Ronald Reagan once observed that the most terrifying words in the English language are: I’m from the government and I’m here to help. In the past year, the government has proved that he was a master of understatement.
In March of 2008, Congress spent billions of dollars to stave off financial calamity when Bear Sterns closed in on failure. Six months later Congress spent hundreds of billions to stave off financial calamity when Lehman did fail. Now six months later we are being told that we need to spend over a trillion dollars to stave off financial calamity. As the economic outlook continues to worsen, why isn’t someone asking whether the government‘s actions are helping or hurting the economy.Why are things are getting worse each time the government tries to help?
The answer is in a house in Michigan, another in Kansas, and a mostly vacant lot near my home in Marietta. It is in the 401K statement of virtually all Americans. The answer is evident to very person who runs a yard service. The answer is all around us. The real question is why is no one in Congress listening.
The answer is in a Michigan home which has lost approximately 35% of its value. The owner started with 20% equity, but his mortgage is underwater and falling. He likes his home so he keeps the mortgage current, but is not investing in it beyond the mortgage payment. He isn’t painting the house, replacing the wiring, or many of the other things that he would be doing without government interference. He is letting the house devalue because in his mind he expects the government to renegotiate his mortgage based on the appraised value of the house. In his mind, any investment in the house actually has a negative return.
The answer is in a mostly vacant lot in Georgia. The bank has replaced the developer as a patient investor in a partially completed condo project. The bank has a generous uncle who provides the 5% capital that makes patience possible. If the bank had to pay market rates for capital, this property would have been sold to an entrepreneur willing to invest new capital and new ideas into the project. Instead of producing jobs and wealth in Georgia, the property sits idle, depreciating.
The answer is the 401K statement of virtually all Americans. The government borrowed the money which it gave to the banks allowing them to comfortably hold depreciating real estate projects. That capital came from somewhere. In all likelihood, that capital came from the stock market, which is down 40% since the government started helping. It also came from real estate projects that were never started. It came from Christmas presents that were never bought. Basically we fixed the banking industry by breaking everything else.
Whether it is the Treasury’s Asset Relief Program (more commonly known as “TARP”) or buying bad mortgages, the government’s efforts are creating enormous economic displacements some of which are counter-productive. The TARP, for example, traps capital in the hands of the people who didn’t see the crisis coming. If that isn‘t foolish enough, the government also limits what these companies can pay to attract better managers of capital. At the same time, this program penalizes better-run banks which have to raise capital in the open market where it is much more expensive. In short, we subsidize weak managers of capital at the expense of good managers, and we wonder why the economy is faltering.
Capitalism is simple. It requires two things: stability and confidence. Confidence drives investment because it stems from the belief that tomorrow will be better than today. Instability translates to risk, which is ultimately priced into every transaction. Risk is sand in the machine. Last summer, my yard service increased my prices by 22% because of rising energy cost. When I asked them about the impending price decreases to reflect falling energy prices, the owner shrugged and said he couldn’t lower prices because he had no idea when energy inflation would return. He smiled and offered me a variable rate indexed to oil. I declined because I have no idea what the price of oil will do.
We may have fixed the banking crisis, but we did so by breaking everything else. Now the government is going to help fix the housing crisis. Where is Ronald Reagan when you need him?
