:LPE:

The closer we get to a new administration in the US, the closer we get to an actual review of what is one of the biggest boondoggles in the history of US graft. Yes, the Troubled Asset Relief Program, which is slowly being revealed to be little more than the Henry Paulson’s Pals Get Free Money program. More than half of 700B spend in 3 months, with almost zero accountability. It makes the Iraq war look well-thought-out.

By and large, the main reporting on the TARP and the financial sector bailout in general has been abysmal. There is almost no critical analysis applied to the transfer of nearly 400B in public funds to failed industries (contrast the column inches devoted to the Big 3’s failings, whose bailout totaled less than 10% of the financial sector).

For example, the very man who created a significant part of the problems in the financial sector was put in charge of bailing it out. He hired his former friends to run the bailout. He failed on many occasions to justify it with any accountability or oversight. He literally handed money to his colleagues, in a massive conflict of interest, with almost no strings attached. And, if it matters, he did so in contradiction to almost everything he had said and stood for for the prior 30 years in business.

If the same thing happened in, say, the auto sector, it would have looked like this. The most recently retired Big 3 CEO would be hired to distribute money. He would be given carte blanche to do so by Congress, after threatening it with chaos and ruin if it did not hand over the money. He would hire one of his favourite junior executives to distribute the money. He would then hand each of the Big 3 tens of billions in dollars to prop up their stock prices without requiring them to make one single change in the cars they made or their contractual relations. He would spend as much of the money as he could before he lost his job in 3 months, so that it would not be subject to a second review. All the senior executives at the Big 3 would keep their corporate jets and their 2008 bonuses, even though their companies were near bankrupt. Not one single dollar would go to analyzing what changes needed to be made to the auto production system to make sure it did not happen again: that would be up to the companies themselves.

Well, I could go on, but it is tiring. Hopefully Michael Lewis or some enterprising insider is doing the history of this recent episode, one of the most scandalous in the history of (Republican!) market interventions. They couldn’t figure out a way to provide decent health care for 25 years, but it only took 2 weeks to bully congress to allocate 700B to banks with a gambling problem.

Slowly and far too late to be of any use to a public policy debate, we are seeing some sober thought. The NYT has some of the latest. Link.

The policy options the Minister of Finance is considering involve, according to the National Post, Ottawa providing more guarantees to banks and their conduits, so, for example, the asset-backed securities market. The options are rather vaguely worded in reporting and probably being drafted by folks on Bay Street right now. They are meant to increase the flow of money to firms “and households”, but it is not clear how the latter will benefit from the asset-backed commercial paper market.

About 18 months ago the ABCP market seized up because the assets backing the commercial paper were not worth much. They may still not be worth much. So one wonders why Flaherty is doing this. Flaherty is taking instructions from the whiz kids at the major banks who issued the junk securities (and pocketed the fees), and those who first stand to benefit from the new policies.

Also missing from any of this is a sober analysis of why the problems in the credit markets arose in the first place. They were’n't acts of nature, they were structural. A basic list would include inadequate oversight by securities regulators, the same by regulators of financial institutions (banks, but more importantly, credit rating agencies), agency capture, in the parlance of the legalists, of the same agencies, and a culture of short-termism in both issuer and investor board rooms that is reinforced by a market structure that responds mostly if not only to share prices and quarterly earnings, not to long-term stakeholders interests. Under those market conditions regulators or extra-market monitors are of increased, even crucial importance, and yet those influences (regulators, short-sellers, corporate monitors, etc.) have been marginalized and hindered in their functions.

And, from a policy perspective, supplying more credit is only half the battle. The supply of credit may be increased, but if it does not get allocated to spending (instead of savings, or paying down existing debt) then it will not have the intended effects of expanding growth. That’s the nature of an aggregate demand contraction. It might not even have any effect at all, because so much of Canadian product is subject to international demand — US in particular — and that is the nature of having a small, open economy: our fate is not entirely in our hands.

So, Flaherty has hinted at tax cuts as “stimulus”, Robson and the CD Howe group have stated that loose monetary policy is the only way out, and shills for Bay Street like Reyolds (why, why, why) are quoting Mundell for the proposition that fiscal policy (read: Keynesian spending) will not work, etc. etc. etc.

What this amounts to, more or less, is the wish-list from the financial sector for the budget. CD Howe has long been their policy voice of choice, that’s what they are paid to do, Reynolds regularly plagiarizes their press releases, that’s what he is paid to do, and Flaherty, well, he’s the one who didn’t think the economy was in recession last month so who knows what he’s being paid to do.

The wish list will have a couple of happy effects for financial service sector and its workers (well, the high-income ones). They’ll have cheaper money and fewer bad debts on their balance sheets (through looser monetary policy, which has thus far failed to convince them to loosen their own lending). It will also allow people to save (or spend) their tax cuts. Of course, if they act like the banks, they’ll do a lot of saving before they do any spending. Cash, right now, is king. This has an economic phrasing, that is, those who receive tax cut expenditures have a greater marginal propensity to save, not spend. This makes this form of “stimulus” an inefficient and extremely expensive form of stimulus. It also has the undesirable policy effect of being very hard to unwind (the tax cut part…despite the rhetoric, it is very difficult for politicians to run on a platform of *raising* taxes ).

And, probably the most serious flaw in all this is that it is supply-side economics. That would be fine is we faced a supply-side crisis, but we don’t. We face contracting aggregate demand. Addressing demand requires direct spending as soon as possible.

Monetary and fiscal policy aren’t mutually exclusive. Both could happen, both should.

If there isn’t enough of this the budget, then the opposition has a very good reason to turf the standing government.