No Silver Lining

A perverse meme is circulating in the news media and blogosphere that some good can come out of house price declines, mortgage defaults, and mortgage restructurings.

Charles Hugh Smith discusses Why a 35% Decline in Housing Values Would Be Good for the Nation. Smith, an otherwise competent commentator, does state the obvious: people have been spending too much on housing and to spend less on that will help households and consequently, the economy in other areas. However he neglects to mention the enormous economic catastrophe that will result from having a huge part of the US National balance sheet permanently wiped out. The US financial sector, as healthy economic agents, cannot survive the permanent impairment of mortgage assets that would result. Bank equity - which forms the basis of banks ability to lend, and even just hold deposits, would be wiped out.

As a matter of fact, it is already wiped out de facto - the FDIC and other regulators just keep banks going in the hopes that a recovery in housing prices will make most of the mortgages legitimate investments again. A further decline to lasting low prices will make that charade simply the legitimisation of a zombie banking system a la Japan.

In a Wall Street Journal editorial on 'walking away' masquerading as an article, the author states:

People's increasing willingness to abandon their own piece of America illustrates a paradoxical change wrought by the housing bust: Even as it tarnishes the near-sacred image of home ownership, it might be clearing the way for an economic recovery.

and:

For the 4.8 million U.S. households that data provider LPS Applied Analytics estimates haven't paid their mortgages in at least three months, the added cash flow could amount to about $5 billion a month -- an injection that in the long term could be worth more than the tax breaks in the Obama administration's economic-stimulus package.

"It's a stealth stimulus," says Christopher Thornberg of Beacon Economics, a consulting firm specializing in real estate and the California economy. "The quicker these people shed their debts, the faster the economy is going to heal and move forward again."

Unfortunately, less money flowing out of the pockets of consumers as debtors means less money flowing into the pockets of citizens as creditors (e.g. the proverbial little old ladies who rely on savings income). It is a bogus calculus which could in any way construe the process as 'healing'.

If "shedding debts" means defaulting (as the article seems to imply), then citizens as taxpayers will feel the suck of money coming out of their wallets as Uncle Sam through the FDIC has to make depositors whole. And, as mentioned above, having a walking-dead banking system is not going to help recovery.

On the whole, the intellectual basis of the perspective of this 'article' is entirely flawed. We suspect it is simply another in a long series of efforts by the Ministry of Truth to put a positive spin on the ongoing havoc caused by the Depression.

Not that this flawed intellectual notion doesn't get the support of some heavy guns. Nobel-prize winning Joseph Stiglitz is quoted in Bloomberg as saying a new kind of bankruptcy needs to be created to let mortgage holders write down their mortgage to a market level and keep it! Either Mr. Stiglitz knows better and is dissembling, or he is the one suffering from bankruptcy - intellectual bankruptcy.

There is a serious moral hazard issue here. Dysfunctional economic units must be allowed to suffer the consequences of poor decisions. Stiglitz's proposal is yet another bailout - this time a bailout for credulous, housing-bubble participants on the borrowing side.

We do not approve of bailouts for housing-bubble participants on the lending side, either. But two wrongs do not make a right. The more poor decision-makers are coddled through bailouts, the more society at large is harmed by resources being diverted to the thieving, hapless and stupid; and the less resources are available to be used by the Intelligent who were wise enough not to get involved in the housing bubble, and who are truly the World's only hope of economic progress.

Painted into a Corner

Mr. Henry Paulson, Jr., has had $350 billion burning a hole in his pocket since October. It's a terrible thing: he had far more money than he knew what to do with. He's been passing out the bucks willy-nilly, handing off bags of cash to friends, former co-worker, and former employers. Even so, it took him awhile to burn up the taxpayer's hard earned dollars: the last of TARP's initial $350 billion are set to roll out from the Treasury's loading dock. Now Mr. Paulson has pockets filled with lint; it is within his powers to now request the second $350 billion immediately... but he's making no moves to break open that piggy bank. 'Tis strange, we think: it's the season of giving, and he looked like he was having a ball of a time.

