Thursday, September 11, 2008

Barry Ritholtz's comments on the bailout of Fannie and Freddie

I had an interesting conversation with Barry Ritholtz today. Ritholtz runs Fusion Analytics, whatever that is. To me, however, he is more like a real-life Zelig; a guy who manages to show up in the background at big-wig economic gatherings or whose name pops up in articles and columns as the expert source on some economic subject. He seems curiously ubiquitous. It is interesting to note that Ritholtz is not a trained economist; he has a law degree, but we won’t hold that against him.

The subject of the discussion was the bailout of Fannie and Freddie. Ritholtz said, as so many others have been saying, lately, that by standing behind the GSE’s, the Treasury had, in one fell swoop, added $5 trillion to the national debt and thereby “raised the taxpayer’s share of the national debt” by some ungodly amount. In other words the bailout was put on our tab and every one of us now has to pay for it.

When I asked him to explain how, exactly, I was going to pay for it (because I had not received a bill in the mail for my share of the bailout), he became vague. In essence his response was that I would have to pay, maybe not in the form of a bill or new tax levy (because there won’t be any), but in some other form, which, again, he had difficulty defining.

I asked him why I have not had to pay for the enormous debt our parents and grandparents racked up for the cost of WWII. After all, the debt swelled to an unheard of, 120% of GDP back then, far above the current, 67% of GDP that our debt now represents (38% of GDP when you consider the debt owed to the public, which is a more realistic way to look at it).

Heck, even if you assume that every single one of the $5 trillion of those mortgages that Fannie and Freddie owns or guarantees goes bad, our debt still would be far less than the debt that we incurred as a result of fighting WWII. (To his credit, Ritholtz admitted that only a small percentage of that outstanding $5 trillion was likely to be bad.)

At this point, Ritholtz, being the good lawyer that he is and realizing he was in trouble with the WWII debt example, tried to shift the discussion by saying that the war had to be fought because the very survival of our nation was at stake. Yet bailing out the GSE’s was not a necessity.

The problem with that response is that we are not discussing the moral arguments for how the debt came about, but rather, the debt itself and the assertion that it represents a claim on future generations’ standard of living.

There is no question about it: Our parents and grandparents left us with a legacy of debt. So what happened? Did it destroy our wealth and make us a third world nation? Did we suffer with high unemployment, high interest rates, surging inflation and sub-par economic growth? Did we transit a long period of economic malaise or depression? The answer to all these questions is, No!

In fact, quite the opposite happened. Since that debt was incurred the country’s economy has boomed. Output has gone from $220 billion at the end of 1945 to $14.5 trillion today. Private investment skyrocketed from $2 billion annually to over $2 trillion per year. Personal saving was $10 billion in 1947; it’s $280 billion today. Unemployment is up slightly today because we are battling recession; however, last year’s 4.4 low in the unemployment rate is pretty similar to the 4.0 percent unemployment rate in 1948.

More to the point, however, is the fact that the prior generation’s huge debt has shrunk to a third the size it was. Tax rates have come down (the top rate was 91% at the end of WWII and even if Obama wins and he raises it back to 39%, that would still be less than half of the rate in 1946), even interest rates have remained more or less constant: The yield on the 10-year Treasury note was about 2.5% at the end of the 1940s and it’s about 3.7% now. Not a huge difference. Inflation has even declined.

Most important of all, however, is the fact that our parents’ generation, the very same generation that racked up an enormous legacy of debt that purportedly would be handed over to their kids and grandkids, is now in the process of transferring some $40 trillion in assets to us! That was the real heritage left to us, not a bill. And when the current generation sails off into the sunset, they'll be handing over what is currently, $75 trillion of assets to their children and grandchildren.

As the late, Nobel Prize wining economist, William Vickrey once said, “debt is the means whereby the present working generation is enabled to earn more by fuller employment and invest in the increased supply of assets, of which the debt is a part, so as to provide for their own old age. In this way the children and grandchildren are relieved of the burden of providing for the retirement of the preceding generations.”

Zelig should read this.

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