Flow of Funds Report: Maybe Bernanke Is Onto Something

Friday's Flow of Funds report from the Federal Reserve provides evidence that Ben Bernanke might be onto something with his idea to save the economy by having banks slash the principal owed by homeowners who are losing their home equity.

Things seem to work best in the U.S. when household assets rise faster than household liabilities - this is the very foundation of our consumption-based economy and life as we know it - so, if you can't keep asset prices rising (which seems pretty obvious now) maybe cutting liabilities at an even faster pace would be the next best thing.

If the red line could plunge down below the orange line in the chart above, then the economy will surely get a boost - things would be back to normal, sort of.

The difference would be that, instead of assets rising faster than liabilities are rising (life as we've come to know it) liabilities would be dropping faster than assets are dropping.
It would have the same effect - homeowners would feel wealthier.

For example, suppose you bought a house in California three years ago for $500,000 and then you heard that the one down street sold for $600,000. Then the bank called and wanted to increase your home equity line of credit by $100,000.

That's the way things are supposed to work.

What's been happening lately is that houses down the street have been selling for $400,000 and then banks have been calling to tell you that they've reduced your home equity line of credit by $100,000 or they've cut you off completely.

That's no way to run an economy.

Under the proposed Bernanke plan, even after the house down the street sells for just $400,000, then the bank could call to tell you that they're increasing your home equity line of credit by $100,000 because they've just reduced your outstanding principal by $200,000.

Do you see how this could work?

In a worst case scenario, this process could be repeated over and over where homeowners' outstanding principal could be reduced in $50,000 increments "freeing up" more and more home equity.

Of course, there is probably a lower bound there somewhere as the bank is not likely to call you up and tell you that they now owe you - the homeowner - money.

Comments

[Warren B. M...:]

the 'tougher' bankruptcy laws of a few years ago have also contributed to a weaker consumer.

Before the new laws you could declare bankruptcy and start over. Today the courts are more likely to hack off some of your future income to pay your old debts.

2008 Mar 09 07:58 AM

[John Lounsbury:]

If this is not tongue in check, then it is scary. Have we come to believe that we can borrow and spend our way to prosperity?

Just as houses built of paper can not stand against a wind, an economy based on no assets can not survive.

2008 Mar 09 10:40 AM

[Mr kumar:]

we dont need bernanke to say that principal reducing by the banks would definitely help the borrower. And the economy if it will be figured out who will eat the loss without adversely effecting the economy.
The real issue is the over dependecne on home equity by the home owners, it was okay when the home prices are rising , but not when the home prices are falling.
will the home owners who took out cash in the boom times return the cash back. It as likely as angelo mozilo returning his millions he made in the boom times.
This will set a very bad precedent , if investors/banks are forced to eat the losses ( boosted by tax writoffs ) , will they be willing to lend money again without factoring this in all future loans.
Bernanke must not intervene in this , yes there will be hard times because of this ( just as there were good times because of raising home values in the boom times ), that has to be figured out by the market.

2008 Mar 09 10:59 AM

[SavCD:]

I think you need to go back and look at the Financial Report of the United States....liabilities have been rising faster than assets since 2000. You are leaving out the Federal laibilities which rose from $20 trillion t0 $50 trillion.

2008 Mar 09 11:28 AM

[CMartini:]

What ever happened to free market capitalism? Will Bernanke reimburse me and all other stock market investors who have lost money in this market over the past year? Let the real estate market and the investors therein implode and let all involved suffer the consequences of their irresposible lending and or investing practices. Why should the taxpayers and the responsible citizens have to pay for the greedy, get rich quick schemes of others, many of whom are foreign investors. Let the free market run it's course. Real estate prices need to return to affordable levels for all. Why should the bubble be maintained? Why should real estate continue to receive kidd glove treatment along with favorable tax treatment? It disgusts me.

2008 Mar 09 11:39 AM

[Richard Shi...:]

jlounsbury59,

Actually, it IS tounge and cheek and it is still scary because, althought Tim if being facetious, Washington may not be. In fact, Washington called yesterday, they are mailing out checks to help, didn't you get a call? Oh yeah, I forgot, they are spending $47 million to mail you a letter about it. Isn't it really all the same thing?

2008 Mar 09 11:43 AM

[The Fat Man:]

Will we never learn to quit playing with funny money???????

2008 Mar 09 01:42 PM

[the final h...:]

i think there was a very slight typo. should read ON something instead of ONTO something

2008 Mar 09 02:05 PM

[gordon:]

good one, Horseman! hehehehehe........

2008 Mar 09 03:29 PM

[Tavit:]

The new American economy will largely consist of white collar homeless people. Our jobs are exported, fuel prices are through the roof, housing prices are tanking and you may ask, if I am a 1 of many millions of US college grads with a degree where might I look for employment? Can you say America the next 3rd world country?

2008 Mar 09 05:29 PM

[gps_geek:]

I agree with CMartini...

Where is it written that a "homeowner" is GUARANTEED a profit? Or if his equity becomes negative, that a contract can be changed so the "homeowner" feels wealthy?

This idea by Uncle Ben is the dumbest thing I've heard of. Maybe because it's an election year, the dumbest ideas just keep coming...

2008 Mar 09 10:31 PM

[Fred W:]

Why not just freeze interest rates for the following 5 years?
Could be a good way for a candidate to "buy" some votes (Mrs. Clinton) ...never mind that catastrophe that would follow. We can deal with that after the election.

2008 Mar 10 01:26 PM