Friday, December 7, 2007

Never fear Bush is here - a subprime rescue

Populism: A political philosophy that supports the rights and power of the people, usually in opposition to the privileged elite.

Populism may sound good on the face of it, but it is the main reason (populism and corruption) Latin America has continuously found itself in a quandary with regards to economic policy. Populism is anathema to capitalism. Populism is an irrational response of the have-nots to perceived injustices by the haves.

It is usually the Democrats who try and institute populist policies, but in the latest move to freeze subprime mortgage rates, I see Bush moving more and more toward populist policies. The Democrats no longer have a lock on populism. We are becoming more and more like a one party system – The Republicans are becoming indistinguishable from the Democrats. This is worrisome to say the least.

Hillary Clinton said Bush’s response to the Subprime mortgages was good but late in coming. Obama and Kerry said he didn’t go far enough.

I personally know individuals caught up in this subprime mess, and I do feel for them, and my earnest prayers are that they can find a way out without ruining their credit. But, individual cases are anecdotal. The employee affected by a layoff goes through a depression, not a recession as the saying goes.

Since interest rates are the prices banks charge consumers, and it is how they make their money, freezing rates are no different than the wage and price controls enacted by Nixon in the early 70s. Price controls in any form do not work in a capitalist or free-market system. President Bush should have learned his history lesson by Nixon’s wage and price controls. These controls popular at the time proved to be injurious to the US economy.

What they were running into was the problem of central planning in a market economy – the market will always undermine any attempt at control. One week the problem was textiles. Because of the political power of the farmers, the administration could not put price caps from the price of greige goods – unbleached, undyed woven cloth that is the first stage in textile production (greige is pronounced “gray”). So they couldn’t raise prices – and companies abandoning that part of the business. All of a sudden, the fabric finishers and clothing manufacturers were complaining that there weren’t enough greige goods…Rumsfeld asked, “Do we raise the price?” Situations like this came up week after week.

Source: The Age of Turbulence, Adventures in a New World by Alan Greenspan

In a centrally planned economy such as China or the former Soviet Union, price fixing is commonplace, but it runs counter to capitalism. In essence, Nixon’s price controls had unforeseen circumstances that just kept popping up. His policies eventually helped pave the way toward long gas lines, double digit inflation, and a stock market decline of 40%.

The only difference between what Bush is doing now and what Nixon did then is the size of the freeze. According to the Mortgage Bankers Association, Bush’s plan applies to only 2.9 million homes.

But what will the effects of Bush’s subprime plan be? First Bush’s plan is only a band aid to the problem. It freezes rates for five years. Sub prime borrowers, by definition, do not know how to manage their money. If they did, they never would have taken out the loan in the first place. Irresponsible behavior begets irresponsible behavior. Five years from now, these borrowers will be in the same predicament they were in as they are today, (of course, by then Hillary will probably be president, and she will put through a bailout via your taxes and mine.) Houses will continue to remain artificially high, and borrowers will not learn from their mistakes. As in Nixon’s wage and price controls, there will be yet unforeseen adverse consequences to the economy. This is always the impact when government tries to control prices in a free-market economy.

Bush’s proposal will only delay the downturn and prolong the misery. In March 2000, the “irrational exuberance” of the dot-com bubble came to a head, and came crashing down. Pundits expected real estate to follow six months to a year later, because history told us real estate values fall following stock market crashes. It never happened. This is because banks became lax in giving credit, and borrowers were looking for a new place to make money. The effect was a housing boom that lasted for years. The longer a boom lasts (artificially), the harder will be its fall be it stocks or be it real estate.

A couple years ago, my nephew wanted to buy a house, I told him to wait because houses were going to have a precipitous decline. I was right. But he waited like many others who are trying to prudently invest their money instead of borrowing money they can’t pay back. Bush is rewarding those who made brainless decisions, and he is punishing those who waited to buy by keeping houses artificially high.

What should happen? Financial institutions that cannot afford to absorb the losses should go out of business. The remaining banks will emerge stronger and healthier. Borrowers who cannot afford to pay the loans back should be forced to go into foreclosure. The stock market will decline, and houses will become affordable to those previously left out of the market. If Bush let the markets work, we would avoid a recession, and the doom and gloom of the economy would be ephemeral.

Bush’s plan is more about political expediency and building his legacy than doing what is best for the US economy.

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