Geithner vs. Schiff: A Thought Bridge Between Two Wrongs 14 comments
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Tim Geithner is pulling every lever possible to "restart lending" and recreate the securitization market - now backstopped by the government.
Every effort made comes with a govt subsidized "cost of debt," which has the effect of crowding out private capital entirely because no private entity owns a printing press. As a result, government is "centrally planning" asset prices. Karl Marx would be proud!
All one needs to do is compare the borrowing rate on a conforming mortgage (Marx) v. a Jumbo mortgage (Adam Smith) to see the difference in risk premiums for publically funded assets v. privately funded ones.
For Geithner, the road to prosperity is to expand credit, on the taxpayer's dime.
Angry yet?
Peter Schiff argues that Geithner's plan is a fool's errand. He supposes that what we need is more saving in this country and that those savings need to find their way into the hands of private enterprises who will borrow to invest in productive capital, hire more workers, and then we'll grow our way back to prosperity.
Both men are partly right but mostly wrong. Here is why:
Peter Schiff needs to go back and read his Irving Fisher and the profound risk of debt deflation. The Paradox of Thrift (Keynes) demonstrates too that when an entire nation starts to hoard and save, aggregate demand collapses, and a deflationary spiral ensues, which has the effect of "crowding out" the benefit of the savings that Mr. Schiff advocates. Oops! Not so simple.
So, on paper, increased savings might seem like a good idea, but in practice, too much saving will take the entire economy down.
Ergo: Fiscal and Monetary Stimulus is Just when people start hoarding - provided it is handled properly
On the other hand, Tim Geithner and his reflationist crew need to switch their focus to balance sheet capacity/debt to equity ratios v. the cost of credit. You can lower the price of money all you want, but if the target balance sheet lacks additional capacity for debt, then the new price of the debt remains irrelevant.
The trouble the US faces is not an absence of credit nor too little savings on a go forward basis.
On the contrary - the answer is that the US (households, business, etc.) has a debt burden that might reasonably resemble that of a 3rd world nation and needs to file for Chapter 11.
Policies that continue to attempt to "step over" this elephant in the room are destined to lead to economic stagnation.
The only way to free-up future savings and or credit flows for future investment or consumption is to lower the amount of outstanding debt. This means the debts need to be either "worked off" (Japan) or "charged off" (Chapter 11).
If, as a nation, we work off our debts because policy makers continue to prop-up creditor's interests (the banks) with artificially low refi rates and zero bound monetary policy, our stagnation will continue until debt to equity ratios mean revert, which could take a very long time.
Alternatively, if bad debts are discharged/haircut, etc. The creditor takes it on the chin, but the bad debt is then flushed from the system so that future economic cashflow can be turned towards consumption v. debt service. In other words, debt to equity ratios correct quickly versus very slowly.
I have no issue with the Fed and Treasury providing liquidity, but I think their ridiculous efforts to crowd out private money with uber-low rates is a ghastly enterprise that simply makes any and all assets prices a complete artifice (eg. housing).
Perhaps there is a middle ground?
How about this for a policy solution:
- Government should reset the cost of capital to a "rational level," e.g. 30 Year mortgages at 5.5% that incorporate a reasonable risk premium v. no risk premium at all (isn't that what got us into this mess?).
- Contrary to Mr. Schiff's opposition, government should reasonably step in to provide credit access to credit worthy borrowers where none is available, provided the money cost has some link to private market reality, i.e. it includes a risk premium
- Let the solvency chips fall where they may. If debtors can't pay creditors, they should default and then work out the loans. If they can survive, then they should earn it off. Call it "Creative Destruction" based upon a market-based interest rate.
- Assets that leave the hands of the weak due to insolvency should find their way into the hands of the strong through a proper workout, not by re-amortizing notes over 50 years or introducing PIKs, etc.
