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Spend or Save?
Or, is it time for both?
For people burdened
by debt, every pecuniary instinct in them signals that now is the time
to save, not to spend. For banks, to restore balance
between equity and debt takes preference over lending until a feeling of
comfort is reached; for businesses, liquidity is needed to keep their
supply lines going and their investments flowing so they can improve on
their performance and compete in difficult times.
Note that the need
for capital is driven by an uncomfortable notion that one particular
piece of paper, The Balance Sheet, just does not look right. Real
capital has not disappeared and is there for all to see: Houses, cars,
factories, assembly lines, raw materials and, yes, human capital. The
work force is all there. The liquidity is there, too. There is more
money in the economy right now than ever before in history. It is just
that it isn’t moving. No one wants to borrow, lend or spend, if they do
not absolutely have to.
How can we restore a capital structure that makes
banks, businesses and individuals willing to invest and spend? The most
effective way is to exchange debt for equity. That addresses the
balance sheet problem that has induced these feelings of uncertainty and
distrust. Increasing equity and reducing debt is the action we should
all take to become more comfortable with our situation.
For banks it could
simply be to offer their depositors (those who have lent money to the
bank for a small interest rate in return) bank shares for some of their
deposits, so that the bank increases its equity share from 10% to 20%,
for example. Thus, the depositors will have traded some of their cash
for ownership of the bank. They now have a new asset that may grow
faster than their former cash deposits did. They now may receive
dividends that might exceed the interest they received before on their
invested cash, and the bank itself is now more solid, more able to lend,
and more trusted; and its overall value, and the value of its stock,
will likely increase.
From the bank’s
point of view, its equity is now at 20%. The stock has been diluted
somewhat, but the bank is no longer threatened by potential bankruptcy.
Rather, it has strengthened its balance sheet, improved the trust of its
owners and depositors, and can now lend more confidently and safely.
(For those of you who read Norwegian, please see the column by Arne Jon
Isachsen, Slik kan finanskrisen löses, E24,
December 11, 2008.)
What works for the balance
sheets of banks, works for the balance sheets of businesses. In 1974,
companies like International Harvester, Allis Chalmers, Mattel and
Occidental Petroleum, were able to deleverage by issuing equity for debt
(see Deleveraging Can Save Jobs by James Barth, Michael Klowlen
and Glen Yago, The Wall Street Journal, Thursday, December 18,
2008, Page A19). At a time when bank lending dried up, companies found
ways to secure alternate sources of capital through IPOs, venture
capital and high yield debt instruments (junk bonds) to finance growth
and create jobs. As long as junk bonds properly represented risk — and
buyers willingly accepted the risk — they provided opportunities for
both buyer and seller to create new investment opportunities, and new
jobs.
Dramatically lower interest rates will put a floor under the
drop in housing values and free up cash for every homeowner
who refinances her mortgage. More home buyers will qualify
for new mortgages, and we may begin to see a rise in home
values. |
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As for the largest
spending group in America, the 77 million baby
boomers, the situation is daunting. They hold IRAs
and stocks that may have lost as much as two-thirds
of their value. The government forces those older
than 70 ½ years to take distributions from their
IRAs that are severely (although, we hope,
temporarily) depressed in value, and then pay the
full amount of taxes on them. If the drop in value
of an IRA account were 60%, and the owner’s tax
bracket is 35%, 74% of the value of the forced
distribution from the retirement savings will have
evaporated.
Is there a way to
counter this disastrous situation? The Bush
administration is seeking to waive the distribution
requirement for 2009, thus postponing the reckoning
until 2010, or possibly later. But that helps only
retirees who have other savings to fall back upon.
Such may not be the case for many, who would then
face financial disaster. How about letting the
retirees convert their IRAs into Roth IRAs without
paying taxes on the converted funds? Roth IRAs are
funded by after-tax earnings; hence, distributions
from it are exempt from income taxes, whereas
regular IRAs are funded from pre-tax sources and
fully taxed when distributed.
The paper
transactions we are proposing have positive and
desirable consequences, but they create enormous tax
liabilities for banks, corporations and individuals
when they seek to convert debt to equity (a debt
reduction is taxable) or to safeguard their
retirement savings. It makes no sense to impose
such taxes during a recession of this magnitude.
Instead of doling out money to failing companies,
the government should help banks, companies and
individuals directly and immediately by removing the
tax liabilities that now prevent them from restoring
the debt:equity balance that is at the core of the
credit crisis. The incentive effects of these
targeted tax reductions will not just constitute a
massive positive stimulus, but will restore solidity
to the banking system, produce financial resources
for the business sector and safety and relief for
fearful seniors.
The only money being
doled out in Washington, D.C., is taxpayers’ money.
Very little from these disbursements reach taxpayers
directly. It seems absurd that people in their
seventies and eighties be taxed to restore the
solidity of a financial system that has depleted
their savings in the first place. Even more absurd
is to then use those tax revenues to rescue
corporations that could and should be given the
opportunity to solve their own problems.
The way government
money is spent makes all the difference in the world
for a rapid recovery. One thing is certain: The
only way the bailout will cause growth to occur and
the crisis to be resolved is to make sure that every
tax payer dollar spent helps raise the productive
capacity of every man, woman and child in this
country — and that includes their economic survival.
There is no other
way to create growth and jobs except spending the
available resources in such a way that the
productivity of this nation improves. Productivity
improvement is the only way to create new wealth,
raise wages and create jobs that will last. This
will happen when the bailout funds turn to
investment in human capital, offering job training,
funding for education and health, and deep reforms
in the way health care and education are delivered
in our country.
And to think that it
could all start by just changing a few numbers on
paper . . .
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