Who purchases things? Who ever it is that does so, they need to get snapping….. kavips

Here is an interesting question. What happens in a Great Depression?

Let’s trace the fallout from one single event: General Motors going out of business. As soon as that happens, its now unemployed workers must cut back on their spending. Sales drop precipitously in neighboring restaurants, and a percentage of those food service employees are quickly laid off.. None of those ex restaurant employees can now buy anything at the supermarket, so it too lays off a percentage of its stock clerks. With everyone in survival mode, the local gas stations no longer can move the amount of gas they are used to selling, and they too, must add their layoffs to the pot… Even insurance salespersons begin to lose a flood of accounts as they expire and fail to get renewed; now they too shop less, contributing to an additional scarcity of business, stopping by the supermarket now for only emergencies. Because of plummeting sales, the supermarket has no choice; again it must make drastic cuts. One week later the gas station does likewise and cuts everyone but its owner, who himself becomes the sole employee, manning it from Monday through Friday, 8 am to 5 pm. Fewer and less people working creates even less economic action, which in turn, causes fewer people to work, which causes even less economic action. The downward spiral grows wider. Left alone,… it is unstoppable. Eventually one very wealthy person, the last man standing with any money, buys up the entire town for pennies on the dollar.

But wait,….aren’t there a lot of other towns supplying parts to GM, simultaneously undergoing the same scenario? Yes. Across this nation, in every village, town, or city, because of GM’s folding, the same downward spiral occurs…. As people lose their jobs it causes more people lose their jobs; the reason they lose them is because their neighbors lost their jobs first… The unemployment curve which once climbed steadily, suddenly shifts, and rises exponentially.

Obviously the critical point where we should attack this economic problem is at it’s very beginning… Keeping GM afloat. As one can see from this projected downward spiral, which widens as time progresses, the longer one waits to apply a fix, the higher becomes one’s cost to correct it. Eventually the price of fixing becomes just too high; money runs out, and there is nothing more which can be done. To succeed, one has to nip it in the bud.

The four best methods for doing so are discussed below.

A) re-running the stimulus tax check scheme.

B) putting a moratorium on household mortgages for three months.

C) have banks flood lending markets with very low rates.

D) creating a WPA to build public works, funded by the Federal government.

Method one is the idea we found to be the most politically expedient; it was the first idea that occurred, after all it was just this past year we tried it. Although its impact or effect on our economy is still debatable, most public opinion polls taken beforehand did show that once it was received, paying down one’s bills was almost every recipient’s first plan of action. Even though the second quarter of 2008 showed some growth, that positivity was short lived. Today as we look backwards from 6 months past, we see there was little residual effect from that stimulus package, except for the admonition that things would have been much worse had we not followed through on it. What is almost forgotten however, it that this stimulus money is not paid for in advance by taxpayers, but is borrowed (as is a large portion of our budget) from various lenders charging us various rates of interest. Not only do we have to pay back the stimulus funds, but when that time comes and we do have to pay them back…..we will be paying back far more than we received,… due to the interest that is now accruing daily.

Fortunately we can learn from past mistakes. We can choose to put our “shot-in-the-arm” purchase on our national credit card, and continue to say “we are living well”. But on the day of reckoning when we do pay it back, our economy could be doing far more poorly than it is now… (which means (1) it won’t get paid back; or (2) that we will really suffer horrible economic hardships when we do pay it back, much worse than we suffer now).

Our investigation discovered that a stimulus package succeeds only when a nation is not buried under debt. Normally, if extra money gets placed in our hand, we spend it. A stimulus tax check should work in theory. If everyone spends their check simultaneously, their extra purchases deplete retailer’s inventories, which if restocked, would create new activity and growth in the manufacturing sector; therefore in theory….the economy should grow. But as it stands right now, when everyone is mired so deeply in debt , the bailout money gets used to write off existing red ink. What winds up happening is that as I write a check to my debt company, who then uses my money to write off a check to their debt company, which in turn, flips those funds over to their debt company… Everyone passes the money around and around, and instead of manufacturing jobs being started, it is only red ink that gets written off. No new investment gets placed into projects that create new wealth. Bottom line: all that is happening within each and every one of today’s economic stimulus packages,… is that we are borrowing from our nation’s public debt, to pay-off our nation’s private debt. The public debt is still owed by the public; so nothing really changes, except the terms of the loan, and name of the entity to whom we owe!

The next option holds much more promise: that of granting a stay for three straight months on paying off one’s mortgage. Stop for a second,……… now imagine how quickly you could get your personal finances in line, seriously, if you were allowed to go without paying three months worth of mortgages?

Month one would be dedicated towards catching up on bills. Month two, would be dedicated to getting completely caught up, and possibly ahead on bills. Month three would be spent on buying cool stuff. Bouncing this idea around to a lot of people, the same exuberant reaction comes from almost every household: this works for them.

