A Stimulus That Keeps On Stimulating

By Peter Asher©

Originally posted on American Solutions, 8 Dec. ’08

“No one saw this coming.” — Dick Cheney

“My great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today”– Robert Rubin

How absurd!

Anyone with an analytical mind could have seen it coming and anyone with an analytical mind can be shown what needs to happen to fix things.

This recession was not caused by a credit crunch and it was not caused by the sub-prime crisis. The cause was that the economy was built on a debt bubble that expanded to a level of unsustainable debt service. The capability to produce goods and services expanded to the money supply allotted to it, but an economy that attains equilibrium on the advancement of purchasing power must inevitably contract when that advancement can no longer be maintained. . Defaulting mortgage debt was the proverbial last-straw-on-the-camel’s-back, the final load on this unsustainable debt.

Debt service now claims a substantial portion of overall purchasing power. The portion remaining to drive the economy is therefore now less than it would be even on a no-credit, spend-it-as-you-earn-it basis. The economy that has expanded to fulfill the demand of earnings-plus-advanced-payment, must contract to the demand of earnings-minus-cost-of-debt-service. What for decades was an economy built on, “Buy now, pay later,” has become, “Pay now, buy later!”

Statistics on sales, from lattes to car purchases, indicate that, as with the stimulus package, people are curtailing spending and are saving or paying debt with earnings. Yet one person’s earnings are created by another person’s spending. One person’s spending enables someone else to earn a living, as someone else’s spending has enabled them. What creates the imbalance in the economy is spending what one has not yet earned on that which will not contribute to earnings.

This is the difference between money borrowed to facilitate production and distribution and money borrowed for consumption and speculation. In between, there is borrowing for personal needs that are essential for personal function, such as a car loan or a new computer. Credit abuse, not credit use, is what damages an economy.

Now, as the numbers of the unemployed swell, more unemployment is triggered because those former wage earners no longer have the spending power to contribute to other people’s earnings. This is feeding on itself and is potentially a downward spiral headed toward a full blown depression.

The bailout devotees claim that frozen credit markets are holding this recession in place. Infusing hundreds of billions of dollars into the banking system was supposed to result in making new credit available (which has not occurred), and yet it is the extent of credit already granted that has brought about the situation in the first place. More credit, which can only be issued to the degree that there are those who can still qualify for it, can provide a temporary stimulus, but after that there is that much more debt load to be serviced.

The proportion of purchasing power created by credit relative to the total economy is far greater than at any other time in history, a direct result of qualification standards being lowered more than at any other time in history.

The housing bubble was really a replay of the 10% margin phenomena that created the 1929 stock market bubble. Highly leveraged purchases of equities that have been highly overvalued by, let’s call it, mob psychology! People do not so much forget history; they seem not to have learned it. I doubt there was a single money-losing home flipper who knew of the Dutch tulip bulb mania which escalated to the point where someone sold their town house to purchase one allegedly exotic specimen!

All of the bailout proposals, including the tax holiday, create new debt. There is no quantitative difference between giving consumers more credit directly or causing them to be indebted by the taxes that will come due to finance stimuli. The only difference between a tax holiday and government-issued checks is the method and apportionment of the distribution.

The one stimulus that would create new purchasing power without creating new debt would be the refinancing of existing debt at lower interest! Paulson has proposed this as a possible 4.5% interest mortgage rate, but that has been acknowledged as only available to those individuals qualified under the current strict lending standards.

Someone rolling over a $300K mortgage from 6.5% to 4.5% would be “stimulated” by a reduction in debt load of $500 per month/$6000 per year for decades. That would be a much more powerful stimulus than a single government check for $1200 or even a two-month tax holiday that would save an average of maybe $4000, one time only. Also, while Government stimuli empirically result in additional taxes, reduced mortgage payments would immediately result in reduced interest deductions, whereby tax revenues would increase. Unfortunately, the number of people who would be able to obtain these possible refi’s is nowhere near enough to generate the purchasing power necessary to give the required “jolt” to the collapsed economy.

Currently America’s internal and external debt is about $60 trillion, almost 500% of the country’s annual GDP of a bit over $14 trillion. Of that total, family debt (including mortgages) is about $15 trillion, financial firms $17 trillion, non-financial firms $22 trillion, municipal debt $3.5 trillion, and national debt $11 trillion.
Leaving aside the fact that all of that debt must be paid back from the flows of personal and business earnings; the $15 trillion family debt, if owed by – say – 60 million households, averages out to $250,000 each.

If mortgages are running 6% to 11% and credit cards up past 30%, we could, for the purpose of discussion, estimate the median interest rate to be 7.5%. This comes out to $1562.50 per month for that average family. That’s $1,125 trillion of interest per year, which is 8% of the GDP. If that interest could be cut in half it would stimulate the economy by a growth factor of 4%!

Now rollover loans at 3.75% might seem extraordinarily low, but if the Fed rate were held long term at ½% to zero, then that lower interest rate could be brought about. If the lenders weren’t willing to do that, perhaps some “Jawboning” or direct stipulation from their TARP benefactors would do it. The newest plan to adjust mortgages in bankruptcy proceedings is short sighted! If mortgages are adjusted by refinancing now then people don’t wind up filing for bankruptcy.

Failing that, the government could bypass the banks and create a direct-from-the-Fed lending entity to give one-time rollover loans to all who were fully current on their debt, as of the first of the year. The loans could refinance both mortgage (home owner only!) and credit card debt. In return, the debtor would agree to a stipulation (recorded on their credit report) that they were unqualified for further credit until some time well-off in the future when they would have significantly reduced their debt. Not only would this reduce the cost of the systemic debt overload it would be unwinding the systemic debt position.

Those that lost their jobs or had major business setbacks could be given a year’s grace by amortizing a year’s interest into the loan which would only raise the interest rate to 3.9%. This would allow them to keep their homes, which would greatly enhance their ability to focus their energies on reestablishing earnings. Simultaneously the economy would be recovering sufficiently to provide the opportunities needed.

This Fed-direct plan would initially require new funding into the system, but every loan paid off would route those funds to the banks or the holders of credit card and mortgage bonds. The banks, having their customer base reduced by the competing loan rollovers, would have excess capital inventory. Money “printed” for the fractionalization expansion could be required to be funded back to the Fed. The bond holders would have their bad and risky loans paid off, be recapitalized, and have new funds to lend. Their “mark to market rate” would recover. There would no longer be a need for a bailout; it would have been done in reverse order!

Naturally many loans would not be fully collateralized, but collateral value would immediately rise upon the implementation of the program, since foreclosures would not be glutting the market and qualified buyers would be re-establishing activity in the home construction sector.

Certainly, the banks and credit card companies would strongly object to a plan that would severely contract their business However; if one can grasp the magnitude of the threat of debt, default, deflation and depression; one can see that surviving at a smaller size is preferable to being larger and defunct!

All of the above, aided by a re-institution of usury laws, could lead to an economy and a society that are less dependent on spending not-yet-earned money for the needs of the present moment.