Monday, February 23, 2009
Fran, Put Down the Crack Pipe
Fundamentally, the proposal for a TARP v. 2.0 results from a gross misdiagnosis of what ails the American economy. The recession is not the result of a "drop in consumer demand". It is the result of collapse in liquidity resulting from the gross overextension of credit. Our problems are closer to those of Southeast Asia in the 1990s than America in the 1930s. A proposal fundamentally resting on an attempt to reinflate the credit bubble is going to inevitably result in exacerbating the very problems that created the bubble in the first place. Banks are not extending credit because they are trying to rebuild their capital. They are doing what they need to do. The deleveraging process, as painful as it might be, is precisely the financial system functioning properly. The level of borrowing that was occuring two years ago was, like it or not, precisely why the financial system fell apart.
But lets move on to the specifics of your plan.
The loans that are expected to be impaired are not the sort of temporary impairments you are suggesting. The bulk of the distress are in a few select housing markets. Modifying the terms is not going to get these loans up and running. The markets are overbuilt. To the extent that banks could salvage the loans in question by modifying their terms, they've already made clear that they're more than willing to do so. But, a loser is still going to be a loser. A loan that is at 250% of value with a homeowner who doesn't have much in the way of prospects to get back to paying is still a crappy investment.
And make no mistake, these are the loans that are at the heart of the retrenchment in the real estate market. Saying that we won't finance the loans that never should have been made is saying we won't finance the loans that need refinancing. 95% of mortgages are and are expected to remain current. Its the 5% that are toxic. Its also the 5% that will blow through the 30% guarantee. As a result, the 30% guarantee would do nearly nothing to set pricing on the securities backed by the garbage.
The fact of the matter is that the original TARP plan took away the immediate risk of systemic failure. Now, we're going through the long, painful process of recovering from an excess of leverage. The private sector is deleveraging. Attempting to equate orderliness of failures in the financial system with the absence of large-scale failures amounts to creating a system of rewarding the very weakness that created the current crisis. Increasingly though, global markets are looking askance at the United States as a long-term credit risk. That is, rather than fear of another Lehman, markets are wondering if the United States government can be viewed as credible. Between a $750 billion Troubled Asset Relief Program that offered no relief from troubled assets, an $800 billion stimulus program offering only 12% stimulus, the flooding of the money supply, and perpetual bailouts of the Big 3, I can't say I blame them.
The American economy has increasingly become addicted to easy credit, much as an addict gets addicted to crack cocaine. Reinflating the credit market by maintaining the zombies in suspended animation idefinitely only amounts to trying to come off of a bender by taking a little hair of the dog. The only way our economy can ever hope to get itself back on an even footing is for us to put down the crack pipe.
