Financial Crisis and Recession
The severe financial crisis and resulting worldwide economic recession we have been forecasting for years are finally unleashing their fury. In fact, the reckless policy of artificial credit expansion that central banks (led by the American Federal Reserve) have permitted and orchestrated over the last fifteen years could not have ended in any other way.
The expansionary cycle that has now come to a close was set in motion when the American economy emerged from its last recession in 1992 and the Federal Reserve embarked on a major artificial expansion of credit and investment, an expansion unbacked by a parallel increase in voluntary household saving.
The most appropriate policy would be to liberalize the economy at all levels (especially in the labor market) to permit the rapid reallocation of productive factors (particularly labor) to profitable sectors. Likewise, it is essential to reduce public spending and taxes, in order to increase the available income of heavily indebted economic agents who need to repay their loans as soon as possible. FULL ARTICLE
Comments (31)
ajax
Superb article. The REAL reason, the root of all this mess IS the Federal Reserve!! Yes, the CRA, the outright government encouragment of lower lending standards etc. have all contributed, but the Federal Reserve supported the whole structure through it's easy monetary policy. This wouldn't have happened without the Fed despite government efforts. The money(easy credit) simply wouldn't have been there. There are far too many commentaries that exclude the Fed as the problem and far too many people who still believe the Fed has a positive role to play. The culpability of the Fed must be continually pounded in the minds of the citizenry for there to be any hope.
Published: October 6, 2008 11:15 AM
burgreen
I agree. Most excellent piece.
I have forwarded it to my local newpaper asking if they have guts enough to publish it. (Unfortunately, I think I know their answer.)
Published: October 6, 2008 11:26 AM
N. Joseph Potts
Oddly, (paradigmatic) Spain has not yet led the list of European countries (Iceland, Ireland, the UK, Germany, "BeLux," Italy) whose banking systems have experienced government intervention. Perhaps the Spanish government is merely (wisely) circumspect about mixing in.
I suppose it's early days, anyway.
Published: October 6, 2008 11:40 AM
Deflationnist
"who have two totally contradictory responsibilities: both to control inflation and to inject all the liquidity necessary into the financial system to prevent its collapse)."
It would be very easy to achieve this:
1) High interest rates
2) No taxes.
No taxes would put more money in the system and high interest rates would encourage savings.
The best regulation against predatory lending is high interest rates.
The best way to "inject" money in the economy and keep it running is to not tax it.
Published: October 6, 2008 12:23 PM
Stanley Pinchak
Deflationnist,
that's no way for a central bank and state to cooperate (I am sure you know this). What do you think these guys team up for anyway? Governmental spending! How to achieve that? Easy money! How does one obtain easy money? Low interest rates set by the central bank. Then taxes don't matter so much except as a propaganda device.
Published: October 6, 2008 12:50 PM
Jasmine
"Curiously, as in the "roaring" years prior to the Great Depression of 1929, the shock of monetary growth has not significantly influenced the prices of the subset of goods and services at the final-consumer level of the production structure (approximately only one third of all goods)."
Is a substantial reason that consumer level goods did not see a similar inflation in prices because many of these products and parts were produced in China and other third world countries thus basically importing extremely cheap labor. Thus statist policies in China, India and other third world countries in the past actually held the US economy afloat!! Mises pointed out on several occassions that it is not knowledge of technology and better and improved methods to increase production that was the roadblock but rather increased saving and capital that make investment in better capital goods to increase productivity possible. Therefore the reasoning on that particular point in this article is in error, I think, since the explanation given is not satisfactory. Discussion on this point would be interesting.
Published: October 6, 2008 1:10 PM
Paul Marks
A fine article with no errors that I can see.
One might say it is "saying the obvious" (such as that cheaper goods from reformed nations such as China prevented open price rises in the shops - but could not save the United States from the credit money doing its vile work in other ways), but sadly "the obvious" is only known to a few people.
It is quite true that one can not prevent the bust, one can only mitigate and shorten the suffereing - by reducing taxes and government spending and by deregulation.
An open and flexible labour market is essential - otherwise unemployment will explode.
Efforts to "keep up wages" at a time of economic bust are poison.
Published: October 6, 2008 3:48 PM
newson
to jasmine:
"cheap labor" isn't eqivalent to "statist policies".
perhaps you are getting confused with the chinese government's massive accumulation of us treasury paper.
