It’s unanimous: Propping up underwater mortgages is a bad idea
by ilene - March 28th, 2010 8:37 pm
It’s unanimous: Propping up underwater mortgages is a bad idea
Courtesy of Edward Harrison at Credit Writedowns
What follows is a more comprehensive re-write of my take on the latest bailout proposals by the Obama Administration. I felt the original write-up was a bit rushed and one-sided. I have tried to outline the objectives of the bailout plans more dispassionately. And I have added some historical references from prior posts to demonstrate the basic merits of the idea.
Clearly the mindset will not change. It’s all bailouts, all the time in the Obama Administration, as it was at the end of the Bush Administration. I want to talk about the most recent bailouts, why they were proposed, what’s wrong with them and why bailouts generally don’t work. My remarks will concentrate on the principal reduction program since this is the newest bit.
Why bailouts won’t work
What should be clear to you as an observer by now is that these bailouts implicitly assume that government can stuff financial institutions full of taxpayer money and in so doing adequately recapitalize them so that they can lend again.
The thinking is that, these policies, while "deeply unpopular, deeply hard to understand," are necessary to prevent another systemic breakdown and a deflationary spiral.
Also implicit is the assumption that economic weakness depends in large measure on supporting home price values by increasing the supply of credit via bank lending and securitizations. But, as I argued 14 months ago when Barack Obama came to the White House, the financial system is so fundamentally unsound that bailouts are like catching a falling knife. The writedowns that needed to be taken – in the absence of serious house price appreciation – are just too large to be handled quickly via bailouts.
Moreover, it is the demand for credit which is critical here because households are over-indebted and reluctant to take on further debt. While I do believe officialdom can be successful in creating mild but brief cyclical upticks in consumer demand, weak consumer spending will last for years. The secular trend is clearly going to be toward increasing savings and reducing debt.
So bailouts alone cannot address the debt problem which is behind the reduction in credit demand growth. Nor are they likely to be adequate to deal with the scale of unrealized losses on bank balance sheets.…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the site