Private Lenders Grow Wary

Annapolis, Maryland

The Dow sank 344 points yesterday. Oil fell $1.46. The dollar rose to $1.43 to a euro. And bonds went up; the 10-year T-Note now yields only 3.64%.

But we’re attending a conference in the town where we were born 60 years ago. So, we’re not even going to try to reckon with the day’s news.

Besides, it’s too hot in this old burg.

Making a bad situation badder

By Bill Bonner

This week, according to the Bloomberg report:

“Prime Minister Gordon Brown suspended a tax on buying some homes for the first time since 1991 and brought forward 1 billion pounds ($1.8 billion) of spending in an effort to revive the U.K. economy.”

Brought forward? From where? In effect, the government will take money from renters and solvent homeowners to help a few people stay in houses they can’t really afford. Meanwhile, in the United States, private lenders have grown wary, but the feds’ money still flows like free beer. Fannie Mae and Freddie Mac face combined losses of up to $100 billion – much of which will have to be swallowed by the taxpayer. Next in line at the bar are the automakers, asking for $25 billion – at negative interest rates, of course.

“The response to this sad situation is unfortunately simple,” wrote Marc Touati, in the new French version of MoneyWeek magazine. “The United States is doing everything it can to promote growth and employment, knowing that as soon as the economy improves its economic policies can be less accommodating. ”

Mr. Touati is an admirer of America’s financial activism. Looking back over the past 10 years, he sees two episodes when US financial authorities acted aggressively and apparently, successively. In 1995, for example, economists thought the US was headed into a prolonged slump while Europe was poised for a period of dynamic growth. Instead, it was America that surprised to the upside. Again, in 2002, same situation. The US seemed to be in for a tough time, while Europe had the wind at its back. But again, America sailed ahead, while the Old World couldn’t seem to catch a breeze.

Now, in 2008, here we go again, he seems to say: “Once again, the consensus is wrong. Thus, the American economy has avoided the much-announced serious, prolonged recession, while the euro zone is threatened...”

Fortunately for you, dear reader, we do not have the space to describe in detail where Mr. Touati goes wrong; we can only summarize: each time the US consumer threatened to stop spending more than he could afford, the feds gave him more credit on easier terms. The US economy “grew,” but it grew worse off.

George Magnus, writing in the Financial Times on Tuesday, also looks with favor on US monetary and fiscal policies: “[T]he Fed has been obliged to do unusual things to avert a systemic financial meltdown. I see nothing in its operations that is irreversible and cannot be undone as the sense or crisis evaporates.”

Mr. Magnus ought to take a look at the Fed’s books. Hardly more than 12 months ago, the American central bank’s vaults were so full of US Treasury debt that anything else in there wasn’t worth talking about. But at the end of last year, the bank began buying up the flotsam and jetsam from sinking Wall Street ships. Now, the Fed’s assets look like a poor man’s attic-- including $106 billion of junk in a category known as “other.” What exactly is in these credits, we don’t know. But we know they weren’t there a year ago and they are only there now because other financial institutions were desperate to get rid of them. The Fed, serving as chump of last resort, was the only player dumb enough, or rich enough, to take them on.

If Mr. Magnus is right -- if the crisis “evaporates” -- perhaps these soggy credits will be crisp and saleable again. And perhaps the British government will make a profit on Northern Rock. Then again, maybe the markets are wrong about oil too. Perhaps it will sell for $10 a barrel again next year...just like it did in ’98. And maybe the Russians will reconsider; maybe they’ll hoist the old hammer and sickle and go back to standing in lines to buy a can of peas.

We don’t know. We have tried to look into the future. Maybe if we could do it, we too would be tempted to improve it before it happened. But we’ve never gotten the hang of it. Instead, we turn to the past...

“[U]unusual events merit unusual solutions, especially when systemic risk is present,” concludes Mr. Magnus. On this point, he is surely mistaken. There is nothing unusual about these events, nor about the solutions. Every bubble in history was followed by a bust. And the feds always use a crisis like a whale uses a beach. Emperor Diocletian, like Richard Nixon and Robert Mugabe, washed up on wage/price controls. Troubled by inflation, their economies got worse when they tried to stop it with price controls. Philippe d’Orleans, Regent for the young Louis 15th, turned to Beau Wilson’s killer to save the monarchy from the Sun King’s debts. John Law, with his funny, paper money, soon beached the entire country, and himself too. And now, the world turns its weary eyes to Ben Bernanke. The price Mr. Bernanke seeks to the control is the most important of all – the price of credit. He holds it down in order to try to keep other prices moving up – and to keep the consumer spending!

Mr. Magnus says the “erosion of the consumer’s purchasing power from shrinking access to credit and dwindling housing wealth has only just begun. This is true in the US and the UK...” Elsewhere in the FT comes word that another $96 billion in risky home loan chickens are coming home to roost in the next two years, citing a Fitch report that estimates an average increase of 63% -- or $1,053 extra per month. This comes as late payments and defaults are already as high as 24% for these make-believe mortgages. Too bad, but no thanks are given to the feds for sending the birds off in the first place.

Bill Bonner
For The Daily Reckoning

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Private Lenders Grow Wary

Making a Bad Situation Badder