Published: October 6, 2008 8:20 PM
newson
to dr huerta de soto:
i really got a lot out of "money, bank credit, and economic cycles". it was the most complete work i've yet read on fractional reserve banking.
Published: October 6, 2008 10:57 PM
Jeremy
Dr. Huerta de Soto,
I second newson's opinion - and this work was what completely turned me over to the small government, no central bank, libertarian point of view - it rocked my world, so thank you.
Published: October 7, 2008 6:28 AM
Jasmine
To Newman:
Is there a good reason why in the absence of state barriers prices of labor would be otherwise what they would have been on a free market of labor? U.S. labor continued to get more expensive because of strong arm tactics of labor unions supported by U.S. govt. It would make complete economic sense for corporations to move their production to countries where labor was lot cheaper and this would have moved capital to move to countries like China as well. It is the law of the market that it always works towards removing huge discrepencies. The discrepency in labor prices in the U.S. and other industrialized nations is one such anamoly that a market cannot tolerate. Movement of labor and capital would have worked towards balancing this out. But U.S. govt. barred the free movement of labor by its immigration laws and Chinese barred (or made the terms so unattractive) for the entry of foreign companies setting up shop in China. Combine that with Chinese govt.'s complete control over foreign trade and foreign exchange and you have the Chinese govt. totally responsible for China's "cheap labor". With regards to the issue of chinese purchases of U.S. govt. securities that has also obviously worked to the U.S. govt.'s benefit to also help hold our economy together. These are free gifts from China to U.S. propping up the U.S. march towards socialism.
If there are errors in my logic and discussion please point these out.
Published: October 7, 2008 7:40 AM
joebhed
Professor, et al.
What is the solution being offered here to this problem?
As the article says, I see the placement of the dual functions of the federal reserve as both incongruous and unsustainable.
Yes, those two functions must be separate.
Being regulator and promoter involves not only tension, but impracticality.
My own tension with this rationale is there is no apparent solution, beyond the invisible hand.
Having read C.H. Douglas' exposition on railroad ticket currency is sufficient to inform me that the function of money, and therefore monetary policy, is unsustainable as long as money is both a store of wealth and a commodity.
His solution is public credit.
And yours?
Published: October 7, 2008 8:53 AM
jlcg
What is the mysterious way by which an individual or a corporation can have a grasp of reality that the state does not have? Every personnal bankruptcy every corporation bankruptcy is a demonstration that such entity did not have the information or the will, which is different ,enough to survive. Hayek's argument is empty. The Spanish may be in trouble now because among other facts they tend to be rentiers instead of entrepreneurs.
Published: October 7, 2008 9:18 AM
Michael A. Clem
Joebhed and jlcg: the answer lies in the market process. Any company (including banks) that engage in bad or unsustainable business practices, such as unsupported expansion, or bad loans, suffers a loss of profit and the threat of going out of business. Without government and central banking to support bad business (and industry) decisions, these things get nipped in the bud much more quickly, resolving the mole hills before they become mountains.
People and businesses would still make mistakes, but they could not become the huge crises that we keep seeing occur now.
Published: October 7, 2008 9:36 AM
joebhed
So, is that how I am supposed to feel today, nipped in the bud?
The bad business decisions were all competitive market decisions.
The government's contribution has been enabling, in the form of money-creation power, and also failure of oversight, compensated by a hand in the taxpayer's pocket.
So, really, I ask, what happens next with the "market" plan?
Abolish the FED?
Begin 100 percent reserves for "real-money" banking?
And, how is new money created, to provide the capital needed for increases in production and consumption?
By the markets?
By the banks?
Again, the Social Credit system identifies means and methods to meet that needed capital.
And in a way that introduces that capital as debt-free money.
As does the system advocated in the American Monetary Act reform legislation proposed by the American Monetary Institute.
The money-creation part of the monetary system and monetary policy is an act of the sovereign people of this or any other country.
Why would I give it to business?
Who represents business that I can vote out of office if I don't like the economic results?
Right now I have the power of my money and my vote.
The so-called market solution wants me to give up my vote on our economic future.
Why would I?
Published: October 7, 2008 11:42 AM
Stanley Pinchak
Lets start with ending the Fed's Open Market Operations. Going to 100% reserves can happen after the "shock" of natural interest rates works through the economy.
