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Monday, March 29, 2010

You Are Government's Line of Credit

Cheap money makes products more expensive. When borrowing gets really easy money becomes cheap. The more qualified borrowers for financing for a product the higher the demand, the more bidders for the product, the higher prices climb. College tuition is a good example. As student loans became cheaper and cheaper more and more people were able to pay for tuition and tuition rose disproportionately to the value of the product produced. Now private colleges will set a family back about $200,000 for four years for a degree that is not much more valuable than that obtained from a state university (also obtained at an inflated price, albeit lower price).

A much more appropriate market to look at is the housing market. As mortgages became easier to obtain and as the amount of money needed for down payment became less and less, home prices climbed. With the introduction of 100% financing with no income documentation prices soared. Suddenly anyone could purchase a home, no money needed, your income was not a problem, hell even if you had crappy credit you could buy a $650,000 home and then all you had to do was wait until it was worth $750,000 and you could sell and make a quick hundred thousand. Or if you liked your home, you could use the same financing to pull equity out of your home. After the first refinance that lowered your rate and your payment and pulled out equity to pay off your revolving debt, you could take out an equity line and use that to remodel your home with all the finest appliances, or buy a boat.

Money for mortgages was cheap, way too cheap, and it created a surge in home prices. But what happened when the money went away? What happened when the mortgage lenders started to fall and the credit decisions became tighter? Housing prices at first stalled and then crashed. Ten percent, twenty percent, thirty percent lower. Suddenly millions of Americans are going through foreclosure, living in homes worth 50-70% of the amount they owe on mortgages and the Obama Administration is pushing lenders to modify loans, forgive principle on debt and relieve borrowers of having to make payments they agreed to make.

At the same time 8 million Americans have lost jobs. Personal consumption, which is 70% of our nation's economy, has dropped precipitously. As a result tax revenues are down, all tax revenues, income tax, property tax, sales tax, capital gains tax. Despite the rising unemployment figures and dropping tax revenues, trends that could be seen to be coming in 2007, our state and federal governments continued on their spending binges. They were like homeowners with an ever increasing home value and lenders willing to make them easy and cheap loans.

Now that the economy has gone further south state governments who do not have printing presses, have now been faced with having to cut their budgets. Despite rising unemployment last year California Democrats, aided and abetted by three Republicans and the Governor, raised taxes, essentially going back to their line of credit--you and me. No doubt they will try it again this year to protect their special interest from budget cuts, yet further cutting budgets for school districts across the state. They see us as their equity line. A cheap and endless stream of funds for them to spend as they see fit. And one can't help but get the feeling that the underlying mentality is, "Obama and Pelosi will bail us out if it gets really bad."

And why shouldn't they have this attitude? GM got bailed out. AIG got bailed out. Homeowners are getting bailed out, or at least they are trying to bail them out. Congress passed a $787 billion spending bill in a few days that went to all sorts of non-essential projects. Why would Washington not bail out California? We are a huge part of the economy, surely we are too big to fail?

The current deficit for the federal government is $1.4 Trillion. This year's spending from Washington is $3.5 Trillion. Our federal debt is $12.6 Trillion. Trillion. I'm not sure everyone is capable of comprehending how much one trillion actually is. The number is thrown around so often it has become as easy to say as "billion" but the difference is enormous. And that is what Washington has been spending with as much thought as you may put into a new set of golf clubs, actually probably less thought since they do not have to worry about paying it back, you do.

Money has become so cheap for Congress and the Obama Administration that they are re-creating the housing bubble with government debt. A health care bill that costs a couple of Trillion dollars. Stimulus packages that add up to a Trillion dollars. Spend, spend, spend, borrow, borrow, borrow. Sound familiar?

Whereas before Countrywide, Bank of America, Wells Fargo, Chase were the lenders for lines of credit that supplied the funds that helped create the housing bubble; today the American voter has become the lender for Congress and the creation of the debt bubble. Our borrow and consume mentality gave us some good times for much of the Aughts, has transferred to our elected officials. Go ahead and spend the money, it's cheap. We'll just have Treasury auction some more T-bills and write another spending bill.

Try to stop government spending and you are demonized. First Senator Bunning and last week the Republican Senators blocked legislation to continue unemployment benefits unless the funding was taken out of either the already passed stimulus bill and unused funds, or cuts are made in another part of the budget. How dare you hold up unemployment checks for Americans in need! Who cares where the funds come from? We are the federal government just spend it!

Just spend it. Borrow it. Rates are low and repayment is cheap. But for how long? How long can the debt bubble continue before it pops? Every month the Treasury has been auctioning hundreds of billions of dollars in various notes, 3 year, 5 year, 7 year, 10 year, 30 year debt auctions have been occurring all year. And most of them have been fairly well received, meaning there have been sufficient buyers to keep the rates on the notes sold low.

But this past week the sentiment was not that great. With the backdrop of Greece having difficulties with its debt, a tremor went through the debt markets. Not as big of a tremor as went through Wall Street when New Century Mortgage had capitalization problems and started the credit collapse, but a tremor nonetheless. Investors hesitated before buying U.S. debt.

Wait a minute. The U.S. outstanding debt is $12.6 Trillion and growing. It's GDP is $14.3 Trillion, and finally growing but at a slower rate. America's equity is mortgaged to almost 90% of its economy's value and they are still spending and increasing their borrowing on their equity line--the American consumer and tax payer. How much more can the United States borrow before its bubble bursts?

Cheap money leads to price inflation, which creates bubbles, which pop. When they pop prices drop, money becomes more expensive and markets collapse. Debt is a market. The more demand there is for someones debt the higher the price and the lower the interest rates the borrower has to pay. As demand wanes prices drop and rates increase. This past week demand was not as great as it has been for U.S. debt.

And Congress went on recess with Democrats upset because they could not spend a few billion dollars more on the credit line. Your credit line.

You, and me, are the lender for the U.S. government, we are guaranteeing debt that at this point approximates $42,000 for every person in America--that's $168,000 for my home, how much for yours? Like the housing and equity frenzy of 2002-2007 a bubble is growing rapidly. When will it pop and what will happen to the credit markets when that happens?

My daughters are 8 and 10, they haven't been to college, haven't bought a car, haven't even had a job yet and already both are over $40,000 in debt. It bothers me to think what that number will be when they start their careers in about fifteen years.

To follow our national debt, revenue and spending check out the U.S. National Debt Clock

DCS 03292010

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