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"An appeaser is one who feeds a crocodile, hoping it will eat him last."
Sir Winston Churchill

1.26.2008

Why "Stimulus" Packages Only Stimulate Politicians

Current fears of recession in America are being driven primarily by the mortgage "crisis".

The mortgage "crisis" itself is largely a function of the federal government's war on banks. Do you remember all the hubbub a couple of years' back on "fairness in lending"? That was the federal government threatening banks to make more loans---especially mortgage loans----to lower-income neighborhoods.

What happens when you make loans you don't want to make to people who are less likely to be able to pay you back?

You lose money.

Banks, neither desiring to lose money nor desiring to be pounded by government regulators, simply began pushing adjustable rate mortgages. This would allow them to issue more credit to lower-income consumers who would then be able to essentially purchase homes now which they wouldn't have to pay the market price for until several years later, when many would be earning more.

Unfortunately, many of the people who took these ARMs not only used it to purchase a home, but to purchase a home much more expensive than they needed or could afford. They did so despite being told that interest rates were at generational lows. They did so despite fixed-rate mortgages being similarly available, if at a point or two of interest more expensive.

Why do such a thing? Because housing values, driven in part by greater availability of mortgage loans, were going up. The thought was to buy a house, enjoy the ARM for a couple of years, then sell it for a big profit.

When interest rates began to climb out of the trough, of course, in part because the price of homes is seen as an indicator of inflation, the amount ARM holders had to pay each month went up as well. That's what "adjustable rate" means. That's what any reasonable person would expect to happen eventually with interest rates at historical lows.

The howling over this has prompted recession fears. The political difficulty banks have foreclosing on bad mortgages increased the amount of mortgage loans they had to write off---that is, to take as a loss---which resulted in most of the big banks missing Wall Street expectations.

So what's Washington's solution to the problem it created?

Why, give lower-income Americans a "rebate" on the theory that this would drive up consumer spending as people blow the rebates.

Here's the trouble with that line of thinking:

1. Consumer spending isn't what's driving the fears of recession. It has remained high enough to cause the Fed to fear the return of inflation.

2. Increased consumer spending won't shore up the banks who've been burned in the mortgage deal. How come? Because banks make money when consumers borrow money they want to spend, not when they spend it. 80% of big bank income comes from fees. If Americans use the "rebate" to pay off credit card debt or eke out another mortgage loan payment, fee income for banks goes down, not up. That makes matters worse for the financial sector, not better.

If fee income goes down, and profits therfore drop, what do you think banks will do?

What would you do if you were running one of these banks?

I know what I would do. I would use the mortgage debacle as an excuse to make fewer loans, particularly to lower-income consumers. And if Washington tries to complain, I'd have my PR folks ready with a press release decrying the government's call to get these poor folks back into the ARMs we've just helped them get out of.

What's the economic impact of fewer loans available to lower-income homeowners?

Fewer homeowners and more renters, for one.

What does that mean?

It means the next industry to take a bath will be the construction industry, since demand for homes has been reduced.

It means that home values will decline, as demand for homes has been reduced.

It means that local governments, dependent upon property taxes, will suddenly be pulling in a lot less revenue, which they will seek to replace by jacking up income, sales, and other taxes and fees.

All of which will worsen the outlook for economic growth.

"Stimulus" packages achieve only one things---they buy gullible, economically-illiterate people's votes and deliver job security for politicians.

That's why they're pushing them, after all.

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