THE OBAMA STIMULUS PLAN

I got an email from a friend asking me what I thought about President Obama's stimulus plan. Here is my reply:

My summary comment on the stimulus plan is that it doesn't matter how you spend it - build bridges, improve classrooms, automate medical reports, put money into research, and so on. The money will be spent and thus enter the economy. I am not very interested in the debate about the "proper" or "best way" to spend it. Tax incentives such as rebates will also induce more spending. I am not so sanguine about giving business tax breaks since, with already holding large inventories, I don't see why any company is going to invest in expanding supply. And we certainly do not need investment in automation to reduce labor costs. But by and large I really don't care how the money is spent, just spend it.

If you read my articles you will see that I have found the financial crisis to be the unnecessary child of panic reactions to a relatively small uptick in the foreclosure rate on mortgages. This rate was just over 1% in 2004. It was just over 2% in 2008. But this caused analysts to devalue all mortgage based securities, as well as mortgages themselves, by up to 90%. "Panic" devaluation of assets worth up to $70 trillion, the estimated $15 trillion in mortgages and bundled mortgages, and the estimated $55 trillion in credit default swaps created to insure these bundled mortgages, blew a big hole in our credit system. All financial institutions saw their balance sheets fall dramatically thereby ruining the whole credit system.

The financial crisis has now infected the whole economic picture with rising unemployment the key issue. Higher unemployment will undoubtedly make the problem much worse, since that affects consumption, that does not require credit. Needless to add, those unemployed will have no chance to get credit.

While I don't really care how the stimulus money is spent, I do not see it as the solution to the basic problem. We have taken maybe $35 trillion off the books and balance sheets of financial institutions and other investors. That is equivalent to twice the 2008 GNP for the whole USA. Uncle Sam has deep pockets but not that deep. He cannot replace this loss.

No, the only way to restore the economy to a sound basis is to give a more accurate value to the mortgage based securities and their further derivatives. To do this we have to suspend the "mark-to-market" rules that call for valuing assets to the "market." At present there is no market for mortgages and mortgage based securities (well there is, but no one knows where it is). Since the actual foreclosure rate is still not high, about 3% now, the actual potential loss on these securities would be just that, 3%. Given this relatively low loss, I say it is proper, indeed vital, to value these assets to their "maturity value" which means a mortgage held for its full period. If we do this we would automatically restore trillions of dollars, maybe $30 trillion, to the economy, instantly. I know that this is dismissed by those who maintain that the market is the only true indicator of an asset's worth, but how do you deal with an asset that has no market?

I am not alone in calling for this remedy. Steve Forbes is perhaps the most visible promoter of chucking out the "mark-to-market" rules.

No matter how the "crisis" plays out, it has produced a major change in the US economy, which has led to what I call , "The New Economy." What I mean is that the crisis has forced Uncle Sam to buy up substantial parts of the private sector - banking, insurance, mortgages and even the auto industry. He is now the single largest shareholder in "Corporate America." Until now the Federal Government has been the largest consumer of the economy, a budget that equals 20% of the whole economy, the central banker and the rules maker for the economy. Now Uncle Sam is the main shareholder. This changes the whole equation.

I have also noted that Uncle Sam has acquired this massive share of the private sector at not cost. Since all investors are shoveling their funds into Treasury Bonds to the point that they go for interest rates less than inflation, i.e. Uncle Sam gets funds to invest at no real cost. We have the absurd situation in which private investors are putting their money into government debt so that the government can buy up the private sector. The ridiculous has become the sublime.

Leo Cecchini
January, 2009