Does Obama's Stimulus Plan Pass the 'Prudent Person' Test?

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Includes: IEF, TLT
by: Michael Steinberg

The health insurance industry has a concept in medical underwriting called the prudent person. If a prudent person would have sought medical attention (in the underwriter’s judgment) that could have revealed a preexisting condition basis for rejection, the policy is rescinded. In essence, it is undone. The premium is returned and the policy holder must reimburse the insurer for all covered medical costs. Does the Obama Administration pass the prudent person test with its now $900B stimulus plan?

President Obama is acting like the messiah or second coming ready to hand us the new ten commandments of economics, and cannot understand why we are not coming together under his lead. First he tried reconciliation through expanding the plan to include every piece of pork and tax break that both parties wanted. Then when he was unable to convince the grass roots American people on the plan’s merits, he resorted to dictating to both the legislators and the people that he knew best. Sensing President Obama’s frustration as a sign of weakness, the Republicans started to revolt.

Beyond the jockeying for political advantage, the grass roots see an imprudent political process. Switching back and forth between dictating and trying to instill fear of economic disaster, is not winning over the American people. President Obama and his staging crew have learned nothing from Presidents Reagan and Clinton’s mixture of humble optimism. Even President Bush, of whom I was no fan, gave a sense of humble sincerity. President Obama, whom I voted for hoping for healthcare reform, makes me feel that I am being talked down to. Successful presidents are not great stage shows, monarchs or dictators. Successful presidents are great communicators; so far President Obama is not.

Let’s get back to the prudent theme: Germany found out the hard way that sovereign debt of G7 or G8 nations cannot be issued without limit. They recently had a failed auction, whereby they did not receive enough bids to sell the entire issue. Even with interest rates on treasuries and mortgages starting to head up, the Obama Administration believes they can lower mortgage rates and sell an additional $2T in government debt this year. That does not give much credit to the rules of thermodynamics, or the law of supply and demand for you economists. The health insurers would rescind the Obama Administration’s economic policy if next week’s massive $67B treasury auction does not go well. Trouble is the American people cannot get their premiums (taxes) back.

The health insurers would have told the President that rising interest rates was a clear indication that he should have returned to the doctors of fiscal and monetary policies for checkup. That would have revealed that the country had a preexisting condition of borrowing up to the limits of its capacity and an economic insurance policy would not be issued. Unfortunately, the Administration’s chief economic architect Larry Summers does not have to pass medical or economic underwriting. The health insurers would surely reject him on both accounts.

On the serious side: The Treasury needs to test the appetite for the volume of debt they would need to sell this year to support both their stimulus and banking plans. Congress cannot judge the impact on the debt markets of one plan without the other. It appears that the Administration has given up delaying the banking plan until the stimulus has passed.

I believe that next week’s treasury auction will indicate whether the Federal Reserve is still in control of interest rates or whether our debtor nation is at the mercy of our creditors. A rise in treasury rates implies that the United States has reached its borrowing limit at the current rates and the flight to safety does not always mean to the dollar. Keep in mind that our lenders in China, the rest of Asia, Europe and even the oil rich Middle East are also in trouble. Their capacity and desire to buy treasuries has been diminished.

I think that next week will confirm that interest rates are past the bottom and starting back up. The Fed has lost control. But the Administration can control the rate of interest rate increase (the second derivative) by the size of fiscal stimulus. The bigger the better is certainly not prudent.

I see a scenario of deflation in real estate and durable goods, inflation in food and other consumables, and a slowly accelerating rise in interest rates. Some commodities would fall or stabilize to conform to lower durable prices. We are heading for a 5% 10-year treasury and 30-year fixed conforming mortgage interest rates in the 6.5% to 8% range by year's end or earlier. Even former Treasury Secretary Paulson called the 4.5% mortgage a pipe dream.