the lenders to extend the terms, tack on defaulted principal to the end of the mortgage and extend teaser-rate interest rates for longer, Gelinas said that they haven’t touched the real problem — the amount that is owed on the mortgages themselves.

The settlement implies that Countrywide defrauded people, yet whether there will be any sort of criminal sanctions remains to be seen. Gelinas pointed out that there have not yet been any high-level prosecutions for the crisis.

And honestly, that doesn’t bother me too much. I mean, people who committed fraud should certainly be prosecuted and go to prison, but I think in the past, in cases like Enron and many other cases, people have focused too much on “Gee, if we can find this one greedy guy and throw him in prison, we’re going to fix things and make everyone safe”, and that didn’t turn out to be true. I think we need the regulatory fixes even more than we need the criminal side… The criminal side is good for justice, of course, but it’s not the main thing in fixing the financial system.

Johnson agreed that criminal prosecution seems unlikely, both in this crisis and in the future, given current legal frameworks, though he thought jail time would be likely to have an effect.

I think there’s nothing that concentrates the mind quite like the prospect of being prosecuted for crimes and potential jail time.

Greece

Greece’s parliament voted today on their austerity plan, leading to angry protests in the street and determining the fate of the banks and possibly even the countries in Europe, creating safer money market funds in the United States. Johnson explained the meaning of the bill.

The Greek government seems to have been able to pass some of the austerity measures that the European Union was asking for, measures that should, in turn, unlock a further disbursement of the existing loan to Greece, but I’m afraid this is far from over. There are going to be more cliff-hangers, both at the European level and at the Greek level, because Greece needs a lot more money if it is to stay reasonably viable and avoid some sort of disorderly restructuring or default on its debt.

Gelinas said a ripple effect on money markets is likely but cautioned against too much optimism, as investors still lack faith in the banks.

The problems that came to the surface in 2008 are still there, they’re just lurking not very far beneath the surface.

The demonstrations in the streets have been ferocious, with workers feeling that the failure of banks and markets is being taken out on them. Johnson said no one is celebrating the measures.

The people in the street have a point, which is when you have a boom, lots of relatively well-off people do extremely well — did extremely well in Greece — and now the austerity measures, they feel, are being disproportionately targeted toward relatively poor people. There is always a distributional fight going on, between the boom and the bust, and Greece is no exception.

QE2

Tomorrow will be the last day of the Federal Reserve Banks Quantitative Easing Program, which attempted to stimulate the economy by increasing the amount of money in circulation. No new rounds of economic stimulus are in the works at this time.

Gelinas said while the fed usually works to inject cash into down economies by buying short-term securities to drive down interest rates, QE2 was designed to take that even further In QE2 the fed bought longer-term interest rates, to push bond rates down and in turn drive down mortgage rates. The thinking was that this would allow financial institutions to borrow at low interest rates, and use that money to buy up some of the assets currently dragging down the market.

So basically they conjured up cash form nowhere — they’re allowed to do that — and used it to buy long-dated securities, pushing more money into the market.

Supporters of the program say that the increase in money and credit gave a boost to the economy, while detractors say that it was unsuccessful in lowering long-term rates and instead set the stage for inflation and a weakened dollar. Johnson doesn’t think the program had much impact either way.

I think ultimately employment growth was anemic mostly because of the kinds of programs we’ve been talking about so far, in the sense of housing, the overhang of debt in the consumer sector, especially mortgage debt, and those are not easily fixed just by trying to pull down ten-year treasury rates to artificial lows.

Gelinas thinks the program was unwise.

It’s like if you’re playing a sport and you get an injury, you get a cortisone shot. It allows you to play through the injury. But maybe its not a good idea to play through the injury. Maybe the pain is trying to tell you something, that you are doing more damage in anesthetizing yourself against it. Same thing here. We have a financial industry that has continued to play right on through the economy’s injury.