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Let The Banks Fail

Having previously supported TARP 1.0, the first round of financial bailouts that poured $350 billion dollars into an emergency backstop for the nation's private banking system, I've changed my mind on any future federal intervention short of outright receivership for failed banks. It is difficult to justify all of the original TARP spending, even though some of the funding did contribute to preventing a full scale financial panic. Many of the TARP assisted banks were healthy financial institutions that intend to use the government financing to make acquisitions and consolidate weaker banks in their operating territory (a good strategy, but one that should be executed with private sector capital, not tax payer money).

However, as with any large federal spending program, political ambition has trumped all other interests as politicians find newer and better ways to expand their power even if they have to make it up as they go along. President Obama's mortgage relief plan ($350 Billion plus) is but the latest grand plan (eerily similar to the Five Year Plans frequently trotted out by the Soviets years ago) to save debt burdened taxpayers that made poor financial decisions in the home buying roulette that has gone unabated since 1995.

To understand what a total waste the $350 billion mortgage bailout is, take a look at this chart. If Robert Schiller is correct, then we have a long way to go before housing prices reach any sort of equilibrium. As James Quinn noted:

As Congressional moron after Congressional moron goes on the usual Sunday talk show circuit and says we must stop home prices from falling, I wonder whether these people took basic math in high school. Are they capable of looking at a chart and understanding a long-term average? The median value of a U.S. home in 2000 was $119,600. It peaked at $221,900 in 2006. Historically, home prices have risen annually in line with CPI. If they had followed the long-term trend, they would have increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan Greenspan's irrational lowering of interest rates to 1%, the criminal pushing of loans by lowlife mortgage brokers, the greed and hubris of investment bankers and the foolishness and stupidity of home buyers. It is now 2009 and the median value should be $150,000 based on historical precedent. The median value at the end of 2008 was $180,100. Therefore, home prices are still 20% overvalued. Long-term averages are created by periods of overvaluation followed by periods of undervaluation. Prices need to fall 20% and could fall 30%. You will know we are at the bottom when the top shows on cable are Foreclose That House and Homeless Housewives of Orange County.

Since last fall, the federal intervention in the financial crisis can be summed up as follows:

  • 1) TARP $700 billion
  • 2) Stimulus $1.2 trillion
  • 3) Obama mortgage bailout $350 billion
  • 4) Undisclosed Federal Reserve lending to banks and brokers $2.5 trillion (est.)

Total: $4.750 trillion

As Baron noted the other day, they haven't even started on the next budget bill yet.

It remains to be seen if President Obama understands that Congress is carrying him over a steep cliff with these gargantuan spending programs. The solution to the current financial crisis is, as Senator Bob Corker (R-TN) noted yesterday, to take our medicine now and get it over with. But the tinkerers and central planners in Congress seem hell bent on extending their Keynesian intrusion into a socialist model that is doomed to failure.

H/T Clusterstock


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Comments (5)

It ain't like it's their mo... (Below threshold)

It ain't like it's their money. Just a couple more tweeks and they'll have it all fixed. After all, they are the elite, they know what's best.

Hey, wanna buy a house? No down, no income verification. Low, low payments? After all, it's your RIGHT.

If the banks don't fail...w... (Below threshold)

If the banks don't fail...wait until Obama unveils his "budget" and watch how the market will react...

Yes, hope and change...

...to save debt bu... (Below threshold)
Mac Lorry:
...to save debt burdened taxpayers that made poor financial decisions in the home buying roulette that has gone unabated since 1995.

Unfortunately, people who made good financial decisions going back prior to 1995 are now being caught up in this economic shrinkage. The spreading fear among workers that they are next to join the unemployment line keeps people who have jobs from buying much more than the necessities, and so our consumption biased economy is shrinking, which puts more and more people in the unemployment line, which increases the fear. Most states have seen their tax revenues drop dramatically and some are laying off thousands of workers. Every level of government from the states down has quit or delayed buying some products and services, which causes more layoffs. Businesses and governments seeking to weather the storm have instituted hiring freezes, which means workers who find themselves unemployed stay unemployed longer and longer. People who played by the rules and didn't take any undo risk are in the next wave of foreclosures.

The loss in housing values combined with the loss in the stock market has taken trillions of dollars out of the economy and we may see trillions more disappear in the next 2 years. Money is in short supply and despite all the hype about inflation that much shrinkage in the economy is likely going to result in deflation. Even the Federal government printing and spending many trillions of dollars may not be enough to stop the shrinking economy and downward trend in prices (hope you didn't buy gold recently). Those who say we should take our medicine now and get it over with don't know how long "now" is. Just letting the economy collapse could mean it will take a decade or more for our economy recovers. That's a long time to live under a bridge and stand in soup lines.

The underlying cause of this mess can be tracked back to the government mandating subprime loans and guaranteeing them, which removed the risk for the bank making bad loans. The other cause was a change in a law that allowed mortgages to be converted into securities and sold to investors. That lead to the creation of derivatives that cannot easily be traced back to specific mortgages. That lead to the problem that no one can tell the financial health of any particular bank, which dried up credit. The market didn't create this mess on it's own nor can it solve it on it's own. Only the federal government has both the authority and the resources to unwind the linkage and remove the toxic assets.

Krugman--Keynesian--thinks ... (Below threshold)

Krugman--Keynesian--thinks the banks should be allowed to "fail", which of course means being nationalized and sold off. Wipe out the shareholders. Glad you agree.

In 2007, I first saw Shille... (Below threshold)

In 2007, I first saw Shiller's amazingly telling graph back to 1890 and hypothesized a mean reversion of real housing prices back to the historical norm. I now wonder if it is not more likely that there may be, possibly considerable, overshoot to the downside before prices then move back up to the mean.

The magnitude of the overshoot, I suspect, could be estimated by comparing the Shiller graph to a graph of historical housing units per person back to 1890. This units/person graph may assist with forecasting WHEN housing will stabilize. If the units/person graph forecast differs greatly from a simple mean reversion forecast of Shiller's graph, then perhaps one should expect something other than a simple mean reversion before prices stabilize.






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