THE NEW PRESIDENT AND THE NEW ECONOMY

Well President Obama will be coming in at the beginning of what I call the "New Economy" which means an economy in which the Federal Government owns a substantial share of the private sector. If you have been following my articles you will know what he will face. But to refresh your memories and bring on board new readers let us look at the facts and fiction emanating from our economic slump.

HOUSING

1. Fact - over the last decade we have greatly increased home ownership in America, we have brought the "American dream" to more Americans than ever.

2. Fact - Housing prices have risen to levels that exceed income levels, the familiar average home price exceeds the capacity of the average income to afford. Of course this rests on a key assumption, housing costs should not exceed 30% of your income. But then, why 30%? This rests on more assumptions about how one should spend his income. It is not a hard and fast rule. Young ladies spend on average more than 40% of their incomes on clothes and accessories. Perhaps the average home owner can spend more than 30% on his home.

3. Fact - people have been using their homes as "ATMs" to spend beyond their means. Home owners have been borrowing against the equity in their homes to supplement their incomes.

4. Fact - This supplemental income allowed consumers to continue to be the motive force for economic growth.

5. Fact - The decline in housing values has caused this source of supplementalincome to dry up.

MORTGAGES

1. Fiction - subprime mortgages were given to people too poor to buy a home. In fact, these mortgages were given mainly to finance purchases of second and third homes by relatively wealthy middle class investors.

2. Fiction - the foreclosure rate for non payment of mortgages has grown faster than ever. Fact, the foreclosure rate for mortgages, according to the Mortgage Bankers Association, the most authoritative voice for this information, stands at 2% when it was 1% in 2005, well before the financial crisis. Yes, a 100% increase but still small. The foreclosure rate in the Great Depression was 25%. And foreclosures due to non payment of taxes run about the same as for non payment of mortgages.

3. Fact - with default rates on mortgage payments at about 6-7%, mortgages remain a good investment. To illustrate, say you hold mortgages that total $1 million. The average return will be $60,000 a year. With a 6% default rate you will earn only $53,700, not a major loss. Of course you are still at risk for the defaults that could wipe out $60,000 of your investment. But you will continue to earn on the remaining $940,000 investment in mortgages.

4. Fact - mortgages were bundled into bond issues that were sold to investors as "securitized debt" or "collateralized debt" and other terms. I refer to all of these as being "mortgage based securities." No one knows how much of these bonds actually exist, since many were used as collateral on loans taken out to buy more of these bonds. Since no one had a handle on the full extent of this debt come asset structure, the relatively minor increase in mortgage foreclosures was blown out of proportion and caused the value of these bonds to tumble.

5. Fiction - Mortgage based assets must be "marked to market." This is an accounting principle that is used to value your assets. Pretty straight forward, you value the asset at what it will bring in a market, in this case what this bond will bring in the bond market. In the panic caused by the relatively small increase in mortgage foreclosures these assets found their market dry up and no one was buying them, there is no market. If the rule was followed honestly the assets would have to be valued at zero. But such has not been the case, they have been arbitrarily devalued down to the depressed price of real estate in extreme locations, typically 30%.

6. Fact - The false "mark to market" for mortgage based assets caused big losses for almost all major investors. They saw their balance sheets fall 30% or more.

7. Fact - the Feds "TARP" plan of $750 billion has been aimed at correcting the balance sheets damaged by the arbitrary devaluing of the mortgage based assets. But it is rather a small assistance. I have heard estimates of $55 trillion in mortgage based assets and the "debt swaps" taken out to insure these assets. The amount of paper loss is staggering, 30% devaluation of $55 trillion equals $16 trillion in loss. Obviously multibillion dollar injections of capital cannot replace this loss.

8. Fact - suspending the "mark to market" rule for valuing mortgage based assets would allow the holder to value them at their "long term" value, i.e. the payment of the underlying assets, mortgages, over their full term. In other words, we should treat the mortgage based assets as investments to be held, not investments to be sold. This would allow financial institutions to pump up their balance sheets by trillions of dollars, not billions.

"BAIL-OUTS"

1. Fiction - the TARP and other US Government efforts to cure the financial crisis are hand outs to be repaid by the US taxpayer.

2. Fact - the TARP and other US Government funds have been used to acquire a ownership stake for Uncle Sam in several key private sector "industries." Uncle Sam has acquired large stakes in major US banks, an investment that has already grown by 3% in its first month. Uncle Sam now owns the core of our mortgage industry, Fannie Mae and Freddie Mac. Uncle Sam now owns our largest insurance company, AIG. And Uncle Sam has bought part of General Motors and Chrysler. I foresee these investments as paying back more than their cost and thus becoming a major new source of government revenue, which is good, since this will reduce government need to increase taxes.

3. Fact - In my articles on the subject we now have Uncle Sam as a major stake holder in the private sector. He already accounts for expenditures worth 20% of our GNP. He already sets the rules for interstate commerce and taxes on our output. Now he is the single major share holder in the private sector. Several have written about the "New Economy" in terms of moving to a service dominated economy instead of one led by manufacturing. Others have written about the "New Economy" in terms of "globalization." To these we can now add Uncle Sam being the main investor in the economy.

HOW TO SOLVE THE PROBLEM?

1. Fiction - stopping foreclosures and helping people stay in their homes will solve the economic mess.

2. Fact - stopping foreclosures and helping people stay in their homes is a good in itself, but not the cure for the economy.

3. Fact - the only way to revive the economy is to pump up demand.

4. Fact - increased Federal spending will pump up demand.

5. Fiction - Tax cuts for businesses will revive the economy - business has no incentive to spend on increasing or upgrading capacity when there is no demand for its products.

WHAT SHOULD PRESIDENT OBAMA DO?

First, continue to inject Federal funds into the economy either to pump up demand or correct balance sheets of major financial institutions or acquire more shares in the private sector or all three.

Second, take whatever action he can to ease credit. The cost to borrow is low, we need to make loans available.

Third, instead of using Fed funds to assist those with mortgage problems, use them to generate new mortgages. As much as it may sound like heresy, Uncle Sam could use his funds to get Fannie Mae and Freddie Mac back to issuing new mortgages.

Fourth, suspend the "mark to market" accounting rules.