The Beltway Crash

I tweeted as much yesterday, in addition to a supposed financial crisis we have a crisis in government. It’s not about Democrats vs. Republicans, but rather the American people against a political system they have little confidence in. Not only did the American public not believe the pronouncements of the severity of this downturn in the credit markets, they also don’t believe that government will be successful at doing anything about it, either party.

The Washington elite have failed, completely failed in the eyes of the average American and that’s reflected in across the board polls that show 3 in 4 people surveyed disapprove of the job Congress is doing, worse than the President and that’s a pretty low bar to not meet.

America has survived a feckless political class in the past, and it will again after this week. But Monday’s crash and burn of the Paulson plan on Capitol Hill reveals a Washington elite that has earned every bit of the disdain that Americans have for it. This crowd can’t even make sausage.

[From The Beltway Crash - WSJ.com]

The political class has been wrong on this housing and credit market issue for 10 years, Democrats were wrong to use Fannie/Freddie for a social agenda and Republicans were wrong to hitch up to the same social agenda and then whisper calls for reform yet not make them a priority when they controlled Congress. Why should the average American believe that the very people who colluded with Wall St. to create the problem will now fix it, seriously, the same people down to a person – Sen. Dodd and Rep. Frank in particular? Hell, at this point it would be no surprise if they appointed Master of Disaster Jamie Gorelick to lead this debt buyback agency.

This last week we have been inundated with televised talking heads and politicians who say the problem is the credit markets AND the housing market. As I watched this pundits and participants it occurred to me that none of these people are talking about this in a fashion that connects the two together from the standpoint of relief, in other words it’s easy to say why bad loans unpinning housing properties not worth what the borrowers speculated on is resulting in a raft of bad debt on the balance sheets of investment banks and lenders, but how exactly will buying thinly traded assets that have impaired value help homeowners?

If the problem is housing, what will this plan do to help the housing market? The answer, we are told, is that lenders will once again lend but that’s not entirely true. Anyone who does not meet more stringent qualification requirements will not get a loan, period. Furthermore, for many in today’s real estate market the value of their property has been reduced to the level where there is little equity to tap into, and/or essentially trade into a different property. If anyone really believes that loosening credit markets will result in appreciating home values they should go on the record, but nobody will because that is exactly what caused this most recent bubble to begin with, just as the dot-com bubble in the 1990′s, it has been supply driven.

A significant amount of the lending that underpinned our economy for the last 15 years should not have happened in the first place and it won’t happen in the future. We have permanently shifted perspectives here and for the foreseeable future lending will not be a function of asset valuation but ability to pay and what that means is that the market for homebuyers just got a lot smaller and/or asset valuations will remain impaired through an entire economic cycle.

Congress also controls tax policy and one measure that would be certain to increase investment in the markets would be to zero out the capital gains tax on housing, bond, and equities held for specific periods of time. Countries all around the world do this to stimulate investment in their economies, at what point did Congress start believing that taxes on long term investments were good? How about creating the conditions where capital once again moves into the market, which is especially important in a period of extreme volatility and low interest rates. We have to create the incentives for a broader cross section of the population to invest instead of losing money in a checking or money market account.

But I think the Average American understands far more than politicians give them credit for and they understand that if the Federal Reserve and Treasury want to open up the credit taps they will do exactly what they are doing right now without a debt buyout plan, lower interest rates and flood the credit market with money. This is where Washington is wrong, they behave as though they don’t owe an explanation to the public (Paulson’s original $700b plan was literally 2 pages) and then they patronize us by saying “we have to do this and it’s complicated so just trust us”.

Back in July I wrote about mark-to-market issues and said at the time that I was undecided on what to do next. I think now that suspending mark-to-market is a good thing for the same reason that I would violate traffic laws while rushing my child to the hospital. Rigidly adhering to accounting rules that have contributed to the destabilization of the markets is insane, but more on point we simply need a better way to value derivative instruments that rely on hard to value assets that have the capacity to be thinly traded.

Lastly, destabilization of the banking sector is a real concern as a result of eroding depositor confidence is a real issue but here again the Feds can do something about it. The FDIC already expanded their reach by assuring investors that money market funds would be insured, so Increase the FDIC insurance threshold to $250k per depositor. The FDIC is facing a liquidity crunch itself but that’s as a result of bank failures increasing, and as we saw with IndyMac, WaMu, and Wachovia, the propensity for banks to fail increases as confidence declines and that can be stemmed by the FDIC, which also can sell more bonds itself to finance themselves as opposed to taxpayers writing the check.

The credit market crash should be renamed The Beltway Crash because if nothing else is clear it is that Americans have lost confidence in Congress, the Administration, and Federal agencies to manage markets, taxpayer dollars, and even to just do the basics like get along. Someone asked me if I had contacted my representative in Congress… my response was “yeah, on the first Tuesday in November”.