So how would this affect those financial institutions actually in charge of handling the notes? Before I go forward with that task, we need to take a moment to familiarize everyone with the difference between real wealth, and “virtual” wealth.

Real wealth is what we are familiar with; it is something we can touch. Our car for instance. “Virtual” wealth is something seen primarily on a computer screen. We all know what real wealth is: as little kids we saw Scrooge McDuck’s money room in our Disney Books … Virtual wealth is the same thing, except it has “pretend” value. This homily should help explain how “virtual” wealth accumulates it’s value.

Let’s assume that somehow you were able to convince me to purchase some gravel which you picked up alongside the highway while you were walking forward to meet me.. I look it over, decide to buy it, thinking hopefully that I can sell it at a profit sometime later, and pocket the difference. And why not?.. I certainly don’t need rocks, … but I could use some extra cash. However my wallet is short of funds and our transaction which we are discussing,… is in jeopardy. To keep it afloat, you decide to take one dollar for every ten of which you are asking, and when I sell the rocks off later, I will give you nine more dollars at that time…

So here is how “virtual value” works. The real value is $1 dollar for the pile of rocks I received, because that was all of the out of pocket expense that I paid you.. However, instead of $1 dollar, I write down its value at $10, because eventually that is value of what it will cost me. But in truth, it will not actually cost me $10, until … that moment after it is sold.. Sound complicated? It really isn’t….

Here is why. You made $1 dollar selling me the rocks. They cost you nothing to acquire. Now that I have the rocks, if they go worthless it will only cost me a dollar anyway. So I lose a dollar.

However… in some computer, it shows on file that you are carrying the value of $9 dollars owed to you by me as an asset (money coming to you), and I am also carrying my value at $10 as an asset so that I can sell it if needed, so between the two of us, we stand to lose $19 dollars if the gravel market goes to zero. And it’s all really just make believe money, since only $1 dollar actually changed hands. *

Our current crises is predominately over “make believe” money; it is over stuff which we thought was owed to us, based on its arbitrary value at the time we made an agreement. We still have the objects of which we paid for in our possession.

Background explanation over.

So back to the mortgage write off. I lend you $100,000 for your house, and give you a payment book. Now that I’ve given you the money, I have a lien on your house, and I collect the money plus interest over time… If you do not pay me back, say skip a month, I do not lose anything except “anticipated earnings”. I am not in the hole any more or less because you did not pay. I do not have to pay anyone for the house. Everything stays the same, except the additional income I thought I would receive… It simply does not come in when I expected it… which is exactly the same thing that would occur during a restructuring bankruptcy. For a while you pay nothing, until eventually you catch up and resume payments and pay off the loan..

Under our agreement, if you couldn’t pay in a timely fashion, I had the right to sell your home and pay your debt for you. In a thriving economy that is possible. But, as a lender, if no one out there has any interest in buying the house, and I unload it at the going rate market value which costs me money instead of making it, I stand to lose all my money I gave you. Obviously it would be better for me to allow you a small grace period, which will cost me nothing in real money (only the virtual money I thought would be coming in), but will guarantee that over the life’s value of the loan, I will lose nothing… Between losing everything and losing nothing, being a rational person, as your lender, I would prefer to take the latter course of action.

To nip another argument before it gets started, allow me to reiterate with one other example. Let’s switch roles, you and I …. Let’s pretend that you are a mortgage company worth one hundred million dollars, and you have lien on a 1000 mortgages worth $100,000 dollars each. During the good times your monthly income averages $900 per mortgage for a combined total of $900,000 per month. Out of that monthly amount, you pay off your employees, utilities, maintenance service contracts, and costs charged to you by other banks. You keep the difference as profit. Speculation suggests that even without the moratorium, this March you will be faced with a 75% failure rate as people accept the fact that they just can’t pay. Your monthly income suddenly drops to $225,000. (down from $900,000).

In the following month, April, 50% of those who were late, will pay their late March payment, but will still not have enough cash available to make their payments for both months. The other 50% will be down by two months on their payments, with no real hope of ever making it up. In virtual terms, by the end of April, your business will be down $1,012,500 dollars. This is sort of the black hole to where all our bailout money is currently being applied… However, disregarding the “virtual” losses, your actual losses would be only the money spent on paying your employees, utilities, maintenance service contracts, and those costs charged to you by other banks. For you still have lien on those 1000 properties. At today’s zero value, those liens are worthless. But if the economy ever takes off again, by tomorrow they could be worth $100,000,000 if one could find a sufficient number of buyers willing to purchase them at the price you paid…..

