Extend and pretend
Extend and pretend鈥�
That鈥檚 the government鈥檚 way of handling the crisis. Extend credit and cash to those who don鈥檛 deserve it. Then, pretend that everything is okay鈥�
But the problems don鈥檛 go away. They just get stretched into the future鈥�
What did the feds do for GM? They took over the company. They extended cash and credit. They put in place a 鈥�Cash for Clunkers鈥� program to encourage people to buy cars. Then, they pretended that the problems were solved.
But yesterday鈥檚 news tells us that 鈥淎ugust car sales plunged.鈥�
They hadn鈥檛 really solved the problems at all. General Motors still needed to be restructured. And there weren鈥檛 really anymore qualified auto buyers than there had been before. They had merely been encouraged to buy sooner鈥ather than wait until their cars were really worn out.
And look at what happened in the housing market.
July sales set a new record low. Why? Because the feds had encouraged people to buy earlier 鈥� by giving them cash incentives, via tax credits. For a while, it looked like the housing industry was picking up. But had any of the real problems been solved?
Nope.
Nearly 15% of all mortgage loans are either overdue or in foreclosure. And nearly one in four houses with mortgages is underwater. Another 5% barely have their heads above water, with equity of 5% or less.
When a house sinks under the waterline 鈥� that is, when its market value is less than its mortgage 鈥� the owner goes through the usual pattern of disbelief, denial, defeat and eventual desperation. If he loses his job or gets divorced the timeline is shortened. Either way, he ends up in the same place 鈥� desperate to get back on the surface where he can breathe again. It takes time. It鈥檚 painful. But the longer the housing market takes to recover, the more these people give up and default on their mortgages.
The US financial system is still holding hundreds of billions worth of mortgage debt that isn鈥檛 going to be repaid. Who鈥檚 going to take those losses?
The feds have already made it clear 鈥� it won鈥檛 be the big banks. They extended cash and credit to the banks and pretended everything was okay. The Fed itself bought up much of the big banks鈥� bad mortgage debt already; it holds it in its vault and calls it an 鈥渁sset.鈥� And the US government nationalized the biggest, most reckless and irresponsible lenders 鈥� Fannie Mae and Freddie Mac. So now the taxpayer takes the losses 鈥� even if he never bought a house鈥nd never invested a penny in the housing industry.
And we鈥檙e only talking about the domestic housing market 鈥� not about commercial loans. All together, the problem is still huge鈥nd still there鈥�
鈥nd if housing prices fall 鈥� almost certain to happen as this 鈥渟hadow inventory鈥� hits the market 鈥� one out of every three mortgaged houses is likely to sink underwater, with millions of new defaults, foreclosures and distressed sales.
Extend鈥nd pretend鈥nd maybe the problem will go away. Or maybe the situation will become so confused that nobody knows whom to blame or what to think!
Ben Bernanke is hoping for the former and counting on the latter. He answered questions in Congress yesterday. At least one of the politicians wanted to know: 鈥淚f you鈥檙e so smart how come you told us that the subprime crisis would be 鈥榗ontained.鈥� How come you didn鈥檛 seem to have any idea what was happening or what to do about it?鈥�
鈥淥kay鈥ell鈥� We were wrong about subprime鈥nd we missed some signals,鈥� said the former Princeton professor of Finance, in so many words, 鈥渂ut you can count on the Fed to regulate the financial industry from here on. No problem.鈥�
Bernanke went on to describe how he thought financial problems got into the system and how they became hard to control.
鈥淭hey are like bacteria鈥ike e-coli鈥︹�� he said (or words to that effect鈥e don鈥檛 have the transcript in front of us, just the press report). 鈥淚t is always dangerous. But you can control it if you use the proper procedures. Once it is out in the bloodstream there鈥檚 not much you can do. It can be fatal.鈥�
Once again we see the same delusion鈥hat corrections are alien invaders that can be fought and beaten鈥iseases that can be controlled and cured鈥roblems that can be corrected.
Bernanke misunderstands the most basic and simple nature of an economy. With its new regulatory powers, he imagines the Fed as the Bureau of Public Financial Health, carefully inspecting the meat and making sure the kitchens are clean. If he does his job well, he implied, we won鈥檛 have to worry about financial crises ever again. All we have to do is to get the bankers to wash their hands after making a loan!
Uh uh鈥� That鈥檚 not how it works. The problem was the bubble economy. It was caused by miscues and phony signals coming from the Fed (along with some other circumstances over which the Fed had no control).
The solution is the correction鈥� In other words, the correction is the good part of the cycle. The bad part of the cycle was what created the need for it.
Once the mistakes have been made, they need to be corrected. A correction is not a disease 鈥� it鈥檚 the treatment. Mistakes are inevitable鈥specially when you have Greenspan, Bernanke et al misleading investors and business with their phony money, artificial lending rates and crackpot theories.
Thank God there are corrections to fix them.
The correction will set things right鈥f it is allowed to do its work. Unfortunately, the apparatus of the feds is at work trying to block it鈥�
Extend and pretend鈥�
The idea now is to finance more errors 鈥� while supporting the old ones 鈥� with money from the federal government. If the feds can pretend that everything is okay鈥y extending enough cash and credit鈥hen everything will BE all right鈥�
鈥ntil the federal government itself runs out of money. Then, the whole thing blows up.
In the meantime, who can say he鈥檚 not having fun?
Here鈥檚 a thought from Bloomberg. The news couldn鈥檛 get much worse, the analyst reasons; so it must get better. How? No double dip recession:
The US economy is so bad that the chance of avoiding a double dip back into recession may actually be pretty good.
The sectors of the economy that traditionally drive it into recession are already so depressed it鈥檚 difficult to see them getting a lot worse, said Ethan Harris, head of developed markets economics research at BofA Merrill Lynch Global Research in New York. Inventories are near record lows in proportion to sales, residential construction is less than half the level of the housing boom and vehicle sales are more than 40 percent below five years ago.
鈥淚t doesn鈥檛 rule out a recession,鈥� Harris said. 鈥淚t just makes it less likely than otherwise.鈥�
The possibility of the economy lapsing into another contraction during the next year is 25 percent, he said in a Sept. 1 report. Harris cut his forecast for growth this year by 0.1 percentage point to 2.6 percent and lowered his 2011 estimate by a half point to 1.8 percent, according to the report.
We鈥檙e not so sure. So far, this correction only took 4% off the economy at its worst point. Not very much, really. Stock prices are down. But stocks still aren鈥檛 cheap. Unemployment is at 9%; it could be worse.
We ain鈥檛 seen nothing yet. So far, it looks like we are following in Japan鈥檚 footsteps. If so, the bottom won鈥檛 come before 2018 or so鈥�
Which is why you鈥檇 better enjoy this correction. It will be with us for a long time.
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