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The Problem

By's like purposely setting a building on fire and running in to rescue the kids.

After years of artificially low interest rates (as instituted by the Federal Reserve of the United States to "stimulate the economy" and "provide price stability") and having created massive speculation, we get the next government initiative and spelled out by Senator Dodd:

U.S. lawmakers will consider providing aid to about 2.2 million sub-prime mortgage borrowers who are at risk of defaulting and losing their homes, Senate Banking Committee Chairman Christopher Dodd said today.

"The impact of losing 2.2 million homes I suspect will be in a lot of areas of our cities and towns that are already pretty hard hit, so we clearly want to look at that and legislate," Dodd, a Democrat from Connecticut, told reporters in Washington after a speech to the National League of Cities.

Congress "may need to do something much more quickly to provide some protection or you could end up with a lot of poverty and blight,'' Dodd said. Federal aid of a few billion dollars "may be a lot less costly'' than $164 billion in lost wealth, he said.

As I have explained several times, the Federal Reserve, through their easy and easier monetary policy, has itself created several asset bubbles, the latest being housing. They have basically made money "free," thus encouraging speculation…borrowers to take out loans and spend or buy assets. They have purposely encouraged risk taking behavior of the most egregious kind in an attempt to reflate asset prices. Reflate them they have, with massive amounts of debt.

That debt is coming home to roost because income growth is not keeping up with the growth in debt. First the less financially secure borrowers have trouble servicing their debt and eventually the more financially secure begin experiencing it too. The most financially secure own the banks that lent the money. Do you smell something yet?

I am not saying people didn't borrow mindlessly. I am saying they should be free to. Rational capitalism will punish them for it and they won't do it again, that is, unless we don't let them learn the lesson.

I am not trying to be hard nosed and mean. I feel sorry for people when they lose their homes. But this country will cease to be free and capitalism will cease to allocate capital properly if we continue to let government first cause our economic problems and then try to solve them. It is a double edged sword.

Congressman Dodd either does not understand the problem or worse. The Federal Reserve has itself caused the bad investments we worry about today by "dropping dollars from helicopters," which is just making cheap credit available to banks. Banks in turn took their cue and lent it out to less and less credit worthy borrowers. They were encouraged by the whispered policy of "the government will not let us fail." Heck, Moody's actually last week raised JPM credit rating for the sole reason of "they are too big for the government to let them fail." Why shouldn't banks have lent out every slim dime they could with such a stealth policy?

Now the government in its infinite wisdom is coming to the rescue. But it's like purposely setting a building on fire and running in to rescue the kids. The result will be that those same participants who made stupid mistakes in the past will be encouraged to do so again. Capitalism is about the allocation of risk and resources. If participants feel there is no risk they will mis-allocate their resources.

This is failed policy. The government needs to get out of the manipulation business. Don't worry, I won't waste too much breath saying that again.

My only question is this. Is Mr. Dodd really worried about the 2.2 million "homeowners" or is he worried about the rich bankers who lend them the money? Grandma may get to keep her house for now, but eventually her equity will be worthless. Why not just let it fail now? Because by not letting her fail now, the banks will recoup years of payments and cushion their losses?

The world is becoming more socialistic as governments of developed nations grow in both influence and budget. Government spending is becoming a huge factor in GDP. That means slower growth and higher debt for everyone. That means a general equaling of a lower "wealth" as governments re-distribute it.

With the U.S. having 5% of the world's population and 35% of the world's wealth, can you see where that is going?

Best Regards,
Mr. Practical
No positions in stocks mentioned.
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