Monetary creation is inflationary. Any stock of money (sufficient to be considered money) is sufficient for any amount of production and consumption. The purchasing power of each monetary unit will adjust according to the supply and the demand. Additional money serves no socially useful end and only benefits the first holders over later holders.
Published: October 7, 2008 12:00 PM
joebhed
So, we haven't abolished the FED.
Private bankers still create the nation's money.
Just eliminate the Open-market operations.
No buying and selling of government securities to either set interest rates or to manage the quantity of money.
Is that right?
To purge the system of inflated money?
To what level?
Whatever it is, we end up with 100 percent reserve requirements. OK.
Now banks can only lend real money.
But, no money creation?
Just leave the money supply at 100?
I don't get how that works.
I would think that price stability was a goal.
And that increasing the quantity of money along with production and consumption is what establishes that price stability.
And, if new money is created by the government paying my social security as a credit, rather than an offset to taxation, how have I benefited over the people that later obtain a loan from my bank deposit to at an interest differential?
Is there either a social or economic inequity there?
Published: October 7, 2008 5:22 PM
newson
to jasmine:
thank you for articulating your answer, which finds me in complete agreement.
Published: October 7, 2008 5:28 PM
Stanley Pinchak
joebhed,
How do you propose to inject the new money that you feel is necessary to maintain price stability? How can you ensure that everyone gets an "equal" share of the new money? How can one define "equal," if that is the goal. Let me give you a hint, price stability is a chimera that central planners use to justify central planning. Under a specie standard, the increase in the stock of money from mining is less than the growth of production. The miners have provided a socially useful task in making more metal available for non-monetary uses, unlike the bankers today. In this case, prices will gently fall over time, but there are no winner and loser classes as the creation of money obtains. Combining this with a prohibition on fractional reserve banking and manipulation of the interest rates by the central bank and the business cycle as we know it will cease to exist. Furthermore the fiscal constraints on deficit spending and trade balances will help to keep the government small and make manufacturing viable again.
Published: October 7, 2008 8:14 PM
joebhed
How to inject price-stability and growth enabling "credits" has already been stated. The government does it through direct payment for government services. And it does so in exactly the same quantity and quality as any other system.
Health, education, welfare, infrastructure.
A direct injection of new "increased" capital in the proper measure.
Again, same quantity and quality as the "marketeers" would put forward.
One would think the mechanism would be less consequential than the amount.
As for everyone getting an equal share, I don't see the relevance of equality on a per-capita basis. How much per-capita equity is there in the tax system or the general economy today?
As a direct public credit payment would reduce the need for taxation across the board, there is minimally the continuation of whatever equity exists in the tax structure.
So, clearly, "equal" is not the goal in this sense.
As to whether price stability is a true or false parameter to plan for anything happening in any economy, I believe that it is.
People, including myself, find price stability desirous.
Again, let's agree that we need to do away with the power of private bankers creating new money as debt - because to me that is 95 percent of the problem.
So, we're operating on a 100 percent reserve system, as called for in the Chicago Plan.
Bankers are only lending out real money.
I want to be clear, if ignorant, here.
We are discussing whether at that point, there should be additional money-creation provided toward continuing future price stability, or whether we should freeze the money supply and allow prices to fluctuate on the basis of the results of that debt-free bank lending.
I am sure that we will disagree on the basis of the proper role of government. I want the government to be in charge and directly involved, for one good reason.
If I don't like the way things are going then I can vote out the government. But I have an impossible task in giving the invisible hand a piece of my mind.
Given that this is a control that I CAN have, why should I give it up?
Published: October 8, 2008 9:03 AM
Stanley Pinchak
Let me try to explain why price stabilization is a false goal for economic prosperity. If we think about specific industries, we can imagine technological advances which will reduce the cost of production, or eliminate the need for that industry all together. To maintain price stability in these cases is counter to the laws of supply and demand. Or expanding to the economy as a whole, the definition of the "price level" must be some particular weighting of some finite number of goods and services. Relative to each other, these goods and services will fluctuate due to aggregate supply and demand for each good. How does a planner know when and by how much to adjust his weighting factors as the relative prices fluctuate? How can he ensure that his "price level" is a constant against which he can determine the requisite amount of money to inject? I think that it is quite clear that any concept of price level is entirely arbitrary and can not be used as a measuring stick due to the subjective nature of human action. If humans were mechanistic, perhaps the price level would have some validity, but until the planners have total control over automaton-people, the price level is only a way to justify ever greater state intervention into the market. It only serves the purpose of justifying governmental deficit spending and artificially low interest rates which make such spending practical.
