The Humpty Dumpty Economy
Peter Schiff
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Before the current economic crisis became apparent to all, the most popular fable used to describe America’s uncanny economic resiliency was the story of Goldilocks. It was argued that our economy was skipping down a sunny path of moderate growth, low inflation and rising asset prices.
However, a much better parable for our economy over the last decade would have been the story of Humpty Dumpty: a bloated, fragile shell perched on the top of a dangerously high stone wall. This week, all the government’s horses and all of its men scrambled to put Humpty Dumpty back together again. Here is a look at some of this week’s highlights:
The Mother of all Moral Hazards
No doubt prodded by the administration, Fannie Mae (FNM) and Freddie Mac (FRE) announced a new attempt to stop the fall in home prices and foreclosures through a loan modification program that would cap mortgage payments so that a homeowner’s total housing expenses would not exceed 38% of household income for home owners who are 90 days delinquent.
In a classic case of unintended consequences, the plan will encourage a massive new round of delinquencies and household income reduction as homeowners will jump through hoops to qualify for the program and maximize their benefit. Those who could conceivably economize to meet their existing obligations will now have a strong reason to forego such sacrifices. Those who are not 90 days past due will intentionally become so. In many cases, dual income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work related expenses will likely exceed the after-tax value of the lost paycheck.
Unfortunately, the last thing our economy needs is falling household incomes and even more bad debt. But that is precisely what this plan will give us.
To Bail or Not to Bail
With the Big Three auto makers now in a plainly visible death spiral, the automotive bailout debate is kicking into overdrive. The disagreement hinges on whether a bailout is necessary to support an important industry or whether the unprofitable dinosaurs of the past should be allowed to fail as America focuses on an information-age, service sector, and alternative energy future.
As usual, both sides have it wrong. The government should let the Big Three fail not because we no longer need an auto industry, but because we desperately do. What we do not need is the bloated, inefficient auto industry that we have today. By allowing the Big Three to fail, their capacity will be turned over to new owners who will be able to acquire the means of production at fire sale prices and hire workers at globally competitive wages. The result will be a more efficient auto industry making cars that people around the world actually want to buy at prices they can afford. Such auto makers could conceivably be profitable and could become the cornerstone of a manufacturing renaissance in the United States. In contrast, Ford (F), Chrysler and GM (GM) are never ending money pits that threaten to swallow a good deal of our economy.
We Shopped and Dropped
This week, the bankruptcy filing by Circuit City (CC) and a profit warning from Best Buy (BBY), served as proof positive that America’s national shopping spree is over. As I have long said, the business model of importing cheap goods for Americans to buy with credit cards was unsustainable. We were told to “Shop till we dropped,” and we did.
Americans two primary sources of spending money, home equity extractions and unlimited credit card availability, have been shut down. With only dwindling paychecks to rely on, Americans are justifiably economizing. As a result, many more retailers will file for bankruptcy over the next few years, and those that remain solvent will only do so by drastically cutting their capacity.
In a desperate move to arrest this necessary process, Treasury Secretary Paulson announced his intention to use part of the $700 billion TARP (Troubled Asset Recovery Program) funds to re-liquefy consumer lending.
Paulson observed that “illiquidity is raising the cost and reducing the availability of car loans, student loans, and credit cards”, “creating a heavy burden on the American people” and reducing jobs. While all of this is true, this is precisely what needs to happen. Americans need to reduce their spending on all of these things, and market forces are in the process of bringing that change about. By encouraging even more borrowing, Paulson’s plan will aggravate the crisis.
Along those lines, our nation’s various bank regulators issued a joint press release this week that “encouraged” banks to make more loans and to reduce their lending standards if need be. Since lax lending standards are one of the primary reasons that those banks “needed” to be bailed out in the first place, it is lunacy to now encourage them throw good money after bad. More risky lending (and currently nearly all lending is risky) interferes with the market’s attempts to rebalance our economy along the lines that Paulson himself admits is necessary, and sows the seeds for even bigger bailouts in the future when this new crop of loans go bad.
Bait and Switch
Reminiscent of his Bazooka maneuver, quick draw Paulson reversed course quickly with his decision to not use any TARP funds to buy the assets that the plan was specifically funded to procure. Instead, he will simply dole out the loot to his buddies on Wall Street and use it for whatever seemingly worthy initiative strikes his fancy.
Although Congress loves to grandstand about oversight, it has thus far shown no courage to interfere, or even question, the change in strategy. Paulson claims that he is simply rolling with the punches. The truth however, is that the original plan was flawed from inception, as I clearly pointed out in a string of commentaries following his proposal. How could the Treasury Department, with all its funding and PhD’s, not make similar predictions? Paulson is either a liar or completely incompetent. My guess is he is both.
It is mindboggling to consider that all of these developments took place in just one week. As the remnants of America’s shattered economy continue to ooze out over the pavement, look for even more bizarre, draconian, unworkable, and downright dangerous policies to emerge from Washington.
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This article has 13 comments:
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constructe
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384 Comments
Nov 16 07:33 AMI also think we need to apply it to financials. Let them go into bankruptcy to get rid of the debt and bad management and be reorganized to be stronger.
Congress etc. don't seem to realize you don't prime the pump except after the economy hits bottom and grinds to a halt. Rather than helping, they are driving us over a cliff.
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investor88
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755 Comments
Nov 16 07:35 AMPeter expects more draconian bailout and encouragement of indebtedness which I agree will only prolong the pain of re-adjustment.
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rm
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105 Comments
My Website
Nov 16 08:49 AMWhat's ironic is that in many cases, homeowners would be better served by the mod they can get on a case-by-case basis than the "streamlined"... terms.
[In many cases, dual income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work related expenses will likely exceed the after-tax value of the lost paycheck.]
