Depleted Banks and Struggling Home Owners

Financial institutions will need to raise cash to offset depleted assets. The second half of the TARP should be used to plug holes in the banking sector. Without a banking sector properly capitalized the system will not function properly. Without a functioning banking sector everyone including individual tax payers suffers. There is a backlash building against the financial institutions. Tax payers want to know how the first $350 billion from TARP was used. Rightfully so. In many ways financial institutions dug their own graves and they should suffer the consequences. However the repercussions of not helping the banks would be too disastrous for the rest of society that there seems to be no choice but to help financial institutions replenish fallen capital.

The idea of helping home owners and small businesses is necessary too. But that should be done by other means. Other federal programs separate from the TARP which could be put through by the new administration could accomplish that. Maybe the programs to help struggling home owners rubs some the wrong way too. Are not these home owners ones who got in over their heads and should not be bailed out? Perhaps that is true but the housing depression has been going on for too long. Federal policies that attempt to help struggling home owners will help home owners who did not over reach.

How To Help Home Buyers And Make Everyone Else Happy

The government may offer a solution to home buyers offering them extremely low interest rates to purchase a home. The problem with that is that other home owners who are making payments on an existing mortgage will not be offered the lower interest rate. These existing home owners will be upset that they cannot get these lower interest rates.

This is definitely a problem but I see a way out of this. The government can move ahead with these super low interest rate mortgages that will be issued directly to home buyers but in return the home owner should be obliged to give up a portion of the gains from a house sale. This portion can be based upon the discount to a standard 30 year fixed mortgage. For instance if the Treasury issued a home owner a new 30 year fixed rate mortgage that is 30% cheaper than a typical 30 year mortgage, then the home owner will have to give up 30% of the profits when the home is sold. The terms can be specified when the mortgage is issued.

It's Official, The Recession Began in Q4 2007

Today the NBER officially declared that the US economy is in recession and that the recession began in December 2007. Interesting to look back at a past blog post I made on January 14, 2008.:

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The Recession Started in Q4 2007

The US is likely in recession and it most likely started in December 2007. The December retail sales numbers from the chain stores last week (except for Wal Mart) were extraordinarily weak. The weakest percentage declines from these reports were on a similar trajectory to the percentage retail declines from the 1982 recession. The December monthly employment figures were recession-like. Sears Holdings numbers today were weak as well. Also surprisingly the Manhattan rental real estate market took a nose dive in the 4th quarter. (See the post on the Manhattan Residential Rental Market).

There are positives that I see too. If the US goes into a recession it is likely that commodity prices will fall and the dollar would strengthen. A drop in commodity prices, especially energy prices, would be welcome by the US consumer and a strengthening dollar would also benefit inflation indexes. The dollar would strengthen in a recession because as asset prices decline (think housing, equities) the amount of dollars in circulation would decrease. This cycle would create a scarcity of dollars which would lead to its increase in value. Commodity prices would likely get hit as the consumer would hold onto his dollars and search for replacements to high priced goods and services. In this cycle competition becomes even fiercer. An example of this can be seen from the company Harman today. Harman said "pricing pressures" have affected its business drastically. Hard to believe how quickly things are rolling over.

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Of note is that the NBER was not swayed by the uptick in the first two quarters of 2008 GDP. The uptick in the first two quarters of GDP was due to the $500 rebate to individuals from the Treasury. Q3 GDP was recently revised down to -0.50% and Q4 GDP may see a -5% or more drop in GDP. These are annual rates.

3 Month Tbills Now Yield 0.01%!!

This is insane, the 3 TMonth TBill has zero yield!!

The Deflationary Storm Continues To Grow

I have mentioned a number of times about the potential for a deflationary spiral. Back in March I warned that "The Fed Is Trying To Avert a Deflationary Spiral." In another essay I wrote "Inflation Will Vanish."

I was a bit early but it now seems to be happening. Deflation in asset prices (mostly housing and equities) is starting to effect the consumer. The US consumer has shut down and this is ripping through the economy causing waves throughout the world's economy.

For example on the Nightly Business Report this evening it was mentioned that some shipping rates which at one point were $150,000 are now down to $7,000.

A drop of that magnitude is shocking and very alarming. This example exemplifies deflation. Now what to do about it is the big question? Flood the system with cash makes sense until the US consumer can repair his balance sheet and pickup spending again. In the interim large government fiscal stimulus is needed to prop up the massive decline in US output / GDP. Lastly the government could offer incentives for people to buy homes. Offering cash rewards may make sense.

Eventually this beast will be put to rest but it is going to take some time for solutions to get traction and start working.

Offer a $2 Trillion Fiscal Stimulus Over 3 - 4 Years

Start in 2009 with a $700 billion stimulus and then in 2010 decrease it to $600 billion. In 2011 make it $500 billion and then finish it off in 2012 with $200 billion for a total of $2 trillion. The real economy stimulus should be front end loaded.

Name Tim Geithner Treasury Secretary Immediately

Geithner should be named Treasury Secretary. He is the best choice and has made some great macro calls. I heard Jim Cramer say that Geithner made a mistake by letting Lehman fail. It was a great mistake to let Lehman fail but I don't think this was Geithner's decision. From what I understand it was Paulson's decision and Geithner may have expressed reservations about letting Lehman fail.

This decision should be made immediately to remove one more unknown from the markets.