I would also think that it is quite clear that democracies are not equivalent to markets. They are a very poor substitute. Democracy is inherently flawed in that the voter receives a say that is not equal to his say in a market. This works both in that some people have more say in a democracy than they would have in the market and others are unjustifiably denied power and influence under democracy that they would have under the market. Think of the most recent bailout fiasco. If this were a market, the bill would have never passed, and if it were to pass, the price would be paid by those who desired the bill. Instead under democratic auspices, the bill was passed over the objections of the majority. If you want other economic matters determined in such a democratic way, then by all means, let us give the state more power over the economy. I suggest that the market is the truly more democratic process and it ensures that those who desire a particular service will pay the bill, instead of the subsidization of the privileged at the expense of the many.
Published: October 8, 2008 10:50 AM
Michael A. Clem
If I don't like the way things are going then I can vote out the government. But I have an impossible task in giving the invisible hand a piece of my mind.
Given that this is a control that I CAN have, why should I give it up?
Not much control to actually give up. Vote Obama in or vote McCain in, but you're not going to vote "the government" out.
The problem with our money is not that it's issued by private bankers, but that it's issued by private bankers with government privileges and monopolies. The government doesn't belong in the money creation business, nor do they need to simply contract it out a la the Fed. "Money" is simply the most commonly traded commodity used for indirect exchange so that we don't have to barter for everything. Having banks issue money and manage it for us is merely a convenience, but a valuable convenience at that.
If private banks were competing with each other without government monopoly privilege, you have a most powerful "vote": the choice to use a different bank's currency instead of being stuck with one legally mandated to be "legal tender" (our current situation).
Thus banks that use fiat currency and fractional reserve banking would be at a competitive disadvantage to banks that use commodity money and full reserves.
This "deregulation" of the financial markets you keep talking about is freedom without responsibility, but rights and responsibilities go hand-in-hand, and cannot morally be separated as the government is trying to do. Like the S&L crisis of the 80s, where they could invest in more things, but were still government-backed by the FSLIC, no matter how bad the investments were. Austrian economist-types want freedom WITH responsibility, and government regulation just doesn't provide that.
Published: October 8, 2008 12:11 PM
Jered
Here's the facts people of this corrupt monetary system called capitol. First do your research on the Federal Reserve. It was established in 1913 in order for the world bankers to gain profit, seeking or (stealing) the American taxpayers money. Why was there a great depression in 1930? Because of the greedy, "rich get richer" wealthy bankers by their failed policies. They will continue to fail th American people as long as we allow them. The Federal Reserve is totally against our U.S. Constitution and we the people of this country can end this corruption, by booting the fed. reserve to the curb and let the American people take control once again.
It is so obvious what their plan is, to establish the Amero/ North American Union through N.A.F.T.A. It's more than a free-trade agreement but they will deny their main goal. The Council on Foreign Relations(elite) is also a big tribute. And who is on the committe no other than good ol Joe Biden. A mere coincidence, NO it's all an act just like the Presidential election. Recall the 2000 Pres. elections. Bush was selected not elected and Al Gore was robbed there were thousands of votes that weren't recounted.
Emerging U.S., Canada, and Mexico by 2010. In Revelations I recall the words of a ONE WORLD Govt./ONE WORLD CURRENCY. The E.U. is seeking global power, and there's the African Union.
You will soon see the Asian/Pacific Union and the North American Union.
Published: October 8, 2008 1:12 PM
Larry N. Martin
The Federal Reserve is totally against our U.S. Constitution and we the people of this country can end this corruption, by booting the fed. reserve to the curb and let the American people take control once again.
Um, does that mean you support Free Banking?
Published: October 8, 2008 1:16 PM
joebhed
Stanley
On price stabilization and government credits, I find your arguments off the mark to my points.
MayI explain.
Your discussion of price stability within the context of something like either single products or specific industries is completely out of my sphere of comment. The markets WILL decide that.
It’s not price controls I am seeking, nor stability in the price of nails. It is general price stability. So I will avoid the red herring of either particular products or industries. I think you broach the overall price stability question when you ask broadly how one of those nefarious planners of government action decides how much to increase the money supply next year.
My answer is this.
It is what we attempt to do now on an ongoing basis.
The main problem is that the government has no tools as it has turned economic prosperity over to the private banking FED rather than maintain those actions within Treasury or Budget.
