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Massive default is best way to fix the economy

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  • Massive default is best way to fix the economy

    Commentary: Clearing away the debt is the only way forward

    September 12, 2011

    NEW YORK (MarketWatch) — You want to fix this economic crisis? You want to put people back to work? You want to light a fire under the economy?

    There’s a way to do it. Fast. And relatively simple.

    But you’re not going to like it. You’re not going to like it at all.

    Default. A national Chapter 11 bankruptcy.

    The fastest way to fix this mess is to see tens of millions of homeowners default on their mortgages and other debts, and millions more file for bankruptcy.

    Fears of recession, tough trading conditions, an ocean of unresolved litigation and the worsening euro-zone mess have delivered a real pounding to bank stocks this summer. Former Goldman Sachs partner Roy Smith joins Mean Street to offer a solution: Break up the banks.

    I told you that you wouldn’t like it.

    I don’t like it much either. It sticks in the craw that people got to borrow all that money and won’t have to pay it back.

    But you know what? The time to stop that was five or 10 years ago, when the money was being lent.

    It’s gone.

    And mass Chapter 11 is, by far, the least obnoxious solution to our problems.

    That’s because the real cause of our economic slump isn’t too much government or too little government. It isn’t red tape, high taxes, low taxes, the growing divide between the rich and the poor, too much government debt, too little government debt, corporations, poor people, “greed,” “socialism,” China, Greece, or the legalization of gay marriage. It isn’t, in short, any of the things all the various nitwits say it is.

    It’s the debt, stupid.

    We’re hocked up to the eyeballs, and then some. We’re at the bottom of a lake of debt, lashed to an anchor. American households today owe $13.3 trillion. That has quadrupled in a generation. It has doubled just in the last 11 years. We owe more than any other nation, ever. And for all the yakking about how people are “repairing their balance sheets,” they’re not. From the peak, four years ago, they’ve cut their debts by a grand total of 4%.

    And a lot of that was in write-offs.

    More than a quarter of American mortgages are underwater. Many are deeply underwater. In states like Nevada and Florida the figures are astronomical.

    The key thing to understand is that most of that money has gone to what a fund manager friend of mine calls “money heaven.” Most of these debts will never, ever be repaid in real money. Not gonna happen.

    Think how corporations handle this kind of situation.

    It happens all the time. Banks and bondholders find they have lent, say, $1 billion to a company whose assets and earning capacity will only repay, say, $300 million. What happens? Does the company soldier on with $1 billion in debt it can never repay? Do the stockholders send back their dividend checks? Do they sell their homes to pay off the bonds?

    Not a chance. The company goes through Chapter 11. The creditors ‘fess up to their blunder, they face up to their losses, and they fix it. They write down the loans and take the equity instead. The balance sheet is cleaned up, and the company starts again.

    Why not homeowners?

    Most of the objections to this idea are well-meant, but misinformed.

    A fund manager I asked raised the issue of “moral hazard.” Why should anyone pay their mortgage if some people were getting a pass, he asked?

    The answer: For the same reason GE and Verizon kept paying the coupon on their bonds while Lehman Brothers defaulted. You want to keep your credit standing. And you want to keep your equity.

    If a company defaults, the stockholders get wiped out. If a homeowner defaults, the bank takes the home. I like keeping my home, as well as my savings, and my credit rating. Most people are the same.

    Some will say the financial impact would be terrible. But the banks would just be facing up to reality. And a lot of these mortgages are already trading at distressed levels.

    Some will say, “why should people get away with borrowing imprudently?” The response: Why should the banks get away with lending imprudently?

    There’s no point telling people not to borrow money. They always will. I have yet to see a Wall Street executive turn down free money. I have yet to see a company in an IPO say, “Don’t give us so much money!” People like money. They will take as much as they are offered.

    In a free economy, the people who are supposed to ration the loans are the lenders. Banks are supposed to lend carefully and responsibly. What else are they paid for? Accepting deposits? You could hire people on minimum wage to do that.

    Some will say, “it’s immoral” for borrowers to default. Alas, most of these people are being inconsistent. They are usually the first ones to defend a company when it closes down a factory and ships the jobs to China, or pays the CEO $50 million for doing a bad job, on the grounds that “this ain’t morality, pal, this is business!”

    But when Main Street wants to do the same thing, they start screaming “Morality! Morality!”
    We don’t live in an economy based on morals and fairness.

    T Mobile doesn’t charge me what’s “fair” each month. They charge me what’s on the contract. Your employer doesn’t pay you more if you need more. He pays you your economic value. Did Dick Grasso give back his bonus? Bob Nardelli? Dick Fuld? We operate in an economy based very firmly on contracts, and nothing else. Companies, and the wealthy, live by the letter of the law.