His compadre, Mr. Ben Bernanke, is having an even better time: $1.388 trillion worth of goodness, to approximate from the Fed's inscrutable balance sheet. We've looked at the Fed's latest excuse for a report... good luck making headway into its decipherment. Bloomberg has apparently sued the Fed for more information about the central bank's various lending programs... but the Fed may fall back to its legal trump card: the Federal Reserve System is a private bank, and therefore doesn't fall under the Freedom of Information Act.

We put ourselves in the shoes of these two men, and we can't help but feel... nervous.

Let us explain: the Treasury wants to keep the bailouts rolling, and the incoming Obama Administration is planning on spending trillions. At present the Treasury's bailouts are funded by investors buying Treasury debt... but when the cost of make-work programs start rolling in, these investors will be swamped. They just don't have enough money.

Enter the Federal Reserve, which can create a theoretically infinite supply of money. The Fed wants to prevent deflation by any means necessary, and buying up Treasury debt on the open market is just the thing for stoking inflation. The Treasury gets its money, the Fed gets its inflation and liquidity.

The policies of the Treasury and the Fed seem to be forcing them into an inflationary corner. Surrounded by seas of financial red ink, they have nowhere to turn but to the presses. They are playing with fire: sooner or later, all that paper money is going to start burning - first, in the people's pockets; and second, in their furnaces.

Redistribution Worsens a Depression

A common theme of government attempts to 'turn this troubled economy around' is merely redistribution: taking money from taxpayers, and giving it to selected recipients; taking toxic assets, and replacing them with Treasury bills; taking private companies, and nationalising them (to some degree or other). In one way or the other, this process represents capital and income forcibly moved from one possessor to another.

For example: Ben Bernanke, Federal Reserve Chairman, recently announced that he is going to expand the Fed's balance sheet as much as necessary (scroll down to the speech's fifth paragraph from the bottom). He also said that the balance sheet would have to shrink in the future... but not to worry about such things now (same link, third paragraph from bottom).

This amounts to simply moving a problem hither and thither, rather than actually solving it. By definition, this is Lemon Socialism: taxpayer money reallocated by the government to support failed or failing enterprises. In essence, lemon socialism takes the bad decisions of a few, and forces the majority to pay for, and suffer the consequences of, those decisions.

As these enterprises have proven unsustainable, such 'zombie-ification' represents considerable misallocation of capital. This, in turn, means that incomes will be generally forced lower by the disruptive economic effects of the 'zombie' enterprises. Falling incomes are part and parcel of all depressions, and so such misguided government bailouts will only serve to worsen the 2007 Depression. Lemon socialism shenanigans are doomed to failure; however, Mr. Bernanke's Soviet-style speech makes clear he will try it anyway.

President-elect Barack Obama comes from a different bent. His economic recovery plan is redistributive from a populist perspective, meaning he will look to prop up the lifestyles of the broadest majority of people at the cost of a few. The simplest demonstration of this is by lowering taxes on 'the poor,' and simultaneously raising taxes on 'the rich;' one can throw in another tax rebate cheque or two for good measure. In a way, one can think of populist redistribution as the opposite of lemon socialism.

A more specific example, though, is the Hubbard-Mayer plan: if passed by Congress next year, this plan will make available to any house-buyer a 30-year mortgage of up to 95% of the house's value, all for a low, low 4.5% fixed interest rate. Estimates put the up front cost of this program at conservative $3 trillion.

Though the mortgage plan is certain to be broadly popular, it is a very, very bad idea: mortgage interest represents someone's income. It's not a fanciful thing, because the interest a bank charges does eventually become someone's means of living. By lowering the 30-year fixed rate mortgage from 6.1% (this year) to 4.5%, money is being pulled out of the economy, lowering income, and since falling income is the essence of a depression, this will exacerbate the 2007 Depression. The math: take 4.5% from 6.1%, and one gets a difference of 1.6%. Take 1.6% of $3 trillion, and one sees that this program alone will take away $48 billion of real income per year. Poof.