Connecting the Dots

“De-leveraging or re-loading”

Last fall, the government passed the “Emergency Economic Stabilization Act”, which, as we all know, had the provision in it for the “Troubled Asset Repurchase Program” (TARP). The initial purpose of “TARP” was to buy toxic assets off the banks’ balance sheets so they would be free to lend once again, which would help stimulate and stabilize the economy. What it turned into very quickly was the government using a provision of “TARP” called the “Capital Purchase Program” (CPP) to take equity in banks and, thereby, increase their capital to make them more stable and continue lending.

A few months later, it turns out the nation’s biggest banks did not use the funds to increase their lending. Instead, the increased capital gave them the ability to further write down their toxic assets. Is this wrong?

My father used to say that America is the only nation that can save money by spending money. As I watched people trample over each other at the “Wal-Mart” in New Jersey on the day after Thanksgiving, the thought came marching through my head. Also, ironically, or perversely, so did the Johnny Mathis version of the perennial classic,“Have Yourself a Merry Little Christmas!”

During the 1980’s the nation moved from substantially a creditor nation to a debtor nation. As the government took steps to stimulate the economy by reducing taxes and as we increased the arms race and brought the “Cold War” to a head, for which, by the way, millions of Eastern Europeans now freely thank us, we took on an increasing amount of government debt. More importantly, a theory developed and
was widely accepted that debt was not relevant to health.

In the private sector in the 80’s, debt flourished. It was the era of leveraged buyouts and leveraged balance sheets. Credit card accessibility and debt accelerated at a rampant pace. Home ownership increased substantially as more people had access to mortgage debt through government sponsored entities like Freddie Mac and Fannie Mae.

In the 90’s the trend largely continued. Deficit spending slowed in the mid 90’s and the economy produced a surplus that the Clinton administration wisely used to pay down the debt. Still, the private sector created new and exotic debt instruments based on computer programs that used theoretical models. This set up a situation that caused massive acceleration in total U.S. debt, primarily in the years following 2000, when the government started deficit spending once again.

Consider this: total debt to the gross domestic product (GDP) was 260% at the height of the “Great Depression” and “New Deal” spending initiatives. From 1940 to 1985, the number ranged from 130% to 165%. By 1990, the number had grown to 230%. By 2000, it was nearly 265%. Today, that number is in excess of 365% and about to grow a whole lot more.

The message that seems to be coming out of Washington today is “lend more, borrow more, and spend more.” Considering the overall debt-to-GDP, I wonder if that is at all sustainable. After all, the businesses and consumers that are most at risk are those that relied on too much debt.

If you take the bad assets off of the bank’s balance sheets and encourage them to lend more, aren’t you creating a further unsustainable situation? After all, how much debt can our children and grandchildren be expected to assume on our behalf? Shouldn’t the message of the future really be, “lend safely, borrow less, and spend within your means?”

A few years ago, various mortgage brokers and bankers were encouraging borrowers to take on as much mortgage debt as possible as it was a good hedge against income taxes. I find it truly ironic that some of those originators have turned into advocates for borrowers in trouble. They are now leaning on the banks to get them to reduce the principle of the borrower’s mortgages by threatening the banks with the outright default of their client. Of course, these advocates charge a fee to the client for this service, and, in reality, not all of the borrowers are really in trouble, but instead see an opportunity to reduce their mortgage.

To me, it all boils down to what kind of world we want to live in. Is it too late to return to a society where people don’t trample each other for a 20% discount? Or, that people borrow only the money that they expect they can pay back. As a banker, why would I want to lend to people that didn’t feel that way? If you handed back the keys to your house to a lender even though you could afford to pay for it, why would I want to do business with you in the future? How do I know that you won’t do the same thing to me should the same opportunity present itself?