The loan aid trickle down effect

November 28, 2008 | Vetting explained

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Last updated: November 28, 2008

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I wonder why everybody is not immediately jumping at it. We don't want trickle down. Trickle down does not work. We want it from the bottom up. The theory goes that the government provides banks with loans and with complex securities to back commercial, consumer, and student lending with the expected result that the credit crunch will unfreeze and banks are hurrying to grant more loans. America's leaders must be delusional to believe that. Providing more unhealthy credit is just trying to keep consumers spending, aggravating their situation. Only unwise lenders would do that. They have smartened up, and the free credit for all era is over. The government can throw $10 trillion at banks and industries and it won't change their mind to return to unwise lending to consumers and businesses. Americans have lived well beyond their means for more than 2 decades. In fact, they spent roughly $500 per month and household over and above their (sinking) incomes. Households are now in dire financial situations with crunching levels of debt service payments. Not to think of paying back debt and most certainly not of saving money or building equity. Businesses are catastrophically leveraged and many in the 30 companies show massive negative equity if you remove certain overvalued good-will items from their books. As values of Dow corporations have been cut in half over the last year, those items have lost their values pretty much altogether. However, they remain in the books with billions and billions of non-existing values, intangibles, so to speak. Their value can only and exclusively be justified if markets show strong growth. Would you provide MORE credit to those classes of consumers and businesses? Would you do it if you would get $10 trillion dollars? No, you would not, except for if you would not only get the doe but also a guarantee for losses if they fail. That concept is not only insane but it is scary how it resembles the complex structures of the mortgages backed "securities" that turned out to be securing an unprecedented economic crisis instead. Only that there is one twist in the new casino gamble: you get the money to lend and later the money to cover losses from the very same government hand. Let me go play! Like that, the money may trickle down. However, there is a catch: the American household is unable to take on more debt. Enough debt is enough. Total debt service should never exceed about a third of income. With $120.000 in debt for the average household and ZERO equity or even negative equity, there is a problem of a magnitude that measures twice the debt for Americans compared to Canadians in relation to income. What might help a little bit, though, is to drastically change the debt service ratio by pushing lower interest rates and interest caps through the system by government mandate. This costs the government nothing and would help not only to prevent many foreclosures, and thus calls on mortgage backed securities, but might also slow down the fall in housing prices that continues to prevail. What the consumer needs to do, instead of loading more debt, is paying back debt and starting to build equity. There is a logical reason for that: Americans now need equity to buy a house, and this is how it should have always been. Zero-down financing is no more. 20 - 35 % equity down is the new, old rule. But then, how are the average Americans, stressed out to their last penny, drowned in debt up to their neck, and with zero equity in their accounts going to perform that stretch? The simple answer to a straight forward question is that they won't. They can't. That situation will hold the housing market in its grip for years to come, if not decades. It will endure until Americans have dug themselves out of debt and into equity, which is only about an amount of 3 yearly salaries away. I am just kidding. The average debt would not have to be reduced to zero but by about a third, which, distributed over two decades, would amount to another $500 per month and household. Housing prices will continue to fall substantially because prospective buyers don't have the equity to do so for a long time to come. There is too few that are capable to bringing up the necessary equity. Wait a minute! Does that mean that there will be more foreclosures? There will be more mortgage backed securities causing more problems through the (financial) industries? More contraction in consumption, more unemployed, more declines in the stock markets? No, it means that there will be MUCH more. So we come full circle, bailout some more, do more trickling down, and find out that it did not work all along. $7 trillion put into the hands of Americans would have solved ALL of the debt problem and would have put millions of American households into positive equity. In my article series (starting with economic stimulus (1): the disabled consumer at http://www.ireport.com/docs/DOC-132064) I have outlined a proposal for those interested. As so much time and money has already been lost and unemployment is shooting up unnecessarily, I would propose to start with immediately forfeiting of all private income taxes only to win the time necessary to deploy a multi-phase emergency program as outlined in my article series, starting with replacing income tax altogether with sales tax, by aggressively and quickly pushing low interest rates through mortgages and consumer loans, and by providing basic health care at $100 per family per month,. That would cost a fraction of the bailouts in motion and would have immediate effects to bring back consumers into the stores, even before Christmas. Please comment. I will address questions, if I can. My responses will be delayed as I am currently in Europe. H.R. Tschudi, economist and entrepreneur, Vancouver

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