Thursday, February 11, 2010

World Economic Leaders Need IQ Bailout

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

There are few things investors can count on during our current era of financial turmoil. One of them is the unerring obliviousness and incompetence of the world's elected leaders and central banks. Somehow they both manage to find the highest cost, least effective solution for every Credit Crisis problem they try to solve. Moreover they usually don't bother to act until every dog in the street has been aware of the problem for some time. There was more than enough support for this view on both sides of the Atlantic today.

There was a summit meeting in the EU today, where the leaders of the 16-nation block struck a deal, at least in principle, on assisting Greece with its debt problems. No details of the rescue package were forthcoming, but there were suggestions of some form of loan program. This is enough to open up the Pandora's box of 'moral hazard', but probably won't be enough to fix the problem - at least not with the initial measures. The final cost for any help to Greece will be much more than early expectations and this will pale in comparison to the cost of future bailouts for other member states such as Spain and Italy.

The whole scenario currently taking place in the EU should seem vaguely familiar to Americans. The much maligned TARP bailout program was initially only supposed to be loans, so it wasn't really costing the taxpayers anything. A number of other bailout programs mushroomed around it and by some estimates reached $11 trillion in promised money (compared to $700 billion for TARP).  While it has been claimed that some TARP money was returned, it is not clear how much actually was. When Citibank announced it was paying back $20 billion (of the $45 billion it received), the U.S. government agreed to give it a $38 billion tax break. It's not clear how many similar deals were worked out to shift the burden from a loan program to a direct cost for the American taxpayer, who after all would have to pay extra taxes to make up for the federal government tax breaks given to the big banks.

While the EU leaders were busy sowing the seeds of future financial disaster for their currency union, the ever out of touch U.S. Fed chair Ben Bernanke was testifying on Capitol Hill about a proposed exit strategy from his easy money policy. As a reminder, Bernanke didn't realize that subprime loans would cause a problem, didn't realize the U.S. was in a recession months after it had begun, and didn't realize that not bailing out Lehman would lead to a possible collapse of the world financial system. Now he doesn't realize the recession and economic problems caused by the Credit Crisis are still not over.  At least he's consistent.

Those who think the U.S. economy is healthy only have to look at the state of the housing market. Almost one in three borrowers have mortgages that are for more than the value of their property. As of November 2009, 5.3% of U.S. home mortgages are three or more months behind in their payments. A year earlier in 2008, it was only 2.1%. In 2009, 2.8 million mortgage holders received a foreclosure notice. Current estimates are this number will rise as high as 3.5 million in 2010. Fannie Mae and Freddie Mac, both nationalized by the U.S. government, have just announced that they will buy back troubled loans contained in securities they have sold to investors (this is a major bailout for the big money players, although the mainstream media did not report it as such). Last year, the Obama administration pledged to cover unlimited losses for both companies through 2012. Draining liquidity from an economy with these conditions in the housing market would send the U.S. into a major depression.

The U.S. experience in the Credit Crisis shows that once you start bailouts, there is potentially no end in sight for how many there will be, nor any limit to the final cost. The disaster precipitated by not bailing out Lehman Brothers also indicates that you must bail out everyone once you start the process. Of course, bailing out no one is the other option. Half and half measures don't work and produce the worst results at the greatest costs. The EU seems not to be aware of this lesson. Maybe they're getting their advice from Ben Bernanke?

Disclosure: No positions

NEXT: China Worries About Inflation, The EU Needs to Worry About Growth

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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