I see this as a good thing. Too many households have one member stuck in a dead-end job so they can pay for their "stuff." The mathemactics of that second job quite often made little sense on a net-after-all-costs basis. If we see a shift to parents spending more time with their children and less money on useless crap, this is a positive, unintended consequence.
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dinochick
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3 Comments
Nov 16 10:53 AMIt bothered me when they brought the bailout proposal on three sheets of paper, then it expanded to over 50.
The prosperity that we were living in was false, created by credit. The inflation of housing prices is what caused many to use their "easy credit", and of course the "disposable goods". When a toaster broke, you tried to fix it. Now you throw away and spend another $20 on one.
However, this "tude" has gone on for a long time. While allot of goods are cheaper than they used to be, some don't work as well. And, of course by the time you buy a laptop, it is outdated.
The old underwriting formula was 29/33 ratios. (yep I am an underwriter) and we didn't even include women's income of child bearing age (yes there was that "prejudice" in the seventies). So obviously, there is a serious "gap" that needs to be closed. Increase salaries or lower housing prices..
When companies lower salaries (as many are doing now due to the extensive unemployed who are desperate for anything) they contribute to the problem. Until standardized salaries for specific work, and limitations on housing inflations are regulated, you will continue to have this mess. I know this affects free enterprise, but obviously we didn't handle it very well.
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fran
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242 Comments
Nov 16 12:44 PMi'm told the wee elfin was lost in the "deep forest" on her trek in search of "mustard seed" and "bear droppings" required to sow the next recovery cycle. i hope she avoids the "big bad wolf".
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djsunshine
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12 Comments
My Website
Nov 16 06:14 PMOn Nov 16 10:53 AM dinochick wrote:
> Excellent article.
>
> It bothered me when they brought the bailout proposal on three sheets
> of paper, then it expanded to over 50.
>
> The prosperity that we were living in was false, created by credit.
> The inflation of housing prices is what caused many to use their
> "easy credit", and of course the "disposable goods". When a toaster
> broke, you tried to fix it. Now you throw away and spend another
> $20 on one.
> However, this "tude" has gone on for a long time. While allot of
> goods are cheaper than they used to be, some don't work as well.
> And, of course by the time you buy a laptop, it is outdated.
>
> The old underwriting formula was 29/33 ratios. (yep I am an underwriter)
> and we didn't even include women's income of child bearing age (yes
> there was that "prejudice" in the seventies). So obviously, there
> is a serious "gap" that needs to be closed. Increase salaries or
> lower housing prices..
>
> When companies lower salaries (as many are doing now due to the extensive
> unemployed who are desperate for anything) they contribute to the
> problem. Until standardized salaries for specific work, and limitations
> on housing inflations are regulated, you will continue to have this
> mess. I know this affects free enterprise, but obviously we didn't
> handle it very well.
>
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kurt walter
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409 Comments
Nov 16 06:33 PM-
kurt walter
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409 Comments
Nov 16 06:56 PM-
tedS
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12 Comments
Nov 16 07:01 PMI agree with the need to flush the system so that its three clogged pipes (falling home prices and foreclosures; the automakers' financial disaster; financial crisis due to the unimaginable consumer debts) are cleared up. But the lawmakers will not listen to you, Peter. Why? It is a simple reason : they know that most Americans do not have the noble courage to sacrifce; they just want the status quo -- spend, spend, spend.
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constructe
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384 Comments
Nov 17 02:31 AM-
MILESCFA
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34 Comments
Nov 19 09:38 PMThe ONLY problem with management is they have NOT drastically cut back. How many brands does GM have now, 20, 30, 40... :-) ? As countires around the world have industrialized, they start car companies (and airlines); it's a vanity thing... and US management is just as vain.
On Nov 16 07:33 AM constructe wrote:
> 100% agree on your thoughts on the auto industry. However, wage is
> not the problem. Japan pays about 50% higher wages, makes more efficient,
> nicer, more reliable, and cheaper cars. Management is the problem.
....
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billddrummer
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539 Comments
Nov 20 11:36 AMThe 3-page bailout package morphed into a 450 page bill that was signed without study. Now the intent of the legislation has morphed again, into something that only Paulson's dream interpreter understands.
If the automakers don't get bailout money from Congress, chapter 11 filings would soon follow. That wouldn't mean the companies would go away, and would provide time for restructuring the business model, which as we have seen, has been flawed for many years.
It's true that American cars and trucks have improved in quality since the mid 1980s. Unfortunately, that period alienated an entire generation of car buyers. Now, most people who were burned by a poorly running domestic vehicle during that period are reluctant to even look at US marques. And foreign manufacturers have responded by broadening their product lines, so that a consumer can find most any kind of vehicle from Toyota, Honda or Nissan (even heavy-duty pickups).
Product development needs to change for domestic automakers. Why has the GM Volt taken so long to bring to market? (The Toyota Prius was introduced in 1997--11 years ago!!) By the time you see a Volt at your local Chevy dealer (assuming he's still in business), Toyota will have had a 15 year lead on this technology.
And why are there so many overlapping products? Despite Tiger Woods's Buick endorsement deal, the average Buick buyer is 65 years old. Now, I'm not saying that's a bad thing, but Buicks don't appeal to younger car buyers.
It seems to me that GM could drop the Buick line (like Oldsmobile--even though that was 7 years later than it should have been), merge the Chevy truck division with GMC (identical products, different badges), and spin off Saab to someone in Europe who cares. Limit Pontiac to the big sedans they became known for, and fold the Sunfire line into Saturn (isn't that a Saturn Skye with different badges?).
But that's just me.
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website
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62 Comments
My Website
Jan 01 03:37 PM