As the Treasury Secretary morphs from designating institutions with “too big to fail” status to demanding regulations where “institutions can be allowed to fail,” we see the urgent hand of executive government in that most dangerous of constitutional times, a time where half the Senate has changed and the balance are now vulnerable. For all three of the US decision making institutions to be aligned again is the greatest fear of incumbents, and so the inevitability of the law of pendulums (they go back and forth sport) must be debased, defeated, deferred or ultimately shoved into the national deficit for others to worry about many years hence.
In a crucial US election year the imperative of preventing reasonable consequences flowing from unreasonable policy and hence behavioral failures is excruciating, but so far US policy has had the mantle of respectability draped over its shoulders as governments world wide have elected the “lesser evil” policy, that of putting the egg back in its shell. Unfortunately for the egg scoopers, much has changed since Mother Goose tacitly endorsed the rescue efforts by the King’s men, not to mention the horses. Ludwig von Mises describes the endgame brought on by reckless expansion of credit:
"There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."
Humpty’s erstwhile rescuers are definitely in the “or later” camp. The desperation of the $300 billion US Housing Bill, totally unfunded, falls squarely into the “do something; anything” category, and will be just as effective as were the efforts of the King’s men in 1810. This from Reuters: A new fund, paid for with profits from the mortgage companies Fannie Mae and Freddie Mac, will help build affordable rental housing. The two companies will be allowed to buy pricier mortgages, up to $625,000, which would make stable loans available to buyers in expensive cities. The problem here is that these companies don’t actually have real profits. They have billions in unrealized losses. Quite how using a government bailout to increase the availability of top end mortgages, qualifies as helping struggling home owners has escaped me entirely. Must be an economists thing.
The President also was sensitive to complaints by fiscal conservatives, who object to the increase in the debt ceiling and the bailout for Fannie Mae and Freddie Mac shareholders. Some, but not all, were mollified by the bill's establishment of a regulator with stronger reins over the two companies and the new "consultative" role overseeing the companies for the Federal Reserve. The White House cast Bush's quiet signing of the bill as an act of expedience, not camouflage
In addition to the helpful components of the housing bill, The Center for Responsible Lending supports additional common-sense solutions, such as providing temporary deferment of foreclosures until housing markets stabilize. In this context “stabilize” means levitate. The inevitable conclusion that is being missed or simply ignored in this wave of Humpty restorations is that what we have seen in housing, auto loan and credit card debt, in the past 5 years in particular, is not normal. Bubbles are always an aberration that always lead to mean reversion in overblown markets
S&P
The current institutional belief is that the S&P can happily hold the range from 1250 to 1450. This belief is based on the assertion that half of the earnings in S&P companies are generated offshore and presumably are therefore immune from being degraded if US experiences several periods of below trend growth. Australia too has this belief with the variance that Down Under it is expressed as “China will save us”. It’s not going to happen folks. As the driver of the global economy US has in a decade swapped its industrial might for an outsourcing contract and ephemeral corporate profits, by arbitraging its back offices to developing countries. Last week Starbucks announced that it would close 60 of its 78 coffee shops in Australia. The Australian economy has yet to feel the ravages of the housing implosion and with mining enjoying a generational boom as Western Australia and Queensland tear large holes in the landscape to pour iron ore and coal into the insatiable maw of China, you cannot find a pessimist in the whole country. Yet Starbucks’ strategy is in tatters here.
Institutional trust that overseas earnings will support current stock price multiples is another egg on another wall.