If durable asset prices (housing) fall to a new equilibrium, so be it! Better to take the pain now than to drag it out over a decade. - Government should stand prepared to recapitalize any "systemically important" creditors, e.g. Citi (C), who might see too many defaults on their books. But, to be clear, shareholders, preferred shareholders, and bondholders should take the losses, and govt should only recapitalize these institutions at the top of the capital structure, with a view to vending them back to the private sector in the future. The current enterprise of immunizing bondholders from losses is sheer madness.
- Government should also stand ready to provide a fiscal stimulus to help restart the economy.
Q. If a man owes a $1,000 and needs a new start, are you better to forgive him the $1,000 and then give him $100 to start over...or do you continue to anchor him with the $1,000 at a lower interest rate while still giving him the $100?
Which scenario frees up more cashflow for him to consume or stimulate the economy?
In summary, too much savings (Schiff) = Aggregate Demand collapse.
Too much cheap money disintermediates "laissez-faire" price discovery and balance sheet restructuring.
Isn't it time that we accept that the cure for a debt binge is just one big Chapter 11, with Uncle Sam standing at the ready to provide "restart" financing/fresh capital v. what they are doing now - throwing good money after bad, and simply manipulating the cost of money below market rates in the hopes that the debtpile will just simply go away.
Oil prices, stock prices, etc. have all corrected 50% in less than a year because these markets are liquid. The housing market is "sticky" on the way down but still needs to correct the full distance. Instead of letting this happen, govt is interfering with price discovery and the downstream consequences, engineering social policy instead of financial policy.
This will only sentence the US economy to a stagnant economic purgatory - that is, until free markets are permitted to flush the system clean.
Perhaps betweem Schiff and Geithner - a Thought Bridge might exist?
Stock position: None.
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This article has 14 comments:
America is not solvent enough to provide that on a large scale at the moment, and besides just pumping money in does not stop it leaking abroad for investment elsewhere. US companies also often lack the products and expertise.
What needs to happen is that the conditions need to be set to make it attractive to foreign companies to invest in production in the US.
To do that costs need to be reduced. The rampant dollar at the moment is only making things worse. Real wage cost need to come down a great deal. Tax breaks need to be given to those investing not those that the government want to bribe to go shopping. All in all it adds up to a lot of pain, but the sooner everyone recognizes that fact and that can no longer continue living in a fool's paradise, then the sooner there will be the opportunity for people to work their way out of the mess.
1. Getting the US consumer to consume has got to be one of the easiest jobs in the world. If he/she is employed and it does not look like we are entering a depression (i.e the prez and his minions dont mention crises every 3rd sentence to further their agenda), then they will consume.
2. To stimulate employment, make it easier for business owners and companies to operate their business and do not punish them through taxes and legal hassles for employing people as is done today.
3. The gov's B/S is more important than anything else because when that blows up, we are all screwed. You mention gov spending very casually like it is pocket change without any regard to the future impact the enormous deficits will have on the economy.
This is the mentality that got us where we are today. Savings produces capital which produces innovation, jobs, production and wealth, all of which lead to consumption. You can not turn this equation around, start with consumption and go the other way. You can't skip the savings part, and if there are no savings then we must save first, not somewhere down the road. Short term pump priming is an illusion that leads to mal-investment and wasted resources, which lead to poverty, not prosperity. Bernanke's most recent stimulus bubble has wasted trillions of dollars worth of resources building houses that we can not afford. What sector would you propose deserves the next bubble?
As a matter of prudence, then some sort of accommodation with the Keyensians may be called for. I would accept a resolution that allowed all sick banks to go bankrupt in exchange for some sort of federal agency that directly would lend to homebuyers at a given interest rate. Note that the government would still be interfering in the market; the benefit of having the sick banks go under, however, would in my mind be greater than the detriment of governmental interference. With the "legacy asset" (Sec'y Geithner seems to have an Orwellian talent for New Speak) losses internalized by bondholders, stockholders, and bank management (all of whom should bear the losses), we can then move forward.
Finally, let's talk common sense. An economy that is 70% consumption based is unsustainable if that consumption is mostly funded by ever-increasing debt. Savings are deferred consumption. Debt is the opposite; it is immediate consumption and deferred savings. At some point, the "others" who finance one's debt have to realize that they will simply not be getting their principal back and will make the logical decision to stop lending.