    American mortgage contracts allow for default. Half of the states in this country are “non-recourse,” which broadly speaking means you can send in the keys and walk away from a bad loan. The other half are sort of “semi-recourse.” The bank can come after you for any shortfall, but only in a limited way. Broadly speaking they can’t touch retirement accounts and basic assets. You can typically keep your car, personal effects, often things like life insurance.

    Most of the people who are deeply underwater don’t have that much anyway.

    And the banks knew this. When they were lending $500,000 to a bus driver with $1,000 in his checking account, they knew that their loan was only guaranteed by the value of the home.
    If they didn’t know it, they should have. Their incompetence is not our problem.
    It’s tempting to say, “if someone borrows money, they should repay it.” Generally speaking, I agree. I pay all my debts. But while that makes sense when applied to any individual, it doesn’t work so well when it’s applied to everyone.

    We have tens of millions who cannot repay their debts. But they are all trying to. That sucks huge amounts of money out of the economy. And that means these people cannot function properly as consumers or workers. That’s the reason people aren’t coming into your restaurant. It’s the reason people aren’t taking your yoga class. It’s the reason they haven’t hired you to redo the kitchen.
    And so tens or hundreds of millions of perfectly responsible business owners and employees are also suffering from this slump. That’s the reason we have a shortage of demand. That’s the reason no one is hiring.

    Even worse: People who are underwater on their mortgage, but who do not want to default, cannot move to where the jobs are either. They are stuck with their home.
    You want to break this logjam? Try Chapter 11 for the nation. Massive defaults. Clear the decks, clean the books.

    What are the alternatives?

    Government cutbacks, higher taxes, and a balanced budget? In a normal economy, fine. But in this situation, when the private sector is also slashing its spending, that could lead to absolute catastrophe. That’s what happened in the Great Depression. And our debt levels are worse than in
    the Great Depression.

    Government borrowing? That’s the Keynesian solution. “The consumer can no longer borrow like a crazy person,” says the Keynesian, “so Uncle Sam has to do so instead.” It’s just transferring private madness to public madness.

    Inflation? That’s probably the least bad alternative. But it’s just default by another name. And instead of taking money from the imprudent banks that caused the problem, it robs grandma’s savings.

    Twice before, advanced economies have gone through what we are going through now — namely a massive hangover after a massive debt binge.

    The first was the U.S. in the 1930s, the second was Japan in the 1990s.

    The U.S. didn’t get out of it until the 1940s unleashed inflation and reduced the debt’s value in real terms.

    Japan still hasn’t gotten out of it. They have deflation, while government debt has skyrocketed.
    The correct moral hazard is to punish the banks who lent imprudently by making them eat their own losses.

    I told you that you wouldn’t like it. I don’t either. But the alternatives are worse.
    Last edited by AngelinaCat; 09-15-2011, 12:35 PM.

  • #2
    Seriously, this is why I am so nervous about waiting--they're going to make it harder, mark my words. The more people need it, the more out of reach it will be. Call me cynical.


    • #3
      I think Moe is right.

      Re the article - the guy is spot on. He said:
      "Some will say, “it’s immoral” for borrowers to default. Alas, most of these people are being inconsistent. They are usually the first ones to defend a company when it closes down a factory and ships the jobs to China, or pays the CEO $50 million for doing a bad job, on the grounds that “this ain’t morality, pal, this is business!” " EXACTLY!!!

      Although he has to (as good wall streeters have to) slap FDR, BUT the alternative is for the gov't - yes DA GOVT to do the following:

      1) no more foreclusures - NONE

      2) 2% mortgages on the REAL value of the house for those who want to stay - say no payments for 6 months.

      3) glut of housing - GONE; people on the streets? No more

      4) profit - small - goes to the gov't

      And then nationalize the banksters...


      • #4
        If past experience of political choices has taught us anything, it is that whatever is done will not be (a) rational and part of a sound long term strategy or (b) to the benefit of the bottom half of income earners.

        Right now, there are more people in poverty than there has EVER BEEN since the poverty index was developed and the only news story is how people in poverty have air conditioning and TV.

        Note: The poorest states are in the South. I would not say that a family living in Georgia in the summer is rich if they have air conditioning.

        None of these reporters ever asks themselves what it would actually be like to live on or below the poverty line.


        • #5
          Exactly moe! That is partly because those inside the DC "beltway" - whether they are lobbyists of reporters - a) buy the BS narrative that we have going in the country today, and b) they're all millionaires.

          Can you imagine a report that would tell Americans that they are WORSE off than their compatriots in virtually every other developed nation???


          • #6
            Any country with a private central bank has been destroyed by that same private central bank, just as is happening to the US as we speak........
            All information contained in this post is for informational and amusement purposes only.
            Bankruptcy is a process, not an event.......


