Print more money, urges economic sage Anna Schwartz

'Mother of monetarism' says soaking up bad mortgages can avert a depression

Jan 18, 2009 @ 12:01 am

By Janet Morrissey

The economist who wrote the book on money said that the Federal Reserve must print more of it if the country is to dig out of its economic hole. Anna Schwartz, the 93-year-old co-author of the seminal "A Monetary History of the United States" (Princeton University Press, 1963) with the late Nobel laureate Milton Friedman, said that to prevent a depression, the incoming Obama administration should follow Treasury Secretary Henry Paulson's original plan and buy up distressed mortgage-related securities. "If they get the Fed printing money, that might help and it probably would be the most successful anti-depression policy that they could choose," said Ms. Schwartz, who has been associated with the National Bureau of Economic Research since 1941 and serves as an adjunct professor at the Graduate Center of the City University of New York.

Essentially, the economist who helped shape modern thinking on monetary policy wants the Obama administration to snap up troubled mortgage-related securities in the marketplace and pay for them with Fed-created money.

That's the same plan that Mr. Paulson proposed last fall when initially requesting a $700 billion financial industry bailout a plan he abandoned shortly after the rescue package was approved, in favor of recapitalizing banks.

"The Treasury never thought out how it would price the dubious assets it would buy, which is why the program went nowhere," Ms. Schwartz said.

If it were to adopt the strategy today, the government would have to find experts who can design a program, examine the assets and price them, she said.

Some experts aren't so sure that sopping up toxic mortgage securities would work.

Dean Baker, co-director of the Center for Economic and Policy Research in Washington, contends that the recent surge in mortgage refinancing signals that credit markets are thawing. He believes the decision to inject capital directly into banks was sufficient to turn the tide.

"We wanted to keep the banks afloat and we've done that," Mr. Baker said. "I really don't see any good argument as to why we would have the government come in and buy up assets presumably at inflated prices when we can just give money to the banks directly."

On housing, Ms. Schwartz agrees with industry analysts calling for the government to take direct steps to stem the tide of home foreclosures.

"They're bailing out institutions, so why shouldn't they bail out households?" she asked, although she believes a housing bailout is less critical than purchasing troubled assets.

Ms. Schwartz is especially critical of the Bush administration for approving the bailout package last fall without having a clear strategy on how the money would be spent.

The "ad hoc" way the government bailed out The Bear Stearns Cos. Inc. and American International Group Inc., but left Lehman Brothers Holding Inc. twisting in the wind, showed considerable inconsistency, which created uncertainty in the market, she said. The firms are all based in New York.

Ms. Schwartz also had some harsh words for President-elect Barack Obama's proposed $775 billion stimulus package, which includes tax cuts and rebuilding crumbling infrastructure.

"How can the federal government become a repairer of bridges and a builder of roadways? Which people does the government have at its beck and call with the technical knowledge and ability to perform these real economic requirements?" Ms. Schwartz asked. "They will spend a lot of money on these programs when the government has no real ability to manage them or execute them."

Japan's massive infrastructure spending program in the 1990s failed miserably, she said.

"They destroyed the landscape by pouring concrete all over," she said. "It was just a waste of money; it didn't produce anything useful. It didn't work."

Extending help to the auto industry is similarly ill-conceived, in her view.

"You do not rescue an industry where the firms are insolvent," Ms. Schwartz said. She recalled how jobs were lost when a vibrant shoe manufacturing industry went belly-up in the 1920s, but how jobless workers "moved to other industries that were profitable."

Allowing failed industries to implode also spurs innovation, said Ms. Schwartz, citing Microsoft as an example.

"Microsoft wasn't the creation of a government rescue plan it was the work of a single individual who had a vision of what could be done," she said.

Richard Yamarone, chief economist of New York-based Argus Research Co., shares her views on the auto sector, going so far as to predict the death of the U.S. manufacturing sector this year, as heavy industry becomes an insignificant part of the economy.

Mr. Baker, on the other hand, said it would be "devastating" for Michigan, Indiana and Ohio to let the auto industry blow up in the current economic environment.

"You'd see towns and cities across those states suddenly unable to pay for their school for their kids or their police protection," he said. "It would require a federal bailout of the states."

Similarly, Mr. Baker supports the infrastructure jobs program, because "the alternative is people being unemployed."

But Ms. Schwartz believes the depth and duration of the recession and whether it will metamorphose into a depression will depend on the steps taken by the new president.

"The question about the fiscal stimulus package that [Mr.] Obama is proposing is, will it work? I'm doubtful. Will the tax cuts that he's proposing work? Possibly, but I'm not so sure."

E-mail Janet Morrissey at jmorrissey@investmentnews.com.

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