'Pretend and Extend' Meet Brick Wall

Feb.23.10 | About: SPDR S&P (KME)

Is This a Defense?
Senator John McCain was quoted to have said that he was misled on the details of the TARP plan:

In response to criticism from opponents seeking to defeat him in the Aug. 24 Republican primary, the four-term senator says he was misled by then-Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. McCain said the pair assured him that the $700 billion Troubled Asset Relief Program would focus on what was seen as the cause of the financial crisis, the housing meltdown.
"Obviously, that didn't happen," McCain said in a meeting Thursday with The Republic's Editorial Board, recounting his decision-making during the critical initial days of the fiscal crisis. "They decided to stabilize the Wall Street institutions, bail out (insurance giant) AIG, bail out Chrysler, bail out General Motors. . . . What they figured was that if they stabilized Wall Street - I guess it was trickle-down economics - that therefore Main Street would be fine."

The TARP was indeed a bait and switch, but is this McCain's defense? If he was misled (among others I imagine) then where is the corrective action? Why have the makers of TARP not been held to account? How is it that banking bailouts are still going on? This defense is an easy way to say "It's not my fault!" but I think it falls flat. The lack of action on the part of McCain and others speaks to the point that if they felt misled they certainly seem to be ok with that judging by their actions since that time.

"Pretend and Extend", Meet Brick Wall
It has long been a central belief of mine that "Pretend and Extend" was policy choice number one for the US government. It has worked well for some past events; the 1987 market crash and the fall of Long Term Capital Management (LTCM). I think the idea was that a temporary dislocation could be waited out and things would turn back to normal. I think this plan was based largely on those two examples but both are poor models for the current credit debacle. This has serious implications going forward.

In the case of the 1987 market crash and the collapse of LTCM the underlying pressures were indeed of the short lived variety. No need to rehash all the details; the point is that buying time was a viable (process wise anyway) way to side step a larger mess gaining steam. In both cases things cleared up quickly.

The current crisis has deep roots and had refused to even make any headway back towards nirvana, never mind a complete recovery. After two long years it should be clear that the "Extend" part of the plan will have become quite a bit longer than many had thought at the onset. In this way the repeated application of this national policy is both destructive and useless.

Case in point; US States themselves have played "Extend and Pretend" (E&P) in regards to public finances for some time. Add to this the looming funding shortfalls on public worker pensions and tax revenue that has remained stubbornly low (no jobs = no taxes) and how long any state can continue the show is now hitting a brick wall. Just one example of many that can be used was over at Mish's site Monday:

'Doomsday is here for the state of Illinois'
It will take a massive tax increase -- and $2 billion more in cuts -- to reach solvency, group says.

Mish's post can be seen here.
Key take away point from the Sun Times' piece:

To become solvent, the state must enact the largest tax-increase package in Illinois history, whack another $2 billion from already starved government programs and wrest major financial concessions from the state's unionized work force, a nonpartisan government watchdog contends.

Yeah, good luck with that.

Illinois, California, you name the state and there is a good chance they are in trouble. The US Government will be hard pressed not to join in and help either by direct assistance or some kind of municipal bond backstop, but neither effort gets to the root of the problem which remains too much spending and no fiscal discipline. The states can extend their run at appearing solvent, but no real progress can be made this way.

More banging heads against walls? No problem.

In what can only be described as lunacy, the government refuses to face reality and instead continues to pretend that home mortgages can be modified for "owners" that cannot afford their home. Newest HAMP story line (via Calculated Risk):
WSJ: Treasury Considering Appeal Process for HAMP
Boils down to another 30 day extension period. CR notes:

Probably the main impact of HAMP has been to keep the supply of distressed properties down by delaying the inevitable. In most cases, this would just be another delay ...

Consider the 3 main reasons a home mortgage cannot be modified:
-Incomplete or missing documentation
-Owner cannot meet income requirements
-Mortgage too far underwater to qualify

Which of these 3 items will change in 30 days? 60 days? Maybe one could locate the needed paperwork with an extension but the culprit is more so missing paperwork because the borrower cannot furnish the information due to a variety of reasons and I think prior fraud is one such reason.

Again, yet another E&P game done for show and in the hope that a miracle turn around occurs, like soon. I would add this program, and all housing support programs, are slaps in the face to borrowers that are paying their notes on time and in full sometimes at great hardship to themselves. The animosity this must be generating in neighborhoods is hard to quantify.

At what point will those running this game start to understand that a Plan B is needed? I know that Tim Giethner thinks no Plan B is needed, but I tend to not think the way he does. I think it fair to the US taxpayer to at least get a time frame or general idea as to how long and how far the government will go to delay recognition of these structural issues. Seeing that is has not been working that discussion needs to happen soon.