This Just In: Our Economy Is Going Down The Toilet

On Reuters.com right now there is an article that says President Bush is putting together a $150 billion "rescue plan" to stimulate the economy. The plan will be composed of tax cuts for families, help for the unemployed, and a 50% tax break on new investments by businesses.

If you wanted a sign that our economy is in trouble, you just got it.

When the current free-market, non-interventionist administration decides to arrange a $150 billion life line to the economy, you know they're afraid. You need not necessarily be afraid, assuming you've got a job, and/or some sort of an education, and/or some money in the bank, but it's quite obvious the government recognizes that this country could be in a world of hurt very soon if we don't figure a way out of this.

And it's all because for six years money was cheap and everybody was giving it away for free. Well, eventually The Bank had to start asking for some of it back, and when Mr. & Mrs. Subprime borrowers down on Main St. all of a sudden couldn't pay their $4,000 per month mortgage payment, then Mortgages-R-Us couldn't pay The Bank, and The Bank shut off the money faucet, and wouldn't give any more money to Mortgages-R-Us so that Mr. & Mrs. Subprime could refinance their mortgage. It's not much more complicated than that, my friends.

Once again, this country has fallen victim to a bubble. If you look back at history, it happens every 12 to 20 years...but we've really shortened the cycle this time. The last one started in the mid-1990s and popped in 2001. This one started sometime after 9/11 and popped in the summer of 2007. Sounds like six years to me. How quickly we forget...

If you were lucky enough to get into the mortgage business in the past six years, you probably made yourself some decent money. If you were lucky enough to own a mortgage company, you probably became a millionaire. But, unless you were smart enough to get out of the mortgage business or sell your mortgage company back in the Spring of 2007, you're now probably out of a job, at best. At worst you've had to sell your yacht, your $4 million cabana in Palm Springs, and your trophy wife has left you.

Magnify that whole effect by about a million, and you would find yourself in the banks' shoes. For years now they've been feeding off the housing boom, rolling this tsunami of mortgages and loans into what are called Mortgage Backed Securities, Asset Backed Securities, and Collateralized Debt Obligations (all basically just bonds). The banks have been selling those bonds to other banks and institutional investors who, in turn, are finding themselves left out to dry as the bonds default because the underlying loan holders (see Mr. & Mrs. Subprime) can't pay any more.

Yes, the good old days are over, and now comes the tough part when we have to batten down the hatches and ride out the storm. Hopefully, our economy is deep enough that the sting will be minimal, and we can bounce back from this and find ourselves in another bubble by 2015...but this one is probably going to hurt us, and the world, quite a bit.

My main question is, where was the government when all of this was happening? One thing the free-market allows is innovation, and that's why the U.S. has the deepest and most liquid financial markets in the world (should I say "had"?). But when that innovation gets out of control, this kind of crisis is what happens. For the past six years mortgage bankers have been coming up with every kind of cockammamy mortgage product imaginable to entice people to buy homes (One of the weirdest is what's called the Neg-Am loan which charges 0% interest for a fixed period, only to reset into a specified rate after that period is over. But the catch is, during that 0% period, the interest is still building up, but it's being added to the PRINCIPLE of the loan itself. Take out a $100,000 Neg Am mortgage and find yourself paying X% on a $110,000 loan in two years. And that's just one of many.).

Worse yet, they've been selling these things to the people who can least afford to buy them, people with low or "Sub Prime" credit scores who can't get loans any other way. In no way am I suggesting the consumer is faultless in all this. I think it is off base to say this all happened because the evil mortgage companies preyed upon the earnest and eager American homeowner. But its not that far off base. Consumers have a responsibility to research what they're buying, just like sellers have a responsibility not to sell them shoddy merchandise that doesn't work. They are both at fault in this mess, in my opinion. But regardless whose fault it is, we're all going to have to deal with it now. So, wouldn't a little bit of government oversight, a little bit of regulation have been in order? It's ridiculous to think that NO ONE, not even our "experts" in the government, could see this coming.

And that's precisely what kills me. As a financial journalist, I've been following this exciting stuff for four years, more or less. In that time I've been to a few financial conferences where they discussed this kind of thing and literally since the beginning of 2005...nearly three years ago...people have been concerned that the housing bubble and the mortgage bubble were going to pop. If memory serves, the housing bubble already popped. So, why then was everybody so unprepared for this whole subprime mess if they've been whispering about it since 2005?

The answer? Well, author Tom McGuane always said about addiction that "You can't quit something until it gets in your way." In other words, when everybody is making money, it's hard to interrupt them and tell them to stop. Just like with the internet bubble, it finally took a stock market crash of Once-A-Century proportions for people to wise up. Only, in this case, the problem is in the BOND market not the stock market, and anybody who knows anything about finance knows the bond market and the loan market are where the real business gets done. Stocks make good headlines and people love to watch them go up and down, but when companies really want to raise money they look to the bond or loan markets. Which is why I don't think this problem will be quite so easy to fix.

If we're not already IN a recession, then we're on the brink of one; like a rollercoaster just about to crest that first long climb. Hopefully, it won't turn into a depression, because if it does, the government will need to start another war to get us out of it...and that probably won't even work.

Strap in folks. It's going to be a bumpy ride.

Comments

Josh said…
Chuck Prince talked about the need to dance while the music was playing. That's what did them in. Of all the banks, only GS hedged. I saw this predicted in 2002-2003 by David Tice, but he was too early.

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