The Government’s Cure for Alcoholism — Whiskey, More and More Whiskey

by Liberty and Power

For nearly a decade, Americans acted as though taking on more debt posed no problem. After all, they owned real estate, and all the experts told them that real-estate prices always go up. The mightiest magnates of finance acted as if they believed this stupid story — I say stupid because the merest child might easily have confirmed that real-estate prices have always risen and fallen cyclically and that real-estate booms have often been the precursors of financial crashes and economic recessions. But things are always different this time, are they not? At least, all the experts say so, just as they said so during the past however many booms, each of which was said to have heralded a “new era.” So, we can hardly blame the nearly destitute wannabe homeowner who signed up for the mortgage proffered to him by the agent of one of those Wall Street moguls. After all, the borrower put nothing down, made interest-only payments at a low teaser rate, and cheerfully anticipated seamlessly refinancing the loan when the time came for the interest rate to be adjusted upward. Couldn’t lose, eh?

Moreover, you could use your house as the basis for a line of credit and live high on the hog while you waited for your house to appreciate as surely as the sun rises in the east.

Thus, real estate loans at all commercial banks increased from January 2002 to January 2009 by 110 percent, and the banks’ total consumer credit outstanding increased during the same period by 37 percent. Household credit-market debt outstanding rose between the first quarter of 2002 and the third quarter of 2008 by 77 percent. Got the picture? The country was, and remains, awash in debt. Of course, these huge increases in real-estate and consumer debt would not have been possible had the Fed not engineered a great increase in the money and credit coursing through the system: thus, the money stock (M2) increased from January 2002 to January 2009 by 51 percent. Greenspan and Bernanke, you gotta love ‘em — real good-time Charlies.

It was paradise, or as close to paradise as we’re likely to come in this vale of tears, but it was a fool’s paradise, which has long since become obvious to anybody with more than half a wit. Once the real-estate prices turned around and headed south, everything pyramided on top of them began to crumble — mortgages, mortgage-backed securities, real-estate-related derivatives of various sorts, credit default swaps, bank balance sheets, big investment banks, stock prices (especially financials), interbank lending, you name it. About the only things that have risen appreciably in the past year or more are fear and despair. (The smart money has taken a long position in them.)

Now, before we lose our focus, allow me to remind you that this whole sad story is a tale of excessive debt. If householders, banks, businesses, and, of course, governments at every level had not become so outrageously overleveraged, the piper would not be in a position, as he is now, to demand such extreme payment. But debt and more debt and still more debt formed the stairsteps by which the U.S. economy (and others) ascended to the dizzying heights from which the world is now in the process of plunging.

But never fear: our government will save the day. Or so it promises us. Especially since last September, the Fed and the Treasury have scarcely stopped for a decent night’s sleep. They have frantically seized upon one “plan” after another (God save us from the central planners!) to “thaw the frozen credit markets,” to “prevent the credit-market meltdown,” to restore the flow of credit to one and all — in short, to make sure that we do not reduce our excessive, unsustainable indebtedness, but instead resume our all-out borrowing whether it is prudent to do so or not, and for most individuals and businesses at present, it most emphatically is not.

This morning’s New York Times announces the latest installment in this cavalcade of cuckoo crisis-fighting, something called the Term Asset-Backed Securities Loan Facility, or TALF. The headline reads: “U.S. Tries a Trillion-Dollar Key for Locked Lending.” The article explains that

The Treasury Department and the Federal Reserve plan to spend as much as $1 trillion to provide low-cost loans and guarantees to hedge funds and private equity firms that buy securities backed by consumer and business loans.
The Fed is expected to start the first phase of the program, which will provide $200 billion in loans to investors, in early March.
The program . . . does not try to change securitization practices that, many investors say, spread risks throughout the world and destroyed financial institutions. Policy makers acknowledge that for now, fixing credit ratings, reducing conflicts of interest and improving disclosure can wait.
Under the program, the Fed will lend to investors who acquire new securities backed by auto loans, credit card balances, student loans and small-business loans at rates ranging from roughly 1.5 percent to 3 percent.
Depending on the type of security they are borrowing against, investors will be able to borrow 84 percent to 95 percent of the face value of the bonds. Investors would not be liable for any losses beyond the 5 percent to 16 percent equity that they retain in the investment.
In the initial phase, the Treasury will provide $20 billion and the Fed will provide $180 billion. Treasury Secretary Timothy F. Geithner said last week that the Treasury could increase its commitment to $100 billion to allow the Fed to lend up to $1 trillion.

Well, there you have it. If you can imagine anything more idiotic in the present circumstances, your imagination is more powerful than mine.

I have this recurring nightmare in which Tim Geithner is lying in a dark corner of a saloon. His bosom buddy Ben Bernanke comes in, sees him lying there in a heap and rushes to his side. He finds his comrade breathing heavily and reeking of a warehouse worth of booze. He shouts for help: “Bartender, get over here quick. Bring this man a whiskey. And make it a double!”

Into such hands has fate delivered us. May God have mercy on our souls.

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BillWoolsey - 2/22/2009

Consumption has only sneaked above personal income from time to time a little bit. Those who were following these things complained that generally, personal saving was too low. That means, however, that households in aggregate could finance current levels of consumption out of current income without borrowing a thing.

