Economic Conundrum

From memo to Oaktree Clients

"The impossibility of reaching into the economic toolbox for that one perfect tool is easily illustrated with a list of some of the challenges present today. For a learning exercise,skip today’s Sudoku or crossword puzzle and take a crack at resolving these dilemmas:

• Consumer confidence and spending are weak. We want to stimulate, but we don’t want to replace weakness with hyperinflation.


• We’re willing to drop fiscal discipline in favor of stimulus through deficit spending,but we don’t want to scare away offshore investors from the Treasury securities we’ll issue to fund our deficits.


• We’re willing to distribute stimulus checks, but we seem unable to make frightened individuals spend the money rather than save it.


• In fact, we know consumers got into trouble by spending more than they earned, and now they should build some savings. But whereas in the recent past consumer spending grew faster than incomes, a rising savings rate means spending would grow
  slower than incomes, just at a time when incomes are falling and spending is needed.


• Likewise, with tax revenues down, states and cities have to balance their budgets. One way to do so is to raise income tax and sales tax rates, but this will further depress local economies and increase the burden on their beleaguered citizens.


• We want to recapitalize the banks, but we don’t want to reward past mistakes.


• We’re thinking about buying the banks’ “toxic” assets. But if we pay above-market prices, that’s a subsidy to the reckless (see above), and if we pay market or belowmarket prices, that will further erode bank capital through write-downs.


• We know suspending mark-to-market accounting would end write-downs, but doing so might also reduce confidence in balance sheets and postpone the day of reckoning needed for our financial institutions to reach bottom and recover.


• We want the banks to lend, but we can’t – and shouldn’t – make them extend loans to non-creditworthy borrowers.


• We want to reduce the incidence of home foreclosure, but we don’t want to reward people who speculated by buying multiple homes or lied on mortgage applications. And we’d rather not treat people who bought more house than they could afford better than those who acted prudently.


• We want to make mortgage relief available to those who are unable to service their mortgages, but we don’t want to give people incentives to stop making payments.


• We’re considering letting bankruptcy judges reset mortgage contracts, but we don’t want to tell lenders that loan contracts are no longer sacrosanct, which certainly would deter them from making new loans.


• We don’t want the depressant impact of auto companies going bankrupt and suppliers and dealers following suit. But we also don’t want to pump money into the industry unless we’re confident it can produce good cars at competitive prices.


• We want to see the auto industry “rationalized,” but that means seeing people lose their jobs or have their paychecks reduced, which would spread pain, put stress on benefit funds, and cut into GDP.


• We want taxpayer-supported automakers to use American steel, but (assuming it’s more expensive than imported steel) that will either (a) raise car prices, making cars more expensive for hard-pressed buyers and making the Big 3 less competitive, or (b) require the companies to eat the difference, making it harder for them to achieve profitability.


• We want to curb speculation in derivatives, but we don’t want to make it harder for businesses, farmers, insurers and investors to legitimately hedge risk.


• In fact, we want to prevent excesses on the part of business, but most people don’t think it’s a good idea to nationalize companies or have the government tell them how to operate.

It’s abundantly clear from this list – and it’s only a partial list – that solving the current problem will require compromises and a combination of disparate elements. Some will work, while others will fail and have to be replaced. And some will work with regard to one facet of the problem but aggravate another. Lastly, no one should think that even a wise combination will produce quick results."