For the FED to raise or lower the discount rate is peepeedickin.
And ineffective.
Just because we didn’t set the timing exactly right the first time we started that government-credit, money-creation engine doesn’t mean we cannot get it humming over time.
Remember, we would have done away with fractional reserves.
Banks are lending real money.
What is the problem with increasing the supply of money next year to provide for increases in productive capacity, brought about by the use of that capital and the labor of the American worker?
Again, in the overall sense.
So that we protect the value of the $USD.
What is the problem?
The economy is $14 Trillion.
The trend is 2.6 percent.
We need $360 Billion more to pay for that growth.
So, where does the government direct those credits?
And, by the way, government-issue credits should remove any necessity of deficit spending.
Undoubtedly, with banks lending real money, this will lead to more cooperative banks and credit unions, again as free market players. As such, I see no problem whatsoever with low interest rates. The lower the better.
Then you get into the government/markets discourse.
May I, again?
I’ve already said that I have a vote for all things political and economic, and I am not about to give up that vote to any marketeer. Unless I can hold that marketeer accountable for prosperity amid freedom.
As far as the bailout goes, I think we can agree that the power of the monied interests that drove this and the global economy into the ground, primarily through debt-monied, fractional-reserve banking and over-levereged free market capitalism, was successful in threatening economic and political extinction if the bailout didn’t go through. It is both a political and economic travesty of immense proportions, and only a fraction of the rest of what is going on.
So, please don’t blame the bailout on government.
It is free-marketeering largesse run amok coupled with a corporately-controlled, rather than a democratically controlled, government that is the cause of both the crash and the bailout.
End private money creation and you end the pipeline to government corruption.
Published: October 8, 2008 3:48 PM
joebhed
Michael
First, I agree the political parties are not the government, and for exactly that reason I am voting for neither of those mentioned, rather for Ralph Nader, the only candidate running against the party-controlled, corporatized power structure in this country. Of course, my objective is to reduce the power of monied corporations to control politics, and I see the freeing of the money-creation power FROM corporations and TO the government as my best means for achieving that objective.
I am not afraid of government.
You make several points, hopping back and forth between the valuable service of “banking’ and that of money creation. I presume you realize that this raises the fundamental issue of the day – whether those functions belong under one roof.
I support private banking.
And I am a discerning banking consumer – you know, in the market.
I support cooperative banks, which are private banks, and I support credit unions, of which I am a member – again as a private, member-controlled financial institution.
Having said ALL of that in favor of both true capitalism and private banking, done with 100 percent-reserved real money, of course, I am against private banks creating new money, or any money for that matter.
The day we decide to switch to either public credits or free banking, we will be starting with the present centralized wealth distribution produced by this invalid money supply created by private banks.
So, I disagree. The problem IS that money is created by private bankers, today by creating debts that are denominated in dollars, for which I am responsible as a US taxpayer.
What do you think Hank Paulson meant when he cringed and said, “The taxpayers are already on the hook!”.
You seem to be in favor of banks continuing to “issue” money, and I am not sure if that just means doing the lending, which I support, or you mean with a private privilege of creation, which I oppose.
So, let’s get clear on that.
Others here seem to agree with me that there should be no private money-creation powers, I believe.
Or, that it is unnecessary.
I could be wrong about that.
I don’t know why you raise the deregulation point with me.
The Boom-Deregulate-Bust-Regulate capitalist business cycle is precisely what I want to do away with.
Respectfully.
Published: October 8, 2008 4:35 PM
Michael A. Clem
I don't know what else I can say. The free market works fine when government coercion isn't there to back it up or "protect" it. The point of free banking is to get government completely out of it. Why anyone trusts the government is beyond me, since they are the ones who enabled this mess in the first place. The Fed wouldn't have existed if the government hadn't created it and given it special privileges. Do you seriously think that the U.S. Treasury would handle money creation better than the Fed? You'd just be changing which special interests are involved, and your vote would still count for nearly nothing. I want free banking, let banks issue money, but without privilege or monopoly.
And as Mises and other Austrians have repeatedly pointed out, the "capitalist" business cycle IS a creation of the government-created-and-privileged Fed, precisely because it IS privileged. Again, without the privilege, banks would have a hard time passing "funny money", and the markets would respond more smoothly, and no "business cycle" would occur. Isn't that the stability you want? I bring up the regulation question because you did in your post, and because government regulations tend to interfere with the natural workings of the market and cause greater problems, instead of helping to minimize "capitalist" swings, as they are alleged to do. Neither the Great Depression nor the current financial crisis could have occurred without government intervention, and not just in the form of the Fed, although that's a big part of it.