Cooperatives seem to have fallen out of public awareness altogether, and yet my bank is a cooperative, is healthy, lends money prudently, encourages savings, and many other good things--why wouldn't that work for essentials like housing, medical care, and education? One can't seem to find a contemporary book on cooperatives.
> As a matter of prudence, then some sort of accommodation with the
> Keyensians may be called for. I would accept a resolution that allowed
> all sick banks to go bankrupt in exchange for some sort of federal
> agency that directly would lend to homebuyers at a given interest
> rate. Note that the government would still be interfering in the
> market; the benefit of having the sick banks go under, however, would
> in my mind be greater than the detriment of governmental interference.
Keynesian policy got us into this mess and the current "fixes" are to apply "more of the same". Let's see how that works.
Just before the situation turns sour, at the peak of oil prices (another bubble caused by wasteful spending), one can buy a new automobile with zero interest loan.
There should be a proper cost for consumption, not an artificially created low or high cost. Throwing money in to stimulate consumption will cause more problems; the money should better be wisely used for useful infra-structure and smart business investment.
Regards
Koh Choon Lin
Except cars won't have windows or air conditioning, maybe brakes.
Online banking, atms, secure banking are all out.
Health care will be completed with leeches, CAT scans and expensive surgeries are out.
Energy - we won't need it, we'll all be living in tents and living off of seed.
Internet - sorry, shut down, just no capital for it.
What petri dish does this all work in?
It isn't the governments job to save everyone from their bad decisions. It's their own job. In fact it's not even advisable for the government to do so. As the proverb goes: let the child fall and pick himself up - he will learn how to avoid falling and have confidence that he can get back on his feet on his own!
On Mar 25 03:33 PM CJJ wrote:
> Here's a great idea. Lets have everyone save 100% of what they earn.
> This will lead to 100% unemployment. All businesses will go bankrupt
> and fail(I mean they were run by terrible people anyway, right, right...)
> and we'll just start over with all the "smart people who don't make
> mistakes" running the show.
> Except cars won't have windows or air conditioning, maybe brakes.
>
> Online banking, atms, secure banking are all out.
> Health care will be completed with leeches, CAT scans and expensive
> surgeries are out.
> Energy - we won't need it, we'll all be living in tents and living
> off of seed.
> Internet - sorry, shut down, just no capital for it.
>
> What petri dish does this all work in?
> Sir, would you be able to comment on the possibility of a kind of
> government organized (but not government-owned) cooperative to lend
> mortgage money?
Well, credit unions ARE a kind of co-op organized by the government, and they lend money for mortgages. The fundamental problem with a mortgage co-op (if that's what you're referring to) is that you'd need a person or persons to put up a sizable chunk of money (even if the borrower put down a decent down payment) for a long (i.e. 15 or 30 years) period of time. Note that this type of co-op DOES occur in certain instances:
* older family members lending money at very low interest rates to younger members so that the younger members can buy property
* established members of a particular ethnic community (Jewish, Chinese, etc.) lending money at very low interest rates or for a share of equity to younger members so that the younger members can purchase capital and build a business
I do not think that this type of activity can gain acceptance among large portions of our population. Families and ethnic communities are willing to take greater risks and lower returns for two key reasons: (1) they have inside knowledge about the borrower and his upbringing that financial institutions do not have and/or (2) they receive some utility/satisfaction by "helping out" a member of their "tribe" or "clan."
Let us look back at the recent history:
- Carl Marx theory and central-planning economy worked only in "intellectual elite" minds. The both have proven to be complete failure
- When people with "great" ideas fail, people start desperately look for leader to follow. It happened with Hitler, Mao, Stalin, etc.,
Consequences are always the same: dictatorship, wars, and endless suffering. Eventually, people become tired of this shit and societies return back to something "normal & peaceful" when people work hard and understand meaning of the life. People standards of living start to improve only when some form of a free-market economy returns back.
But in any case, life continue regardless of anything.