Wednesday, February 11, 2009

The Wrong Question

By Mr. Quarter

Yesterday, Tim Geitner (our new Secretary of the Treasury) announced a plan to shore up the financial sector. The details of the plan are murky, however it seems to be oriented around increasing liquidity by trading federal dollars in exchange for assumption of bad debt paper that the banks and financial institutions are holding. In today's Financial Times, Martin Wolf opines that perhaps the question isn't really how to prop up the banks, but to "clean the Augean banking stables" and restructure the healthy banks while slaying the zombie banks immediately. I agree with this approach and extend that logic to the entire stimulus package that is in now conference in the congress (as an aside, Arlen Spector has lost my vote and I encourage all other Pennsylvanians to vote him out next year).

One type of "toxic asset" that the Geitner plan would purchase is called consumer debt obligations (CDOs). Now, most of us have credit cards and use them regularly. Every transaction we ring up on the plastic used to be bundled up with other hundreds of other peoples transactions as a CDO and sold as an asset to investors. I understand that as recently as last year, $100 in credit card debt could be sold to investors for $115 as a CDO. The investors figured to make a profit on the payment of principal, interest and late fees by the consumers that hold the charge accounts, and the credit card company made it's profit in the sale. But the economy started to turn, jobs were lost and people stopped making their credit card payments, and they stopped buying. The halt in consumption slows the economy even more, so more jobs are lost, and so on ad infinitum. Now the investors are holding "toxic assets" that are filled with delinquent credit card account debt and cannot sell the CDO asset because either the value has plummeted or the value cannot be assessed.

So here is the logic that I do not understand. The premise of the Geitner plan is that the government will purchase these toxic CDOs, among other bad assets to inject liquidity into the banking system and free up credit. The theory is that banks will extend new credit to consumers who will in turn go out and spend money on their credit cards to purchase goods and services, again running up personal debt.

Now most of us - or at least some of us, pay off our credit cards every month or we at least stay current on the personal debt service. So, increasing the available credit of this group really isn't going to stimulate diddly, is it? This group is already spending and, isn't likely to spend more simply because they get a notice that their credit limit was increased by $5,000. Alternatively, the consumers that were defaulting on the personal debt previously aren't going to go out and rack up new additional debt, are they? First, simple good judgement would prohibit that course of action. Second, if they are already in debt to the point that they cannot adequately service the debt then they are not likely to increase their debt load. Lastly, if they have not been making payments to service the debt or have filed for bankruptcy to escape the debt, are they going to have their credit increased? I think not.

No, this whole thing looks like a giant mistake that will burden our children and grandchildren with federal debt load that will rob them of anything close to the quality of life we have enjoyed to date. I strongly believe that it is time to clean the Augean stables of the economy, let the weak fail and the strong survive. As a nation, we will be stronger as a result.

1 comment:

Anonymous said...

I agree with you 100% on this. Spending is NOT the only measurement of economic health. Hell, there seems to be very little reward for living within your means. Can the 'system' be improved to reward this element? My Dad was a banker, excessive debt was irresponsible period. There is one proposal out there that might work. (I don't even know). Stop foreclosures by making homeowners in default pay 31% of their salary to the reconfigured debt. It's the only interesting compelling idea I've heard so far and of course it's not in the bill. As George Will said Sunday morning, "Obama is quite over exposed" right now. Drunken spending and cheerleading won't get it done. PAYING OFF BAD DEBT by those who borrowed is an idea. Call me crazy.