Treasury’s TARP is a useless endeavour

November 11, 2008

The Tarp is a mistake, and it is very likely to fail. Why? Because it is like trying to extinguish a fire without first shutting down the gas supply. The Fed is throwing money at institutions which are burning it at an alarming rate, and is it hoping that it can thusprevent the financial system from collapsing. But is the financial system itself the cause of the turmoil? Is it really a lack of liquidity, the irrational unwillingness of the banking system to lend which lies at the root of the problem? If indeed this was the case, flooding the system with liquidity, a few rescues and some emergency lending by the Fed should have already contained the problem. The crisis of 1998, which was not born of the long-term weaknesses of the system, was more or less dealt with by means of the aforementioned measures. So why don’t these measures work now, will they? 

 

For reasons that I have stated in previous posts, and for others that I will also expound on today, I am confident that the Fed and the Treasury’s extreme and heavy-handed measures  will have no effect at all in solving this crisis. At best we can hope that they will reduce the severity, and lengthen the course of some of the worst aspects of the crisis.

 

If we carefully examine all the steps that have been taken so far, we notice that they are mostly aimed at alleviating the pains of financial institutions. The Fed’s facilities, the Tarp, the bailouts, all these have one purpose in mind, and that is to allow the firms that dominate the financial system today to survive the calamitous phase of this crisis, and, one would assume, thereby to prevent a severe and general evaporation of confidence in the US financial structure.

 

The counter-intuititive, and anti-capitalistic nature of these measures aside, there’s one crucial aspect that appears to be ignored by many of the commentators in visual and print media. It is that all the solutions that have been offered by the govenment are ad-hoc and anti-symptomatic in that not even one of the purported panaceae to  the ills of the financial system aims at curing the causes and the uprooting the base of the crisis: overleveraged consumer defaulting on his obligations, unpaid mortgages causing home values to plummet, and the consequent collapse in economic activity which causes unemployment to rise, and leads the other factors to intensify in effect, and perpetuates them.

 

What is the wisdom of bailing out banks, when the rising lists of foreclosed homes adds non-stop to the burden of write-downs? Wouldn’t it be far more prudent to spend all these sums in rescuing, or bailing out the subprime borrower, and the reckless overleveraged consumer? In other words, isn’t it wiser to first cut off the gas supply, before trying to extinguish the fire with buckets of water?   

 

I’d like to ask the reader the wisdom of lending free and unlimited cash to all banks when the failure of the bankrupt consumer and corporate sector to pay their debts is essentially creating a depthless black hole in the balance sheets of these financial institutions. Is it not clear, at this stage, to every prudent individual in the world, that we’re only at the beginning of the reversal of the debt cycle, and that the consumer especially is on an irreversible journey to the bankruptcy court? Is it not obvious, by now, after two decades of toying with monetary policy, that loose money is completely useless in solving any problem as long as the fundamental, underlying issues are not addressed and resolved first? Do we need another collapse in the US, probably in the credibility and credit of the US government, before we understand that financial folly, borrowing without worrying about repayment, and spending without looking at the bill, are a sure recipe to doom and mayhem? The US consumer borrowed without worrying how he’d pay back, now he’s in the process of going bankrupt. The US government is now doing the same, should we really expect that the outcome will be any different in the end?

 

Is the American public so delirious that it will entrust the future of this country to a group of people at the Federal Reserve whose credibility has been torn to shreds by their own record, and whose only promise, only solution to any problem is just creating more money?

 

Whether it is me and the likes of myself, or the Fed, and their learned supporters who are deranged and deluded about what they propose, will be seen in all clarity in a few years. And this, at least, is a source of consolation.

 

—–

 

Here’s an article from the New York Times, November 10th.

 

 

Almost 90 percent of homeowners in Mountain House, Calif., owe more on their mortgages than their houses are worth.

Because of plunging home values, almost 90 percent of homeowners here owe more on their mortgages than their houses are worth, according to figures released Monday. That is the highest percentage in the country. The average homeowner in Mountain House is “underwater,” as it is known, by $122,000.

 

A visit to the area over the last couple of days shows how the nationwide housing crisis is contributing to a broad slowdown of the American economy, as families who feel burdened by high mortgages are pulling back on their spending.

 

Jerry Martinez, a general contractor, and his wife, Marcie, an accounts clerk, are among the struggling owners in Mountain House. Burdened with credit card debt and a house losing value by the day, they are learning the necessity of self-denial for themselves and their three children.

 

No more family bowling night. No more dinners at Chili’s or Applebee’s. No more going to the movies.

“We make decent money, but it takes a tremendous amount to pay the mortgage,” Mr. Martinez, 33, said.

First American CoreLogic, a real estate data company, has calculated that 7.6 million properties in the country were underwater as of Sept. 30, while another 2.1 million were in striking distance. That is nearly a quarter of all homes with mortgages. The 20 hardest-hit ZIP codes are all in four states: California, Florida, Nevada and Arizona.

 

“Most people pay very little attention to what their equity stake is if they can make the mortgage,” said First American’s chief economist, Mark Fleming. “They think it’s a bummer if the value has gone down, but they are rooted in their house.”

And yet the magnitude of the current declines has little precedent. “When my house is valued at 50 percent less than it was, does this begin to challenge the way I’m going to behave?” he said.

 

Mountain House, a planned community set among the fields and pastures of the Central Valley about 60 miles east of San Francisco, provides a discomfiting answer.

 

The cutbacks by the Martinezes and their neighbors are reflected in a modest strip of about a dozen stores in nearby Tracy. Three are empty while a fourth has only a temporary tenant. Some of those that remain say they are just hanging on.

 

“Before summer, things were O.K. Not now,” said My Phan of Hailey Nails and Spa. “Customers say they cannot afford to do their nails.” She estimated her business had fallen by half.

 

At Cribs, Kids and Teens, Jason Heinemann says his business is also down 50 percent. He opened the store in early 2006; last month was his worst ever. “Grandparents are big buyers of kids’ furniture, but when their 401(k)’s are dropping $10,000 and $20,000 a week, they don’t come in,” he said.

 

Mr. Heinemann laid off his one employee, a contribution to an unemployment rate in San Joaquin County that has surpassed 10 percent. He dropped his advertising in the local newspaper and luxury magazines.

 

As Mr. Heinemann’s sales sink, he is tightening his own belt. “I used to be a big spender,” he said. “We’re setting a budget for Christmas.”

 

In the window of another tenant, Wells Fargo Home Mortgage, a placard shows two happy homeowners holding a sign saying, “Someday we’ll owe a lot less than we thought.”

 

Someday, maybe, but not now. First American has been refining its figures on underwater mortgages, formally known as negative equity. The data company evaluated 42 million residential properties with mortgages. (Though Maine, Mississippi, North Dakota, South Dakota, Vermont, West Virginia and Wyoming were excluded because of insufficient data, none of those states have been central to the mortgage crisis.) A computer model was used to calculate current values, using comparable sales. More than 10 million homes do not have mortgages.

 

The figures rank the 20 ZIP codes that are furthest underwater. The 95391 ZIP code, which includes all of Mountain House and some properties outside it, has the unwelcome distinction of being first in the country.

 

Out of 1,856 mortgages in the ZIP code, First American calculates that nearly 90 percent are underwater. Only 209 owners owe less on their mortgages than the homes are worth.

 

 

The government may well have to bail out the state of California in the next step.

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