Yes, I'm making assertions, just as you are, but there's plenty of online literature to read here at Mises, stuff that Nader might be dimly aware of, but unlikely to recommend. I just don't understand people who refuse to recognize that the source of the Fed's power is the government, and claim that the solution is to end the Fed and let another branch of government do the SAME THING it does. Just like I don't understand lefties who ignore the fact that corporations are also government-privileged entities, and not free market entities.
Published: October 9, 2008 9:37 AM
simik
joebhed,
There is no good named 'general', the price stability of which one can seek. General price level is always defined as weighted sum of prices of a set of (arbitrarily chosen) goods. And we are back to Stanley's argument, which is perfectly viable and to the point. So, you want to give politicians the power to distribute that newly made free money? How is it different from them distributing tax money in respect to corruption and general money wasting?
Published: October 10, 2008 7:59 AM
Robert
In the US it would be Constitutional to return to real money and discard the Fed. It would also be Constitutional to reduce federal spending to the very limited power enumerated in said document . All we would need to keep this from occuring again would be A balanced budget ammendment and line item veto of spending items and eliminination of IRS and personal income taxes. I have confidence that an actual free market would take care of its self.
Published: October 12, 2008 6:01 PM
Heywood
Its time we rally against the inept Government . Its time we Rally against the Chief Executive Officers and CFO's who have walked away with our cash. Its time the people of this country stand up and say no to the B.S. that has been splashed in our face. A March on Washington and a March on the Offices and homes of the Chief executives of AIG , Lehman, Fannie and Freddie is in the works. The 700 Bilion Dollar Bailout of the Banks and Financial institutions will be like adding fuel to a roaring Fire.With its 100 Bilion PLus in Pork, It will temporarily bring some smiles as the indexes close up but an eventual collapse of this unstable system is inevitable. The Government plans to print new money to pay for the bailout. The U.S. Dollar will be worth less than toilet paper( which we thought it already was.) Make your voice heard, Join the Rally to Protest the Theft of our country. So much for the mortgage mess, subprime lending and Fraudulent rating and selling of Mortgage backed securities. Next shoe to drop is the Consumer Credit Card mess that Bankers have gotten into. The Credit Card and Car Loan Bubble is the next to burst. The Middle class will pay again for the mistakes and misdeeds of the very corrupt, irresponsible chief executive and chief financial officers. Dont stnd by idly while this Lame Duck smiles as we go up in flames..Join the March...
Published: October 22, 2008 3:43 PM
guys background search
USA FAST ECONOMIC RECOVERY IN 2 STEPS
Step 1 - STOP THE BAILOUTS and FIX THE BANKS
- Solve the loan problem.
- Solve the derivative problem.
- Reassemble whole loan mortgages
The U.S. economy is shrinking fast, because businesses cannot get loans that they need to operate normally. Banks and lenders already own $ billions in bad loans, and they are afraid to make new loans. The government gave $ billions in bailout money for banks to start lending, but banks hoard the money to save themselves.
Our financial system became untrustworthy, because it mixed $ billions in bad loans in with the good loans. Now, banks do not trust any of the loans, and the entire credit market stopped working.
The U.S. economy will continue to shrink until we untangle the loans. Once the bad loans are isolated, they can be fixed one at a time. Then trust will be restored. Credit will flow, and the economy will grow.
So far, our government is spending $ trillions on bailouts and pork projects, out of ignorance and political ideology. The real solution is much less expensive than that.
The USA has fixed this problem before, and it is not hard to fix again. This is how:
A) Start with the Resolution Trust Corporation (RTC), which the federal government setup to solve a Savings and Loan problem in the 1980s.
B) RTC buys up securitized mortgages and derivatives to reassemble whole mortgage loans.
1. “Securitized mortgages” are home loans that have been bundled into large groups and sold to investors. A group of about 4,000 mortgages can be “securitized” and sold just like a stock or bond. Investors like to buy groups of mortgages because they receive all the monthly house payments.
2. Some groups of securitized mortgages were subdivided into smaller pieces, called “derivatives.” However, both of the fancy names refer to mortgage loans.