While there may well be many households that were consuming well above their incomes, perhaps through home equity loans, there are other households that have been saving. While it is arbitary, I guess, to split things up in this fashion, one could say that some households were saving to finance the other households' dissaving. (Also, keep in mind, these figures include retirees liqidating asset portfolios in their senior years and so dissaving too.)

Corporate retained earnings, or business saving, remained strong. But, then, of course, government budget deficits remained high. And so, the commonly stated view that "national" savings was low. (About zero.)

Again, it is a bit arbitrary to split things up in this fashion, but I admit to sometimes thinking that foreign savings and the net capital inflow was financing U.S. investment--the production of capital goods, including new family homes.

It is incorrect that the Fed has to engineer a vast credit expansion for this to occur. I agree that errors in Fed policy exacerbated the problem. Claming that the Fed "engineered" an increase in M2 ... well, I don't doubt that the Fed could control M2 if it wanted, but any measure of the money supply that includes under 100k CDs only, (as opposed to the over 100k CDs. Of course it includes things that are clearly money as well as a vast amount of savings accounts) is pretty arbitrary. I have a lot of respect for Milton Friendman, but it is pretty clear by now that trying to find the holy grail of a conglomeration of financial asssets whose nominal quantity is at a fixed ratio to nominal GDP (constant income velocity) was unreachable.

Even if everything plausibly described as "money" was in aggregate fixed, Credit could expand tremendously if there are willing borrowers and lenders. Personally, I don't think CD's or 90 day commercial paper count as money.

That commercial banks were so heavily invested in real estate loans (and thrifts are certainly worse,) was troubling. And it is worrisome now. (The banking system has about 1.2 trillion in mortage backed securities, about 10% of total assets. But there is another 20% of home loans and 10% of commercial mortgages.)

I was working on a habitat for humanity house yesterday with my Kiwanis club. The young banker from the regional commerical bank explained that they offloaded all of their mortgages to Chase. But they hold commerical loans and second mortgages. The older banker (really personal investment advisor) from the local thrift explained that they held all of their mortgages--all 20% down.. etc. But, their earnings last quarter were used up with bad loan reserves.

On a different note, I have about $1000 in savings accounts--included in M2. These are not excess money balances that I am about to spend. Part is a remainder of an account mostly emptied to pay tuition 1 1/2 years ago. The other is an account where all of the money my wife and I would spend on gifts for one another is accumulated to finance a trip together at some unspecified future time. No time soon.

I do have a checking account and the balance fluctuates in that account as our salaries are credited and we pay bills. It has not been ballooning over the last decade because of monetary policy and I have yet to find ways to spend. My house is probably worth 25% less than at the peak, but my mortgage is probably about 1/3 of its current value. I have a home equity line of credit, and I have borrowed against it to pay more tuition. The interest rate was 5.75% when it was opened. It is now 2.75%. It is currently about 20% of my total mortgage debt, but again, the total is about 1/3 of the value of the house. BOA services these things, though I don't know who holds them. I am pretty confident that these are "good" loans for them.

Anyway, I think that any macroeconomic reasoning must always keep in mind some basic principles:

1. Scarcity.

2. The purpose of production is consumption, either now or through production of capital goods, in the future.

3. Income equals output.

4. For every buyer there is a seller, for every borrower there is a lender.

If too many people were borrowing before, then some people were lending too much. (Maybe they were Chinese.)

If some people need to be paying down their debts, then those receiving those payments need to.....

The answer to that is either buy consumer goods now or else buy capital goods so that they can produce more consumer goods in the future and buy them.

The notion that all of us have too much debt and all of us should spend less on everything, so that all of us should reduce our debt--is incoherent.

It is, of course, possible that all Americans should spend less, and we should produce consumer goods to sell to the Chinese (or something along those lines.) But leaving asside trade surpluses, total real spending in the U.S. should remain equal to the productive capacity of the economy. And if someone isn't using resources to produce capital goods, that basically leaves current consumption.

The economy is currently "set up" to produce way too many single family homes. That needs to shift. There has been a real loss in productive capacity, real income, and the appropriate level of real expenditures.

But the "reason" home construction capacity is too large is that the resources are better used elsewhere. They should be moving to expanding sectors of the economy.

The notion that everything should shrink because debt was too high is inconsistent with basic principle of scarcity. The notion that we cannot afford to buy what we are producing without ever increasing debt, is inconsistent with the basic identity of macroecnomics--income equals output.

Lately, I have been thinking that maybe Rothbard's discussion of Robinson Crusoe in Man, Economy, and State was really important.

How does a market economy reflect fundamental realities? Of course, unlike Rothbard, I am more willing to accept that if it isn't, then something has gone wrong.

And, naturally, following Yeager, I always seem to find that when something goes wrong there is an imbalance between the supply and demand for money.

I know that this may sound crazy, but I believe that short term, low risk nominal interest rates should be negative. The signal should be, postpone paying down debts now. IF you want to earn interest income, take risk (buy Baa corporate bonds) or go long. If you don't want to do that, consume now. Consume it or lose it.

The notion that everyone should pay down their debts, and those receiving the funds should accumulate T-bills, insured bank deposits, deposits at the Federal Reserve (for banks,) and the like-- IS INSANE!