            • #7
              Right frogger!!!!


              • #8
                Why is the writer specifically suggesting a Chapter 11? Could someone help me understand?


                • #9
                  APL I think it's because he's a business writer, and to him BK = Ch 11...OR because he's thinking wholesale supervised "reorganization..."


                  • #10
                    Sigh. Isn't it crazy. People don't know they could be so much better.

                    I don't know bupkis about Central Banks. All I know is that I am worried about people. We could fix ALL of this if people would just calm down and not be insane.
                    What if we all pulled together and had concern for everyone in the country? How could we make sure people are OK? I worry less about the actual situation, which is EMINENTLY fixable. ALL the things of concern right now can be fixed if people would act NOW.

                    I am worried because there is a paralysis and craziness. We could fix all these problems, of course we could. But instead I worry we will fight amongst ourselves and the ship will sink because people are too busy going bonkers.


                    • #11
                      Right moe - all of these problems are MAN made - and thus can be fixed by man. Greed, stupidity, and the settling for the mundane is what is keeping us here...


                      • #12
                        Don't worry a major default is on the way. The way I see it is in the next few years we will most likely see major inflation far worse then anything we have ever seen before.

                        After this happens you will see real interest rates go to the moon. Investors won't tolerate the high Bernanke inflation, so they will demand high rates and once this happens the housing markets (or what's left of it), the stock markets will eventually crash as they always do from high interest rates.

                        Once this happens the US Government will then default on it's debt. The US debt is mostly short term, so as investors demand high interest rates to say 20% (like 1980) that would be between 2 to 3 trillion dollars IN INTEREST ALONE to service the debt.

                        Once this happens is will be chaotic at first then we will be in recovery since any sheep that hasn't been slaughtered will be awaken and home and other asset prices will be back to normal.

                        (BTW Please think twice before reaffirming your house in your bk filing. It's going dooooown)
                        The essence of freedom is the proper limitation of Government


                        • #13
                          Perhaps, banca rotta, the world needs a reboot in this sense - end the tyranny of finance capitalism - reset everything to zero - no one owes anything to anyone...


                          • #14
                            I am going to have to disagree with the article in that "the real cause of our economic slump isn’t too much government or too little government. It isn’t red tape, high taxes, low taxes, the growing divide between the rich and the poor, too much government debt, too little government debt, corporations, poor people, “greed,” “socialism,” China, Greece, or the legalization of gay marriage. It isn’t, in short, any of the things all the various nitwits say it is. It’s the debt, stupid..." That's nonsense.

                            Our biggest problem is that we as a people have lost our good jobs and our (real) earning power, primarily due to outsourcing. The fact that American households are so heavily indebted and/or are defaulting on their debts now is a symptom of that problem--not the actual problem itself.

                            For the past 12 years, real wages and inflation-adjusted earning power has fallen for most middle and lower class households. But cost of housing, food, energy, and just about everything else have risen! So it stands to reason that people would turn to debt to cover that shortfall and make ends meet. That is what kept the economy "humming along" during the Bush years and made us feel so prosperous and successful even as our good jobs went to China and India and the jobs which were created here paid lower and lower real wages.

                            What set off this economic collapse--which is far from over--is not the fact that people (and companies) have "over-leveraged" themselves and taken on too much debt. It's the fact that people have lost their jobs and/or had their earnings remain stagnant while costs of living have skyrocketed. People did not just wake up one morning and decide that they wouldn't be paying their mortgage, car loan, and credit cards because they don't "feel like it" anymore, even though they have the money to pay. Most people who are defaulting (or have already defaulted from 2008-present) are doing so out of necessity--they have lost their job and simply cannot afford to pay anymore! That is why mortgage modifications don't help. People who are unemployed or underemployed are in "survival mode" and barely scraping by. Reducing the payments, or even writing down the principal simply won't help.

                            What it will take to really fix this country and put people back to work is a President and Congress that has the courage and integrity to do the right thing and stop rewarding companies for shipping our good jobs overseas. If that doesn't happen--and soon--I suspect that we will have a second civil war here, as the growing dispossessed middle class reaches the conclusion that our government is simply out of touch with what the people need.

                            Even if it were possible to forgive/discharge everyone's debt, that would not solve the underlying problem that there are simply not enough jobs out there that truly pay a living wage, and that most people simply cannot afford to live indoors on the wages that are available without using debt to supplement their income!


                            • #15
                              Right bcohen - the average wage for the average American has been STAGNANT (at best) since the 1980's - people essentially supplemented their income with borrowing.

                              We need to return to protectionism and tariff - that's not a dirty work - just ask Germany, France, Japan, China, etc etc etc .


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