Recovery and Bailouts

Sunday, June 20th, 2010 @ 10:37 pm | Finance

So read this interesting article at Seeking Alpha  and I am going to use a few of the pictures in my discussion of the article.  The Joe Sixpack media seems to only be able to grasp at the simplest concepts, and lately that is pictures of oil covered pelicans or TARP money. With TARP they all talked about how it was an injustice for the government to extend loans to struggling financial institutions that had liquidity problems when the credit markets seized. No one in the media explained that the credit markets seized or what they are used for, but jumped all over the dollar amounts of the loans (which bear interest by the way).  The secret bailout has happened in the shadows, and its scaled is enormous. The shear concept is probably way past the average american, but it goes something like this: Lower rates below what is long term sustainable at the expense of people who save, and allow banks to borrow at that rate. Banks then in turn use that cash to lend out several times over at a much higher rate. Part Two of the bailout goes something like this: Make everyone aware of a problem in the housing market, then while things are still rated AAA, sell those housing assets to the government. If you look at the chart below you will see that mortgage assets grew at an incredible rate during the last ten years, and you will notice that the GSE (government sponsored enterprises) held a small percentage of those loans. Then in late 2008/early 2009, you will notice that the banks dumped all the toxic mortgage assets on the GSE. This pretty much happened at face value, and the GSEs will likely assume all the losses. BTW, the GSEs are government backed companies, so that it the general public. Combine that with the fact that Sallie Mae is predicting that 40% of all outstanding student loans will default and you have a pretty good case for why the government should never intervene with the market.  The profit was made on those loan portfolios, housing prices are way out of reach to most people and the government will assume all losses on those portfolios. All this in a vain attempt to prevent housing prices from correcting to historical levels. Everyone likes to make money but when they mess up… its someone else’s fault.  Taxpayer Next if you start looking at housing starts, all this talk about a recovery under way in the housing sector looks way out of place. The current recovery is more like a dead cat bounce and the scope of the fall shows this. With all the losses still to come I don’t know of too many investors that will invest here unless the rate of return rises dramatically. For that too happen the price has to fall much much lower. Someone making the median income, should be able to afford the median house on a fixed rate mortgage and on a normal amortization. Median household income has gone up in the last 40 years, but almost all of those gains have come from the increase in working women. A single person making the median income should be able to comfortably (<30% of income for housing expenses) be able to afford a decent 2 bedroom apartment or a bungalow. Thats not the case here in Canada nor in the US. Let the prices fall until they do. People seem to have this natural tendency to use any discount they may get to buy more house, so in the last 20 years of falling interest rates, longer amortization and dual incomes houses have been bid up ridiculously.  HousingStartsNote: I hope Obama manages to push China over the edge and this whole mess gets accelerated. Prediciton:US calls China a currency manipulator and places tariffs on imports or forces China to float their currency.US Rates skyrocket because you have just taken away the largest buyer(China kept their currency pegged by buying US Notes)The Chinese Yuan used to be much much stronger versus the US dollar. 1.5 versus the 6+ it is today.If the Yuan appreciated half of that most of the wage advantages would be erased, but the infrastructure in the US is gone. Short term the US would get a taste of Cost push inflation, long term the US would be forced to get more competitive.    



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