So all that mortgage companies simply need to do in order to sustain themselves for three months of no income, is to pay their expenses. And they could again pick up where they left off starting on the fourth month. After all, it does not help our overall economic problem if we lay off numbers of financial service workers, because we were helping the economy by canceling three months worth of mortgages.

The above example is based on estimates which show that twenty five percent of mortgages will continued to be paid through April.. However the boost of this economic impact would be minimized, if only those people in dire financial straits were only the ones given a grace period. Those others fully capable of continuing to pay, would find themselves penalized for having been good creditors and paying their full amounts on time…. Not fair.

If it is to work, the three month grace period must be applied across the economic strata …. covering everybody. Everyone, no matter how poor or how wealthy, needs this same privilege. Remember, our primary goal here is not to stop foreclosures; it is to jump start the economy. To tip the balance of our economy, we need every bit of money pumped back into our system. We especially need those still untouched by our failing economy, who can still afford to keep their mortgages current, to throw their cash into the economy and sweeten the pot…..

As we all heard during the 1930’s, back then banks went on “holidays” for up to weeks at a time. None of those “holiday” banks ever threw in the towel during the time they were closed; however, had they remained opened, bank runs being made on them would have put them under. The same principal holds forth with our mortgage industry and financial institutions today. They will lose no money over their three month closings, but will instead gain the benefit of still being solvent three months from now; something which is doubtful if the dangerous current trends run unabated….

This plan has several major advantages, and a couple minor disadvantages. The major advantage can be dreamed of by every mortgage payer today. “Gee, if only we didn’t have to pay the mortgage this month”. This plan does not require Federally borrowed money like a stimulus package that someday will need to be paid back. This plan does not cause a single dollar to be lost to those businesses who lend money. This plan places a tremendous amount of spending money into the hands of purchasers within three months. The minor disadvantage will be determining who will pay for those employees who usually receive their income from these lending institutions….

The Federal Reserves estimates that this action will put 3.5 Trillion into our economy each month. There is no way federally funded mandates could match that level of impact. There is even perhaps some poetic justice in that since mortgage companies were the ones who first put the global economy into this mess, they should be the ones responsible for pulling us out……

Technically this action could be done very cheaply through the issuance of an Executive Order: stating that no part of the Justice Department will hear or prosecute any cases regarding any unpaid mortgages falling inside the three moratorium months of 2009. If there is no recourse in the Federal courts for not paying one’s mortgage, then by de facto the moratorium is in place. For if you, the mortgage payee, are being pardoned by the Federal Government for not paying your mortgage…then why pay it?

In other alternative situations the same plan could also be passed by Congress, State Legislatures, etc, etc, by anyone who wanted to bask in the warm accolades of regular people….

The next item (much less interesting) is that of dropping interest rates to the floor. After the recession following 9/11, that same thing happened and the housing market took off… quite possibly to our detriment today…. In late December 08 the Federal Reserve dropped the interest rate on inter bank lending to half a point, and speculation was that that it may go to zero, or even negative during the next few months… Zero interest rate? As happened during the last time we had low rates, the purchase of homes became remarkably cheaper… In late December, the Fed released information confirming that a record number of applicants inquired that week about re-financing just after the news was announced….

This has possibilities, but it must have the support from other factors of our economy to be effective. Just cutting down the cost of building a business, the cost of buying large purchases on credit, the cost of taking on a bridge loans to cover a brief, rocky, financial moment that one finds himself, ….. can, if available, provide an incentive to switch money now lying dormant in a safe account, over to flipping a new business that may hopefully one day generate new fresh money towards the GNP.

However for it to work,… banks have to lend…

That openness towards lending did not happen during the previous Great Depression, and from what little evidence is available to be seen thus far, it appears that banks are loath to let money again slip beyond control of their fingers…

That fear revolves around the habit that banks have of “calling in a loan”. When a bank lends money, it has the right to receive full payment if requested on demand. All banks lend to other banks. If one bank is in trouble needing cash, it calls in its loan. Unfortunately that poor bank holding the loan just called in, now has to ante up a considerable amount of cash rather quickly. Most likely, it will also call in its loans in order to pay off its loan that got called in earlier. The pyramid scheme fans out as each bank triggers two or three additional banks to call in their own loans as well.

A banks only defense in this scenario, is to have huge stocks of money available in cash, for those times when their neighbors call in their loans… Therefore banks are loath to lend out their reserves. If a bank puts most of its money back into the economy, jump starting it as quick as possible by investing in neighboring factories, production units, and houses, and automobiles,….. and then gets “THE CALL”….. it can’t unload all those properties in time to prevent its going under.. But if it has cash, it simply says “here it is….” So one can rant, rave, and rail at banks for not lending out their reserves….. but it would be foolish for anyone to place a monetary bet upon any bank that would make the choice of being altruistic, over it’s own survival…… Until the problem of calling in loans has been eliminated, credit will remain frozen.