3. The problem is that many bad loans (with no payments) got mixed in with good loans. That turned the all the securitized mortgages into bad investments, which are ruining our banks. It is a huge problem, and the government has to fix it, before our economy will recover.
4. Total securitized mortgage and derivative market is estimated at $1.3 Trillion by a Professor of Economics at Ohio State University. (Also see the graph from Deutsche Bank at “The Death of Securitized Mortgages” http://www.nakedcapitalism.com/2008/06/death-of-securitized-mortgages.html )
5. Government should buy up securitized mortgages and derivatives at the lowest market price, which is set via a reverse auction. (Google on “reverse auction”.)
6. Squatters, who sit on their mortgage derivatives, in order to extort big $ from the rest of the system, can be forced to sell. (Law is analogous to eminent domain, or sales forced on cybersquatters that registered the domain names of well-established companies.)
7. Government pays mortgage derivative squatters at market price set by previous reverse auctions, perhaps with a penalty to the squatters.
8. Sellers give up all rights. No new law there.
9. Banks, investors, and insurers now have cash instead of questionable mortgage loans and derivatives. So, the banking system is healthy with cash to lend.
10. Credit will flow, and the economy will grow.
C) Government reassembles whole loans from securitized mortgage components and derivatives.
D) Government sorts the newly reassemble whole loans (mortgages) into groups according to risk/quality.
1. Government uses traditional mortgage experts and guidelines to sort the home loans into quality groups, for example, a high quality group would include homeowners with 20% (or more) equity in their house at today’s market price; and house payments that are 25% (or less) of homeowners monthly income.
E) Government (RTC) sells the reassembled whole loans to traditional mortgage banks.
1. This solves the problem of renegotiating home loans with homeowners. Read on.
2. Law must be changed so that reassembled whole loan mortgages cannot be securitized into derivatives, again.
3. An important purpose is to reconnect each homeowner with his lender, and vice versa.
4. It eliminates incentive for mortgage lenders to make predatory and junk loans. If the loan fails, the lender is stuck with a bad loan.
5. Government recovers much of the $1.3 Trillion purchase cost, because government auctions off the reassembled mortgages.
6. The lower quality, more risky mortgages would fetch a lower price at auction.
7. Mortgage companies, that buy the risky loans, will have more room to negotiate with the homeowners.
8. Some homeowner negotiations will not succeed. Those homeowners will move into affordable rentals. (The government does not owe everyone a free house.)
9. Other renters would like to buy those empty homes at reduced market prices.
10. If the government gets stuck with some homes, the government could profit by selling the homes when the housing market recovers.
F) Insurers like AIG may be reorganized through bankruptcy.
1. Securitized mortgage pools never made business sense, unless they were protected by various insurance schemes.
2. Those insurance schemes always were a scam.
3. Insurance only works when most of the insured assets are never hit with a disaster. That is why flood insurance does not work very well. A major flood ruins all the buildings in a large area, all at the same time. So, the insurance company goes broke, and people that bought the insurance are not protected. That is the problem with securitized mortgage insurance. In an economic downturn, the “disaster” hits all the houses at the same time. Securitized mortgage insurance was doomed to fail, and the insurance companies went broke in 2009.
4. Companies that ran the insurance scam may have to go through bankruptcy.
5. Never ending government bailouts for insurers like AIG are just throwing good money after bad. So, stop the bailouts.
This plan is inexpensive, tried and true. It leaves the banks healthy, with cash to lend. It restores trust in the credit markets, so loans will be made. It reassembles mortgage derivatives into whole loans, and restarts traditional mortgage lending. People can get loans to buy homes. Credit will flow, and the economy will grow.*
Step 2 – STOP THE PORK and START THE RECOVERY
*The economy will grow if President Obama’s massive tax, borrow, and spending plans can be stopped, before he creates another Great Depression. Presidents Hoover and Roosevelt already tried to tax, borrow and spend their way out of a recession in the 1930s. Instead, they created the Great Depression, which lasted 12 years. Straight as he goes, President Obama is doing it, again. Nevertheless, cleaning up the securitized mortgage mess is a necessary first step.
If President Obama announced Steps 1 and 2, today, the stock market would go up within hours. Investors love a real business plan, instead of a political pork plan. Millions of people will be wealthier, feel wealthier, and have money to spend. That is how to jump start the economic recovery within days.
Published: March 8, 2009 9:27 PM