Subprime Crisis #2 Coming Soon

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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It constantly amazes me that the people running the government and reporters who cover the government seem incapable of doing arithmetic at the first grade level. This is usually all that is necessary to foresee a disastrous outcome in the future. This is certainly the case with the impending FHA (Federal Housing Administration) crisis which will be blowing up soon. The FHA insures mortgages that have less than a 20% down payment. It is currently insuring four times as many mortgages daily as it did in 2006 at the height of the last subprime crisis and has 5.4 million loans on its books. A prominent congresswomen recently stated, "without the FHA there would be no mortgage market" right now.

In congressional testimony the head of this government agency recently stated that the FHA's finances were sound. Oh really? The FHA claims to have $30 billion in cash reserves. How long will that last considering that there are $675 billion in loans on the books and 24% of the loans from 2007 are troubled and 20% of the 2008 loans are troubled so far (these numbers can rise). Those percentages could be worse in 2009 and after. If more than 4.4% of the loans insured by the FHA go bad, it could be out of money, assuming (probably foolishly) that the $30 billion they claim in cash is unencumbered. If not, the percentage could be much, much less than 4.4%.

How is it possible that there be even more problem loans on the FHA books from this year and in the future? Anecdotal reports from some areas of the country say that as much as 100% of recent housing purchases are insured by the FHA. All you need to get this insurance is apparently a 3.5% down payment. A spotty employment record doesn't disqualify you, nor does having filed for bankruptcy in the past. Even more eye popping, having a previous mortgage that went into foreclosure does not keep you from getting a new loan insured by the FHA! The FHA business model is roughly equivalent to a company offering $100,000 life insurance policies for $100 to hospital patients who are on life support. Yet, the head of the agency claims that their finances are in good shape.

The FHA is only one of many new bailouts coming. A number of state and local governments are falling deeper into the red. Tax receipts are coming it at even lower levels than anything previously thought possible (another mystery of the 'recovering' economy). Small and midsized banks are falling like dominoes because of their commercial loans going sour. The FDIC insurance fund is already insolvent and the government will have to step in to prop it up. The Credit Crisis is by no means over, we have simply finished phase one and are about to enter phase two. But don't worry, the U.S. government has a printing press and can print all the money necessary to solve these upcoming problems.

NEXT: Dollar Breaks Support ... Again

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.

The Simple Arithmetic of Hyperinflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

The U.S. government inflation figures were out last week. According to official statistics, about as reliable as a pronouncement from Pinocchio, CPI fell 1.3% year over year. This was the biggest drop in 59 years. Core CPI was up 1.8% year over year, so no drop there. Core doesn't include energy and food prices, so the fall in oil prices from last year doesn't fully show up in it. The PPI figures had an even bigger annual drop. Mainstream news articles were filled with remarks about how great it is that the Federal Reserve has lowered interest rates to zero and flooded the economy with money to save us from deflation. I have no doubt that they will be very successful in this endeavor.

While there are still a lot of deflationists out there, I think even they could all agree that if a government has so much debt that its tax receipts could only cover interest payments on that debt, massive inflation would necessarily follow. This would happen because the government would need to constantly print a lot of new money to cover its regular expenses. Few outside sources would be willing to lend to that government. While this is an obvious worst case scenario, the inevitably of hyperinflation takes place somewhat before this situation is reached. Finding that exact inflection point depends on a lot of complicated mathematics involving a large number of factors and is subject to significant interpretation. For that reason, it is not possible to say that the U.S. has already reached it.

Examining the national budget figures for 2009, there is now $3.9 trillion in projected spending. Government receipts (mostly taxes) look like they will come in at $2.1 trillion. Only 53% of expenditures are covered. It is the decreasing coverage of government expenditures by tax receipts that led to the hyperinflation in Weimar Germany. The government had to print more and more money to keep itself running. Five years before their hyperinflation peaked, only 69% of the national budget was covered by taxes (yes, 16% more than is currently the case in the U.S.). Falling below 50% coverage seemed to have been the point of no return for the Weimar government.

What about interest payments on the national debt? In 2008, they were only $412 billion. This was during a time of multi-decade low interest rates that were close to zero for short term bills. Interest rates can't go any lower, but have a lot of room to go up. Everything else being equal, if we went back to the interest rates at the end of the 1970s, interest payments on the current debt would use up all tax receipts. Everything else will not be equal however. Every year the national debt is going to increase substantially and the interest rate needed to use up all tax receipts becomes lower and lower with time. Tax receipts need to rise enough to compensate for that. However, this would indicate a rapidly growing economy, that could easily raise interest rates more than enough to overwhelm the benefits of more taxes.

How can the U.S. government deal with this situation other than cutting the budget drastically (don't hold your breath for that one)? Since it is increasing the supply of government debt rapidly, it needs to increase demand even faster for its bonds. But foreign lenders are backing off. So the only solution is to print even more money, so it can buy even more of its own debt. Now that's going to help keep inflation under control!

NEXT: Stock Market Turns Ugly

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.