(The problem can be quickly fixed by changing those rules regarding the “calling in of a loan”… most particular in its regard their “timing” or lead time, leading up to that act.) As an extreme example, changing the rules to allow a bank a full year to comply, would relieve much stress on any financial institution getting the call. Any bank given a year could figure out how to get liquidity to pay off that “call”. In an area where every bank lends to every other bank, the threat of going under would be abated. Keeping money tied up in reserves, at 0 percent, is costly if one could otherwise get 10 or 11 percent upon it…. Remove this threat…and the credit markets rapidly open up.

Again this action can be done cheaply by an executive order aimed at the Federal Reserve, stating that over a certain period of time, a bank has up until one year from the date its loan is called, to ante up… The bank originally calling for the loan has no worries… it has a year.. The chain reaction of calling in loans is never begun. Banks no longer need more than the required reserves on hand and lending becomes easier because banks are in the business to make money too…… Or again a law regarding such could be passed by Congress, state legislature, etc, etc, or anybody else desirous of basking in the adulation of the public’s citizenry.

(Although the “effectiveness of various tactics” will be written about in another chapter, the best option available today to initiate open credit, would be to issue a national Executive Order stating the obvious, and within it: installing an expiration or Sunset Date, by which it had to be passed and endorsed by another governing branch or legislative body if it were to continue further.)

So dropping the interest rate to zero, CAN put money into the hands of those purchasers who refinance existing loans, and CAN create new business opportunities since the cost of opening a factory will become much cheaper, if and only if, banks are given some way out of having to instantly pack up all their reserves and ship them out at a moment’s notice …….

Finally the most popular idea leaked out by the initial transition team’s encampment, was: creating a WPA to build massive public works funded by the Federal government. For those too young to remember, the former WPA was a Federal Program run like a business, but was funded with the taxpayer’s money…. and not by the purchase of private stock…. The principal is simple.. If banks won’t lend to start capital improvements, the the Federal Government will lend the money to itself (or a division thereof), and something at last will get started. During the last Great Depression, some examples of massive public works built include the planting of a wind break across the entire Great Plains, of building dams along the Tennessee River (TVA), as well as up and down the Colorado and Columbia Rivers… It also included building the Golden Gate, as well as the building of the then ultra modern Pennsylvania Turnpike across the Appalachians…

These local investments spur the economy in their respective areas. Concrete is needed, heavy machinery is needed, as well as are paid personnel. Those people then need to spend their paychecks and money enters the economy.

If one looks back to the last Great Depression, one sees that within the local areas, Public Works did jump start economies on a scale relevant perhaps to the size of a county or a township. But after the job was finished, the work moved away, a little further down the line perhaps, and the brief high level of economic activity was not sustained. As the extra workers move out, that area fell back into a recession. Only in a case like the Tennessee Valley Authority, where continuous activity lasted for decades, was any long term economic viability enhanced.

The added benefit was that we did get some great dams, which are then able to provide electricity over wide swaths of rural areas… or a turnpike… or a nuclear plant…. or a massive bridge….something of lasting value…

But proposing public works as a method to rebuild the economy, doesn’t seem to pan out, based on historical evidence… Essentially the amount of public work that can be done at one time, is just too small to make a dent on the national economy. Building Hoover Dam does not relieve those living in the Hoovervilles of Indiana. Building the Golden Gate Bridge, does not assist those starving in St. Louis, the Gateway to the West. Another Bridge to Nowhere, helps very few people somewhere else….

And that is that is fallacy behind using public works to grow our economy. It’s handsome bucket of water being thrown upon a blazing house. The silver lining of that program is that since we are we paying for unemployment anyway, this option provides a better return to our investment (again we will be using borrowed dollars to pay its way). Paying someone to reforest a clear-cut forest instead of watching Ellen DeGeneres on television, is arguably the better use of our tax dollars. Paying someone to demolish condemned city properties does more far more public good than seeing that money going to seed criminal activity…..

So the money spent towards unemployment, supplementing the welfare of those citizens out of work, could be better spent on Public Works with those same wages being applied to those same people who were underemployed. Again, an Executive Order directed towards the Department of Labor, could require that only those working in the service of their country (assuming other factors were not in play), would be eligible to receive future unemployment benefits. We would then scramble to figure how to accommodate that directive.

Review:

The four possibilities were:

A) Tax stimulus checks
B) 3 month moratorium on mortgages
C) Dropping the Fed’s interest rate very low
D) Building Public Works

Although all have the propensity to help jump start our economy, the one having the greatest impact upon our economy in the shortest amount of time, ie putting the most money into the hands of purchasers, is Plan B: a 3 month moratorium on mortgages.