COMMENT
Bailout cure worse than disease
By Peter Schiff
With President George W Bush no longer threatening a veto, the subprime
mortgage and Fannie and Freddie "bailout" bill was able to sail through the US
Congress. In anticipation of its enactment, congress had the foresight to raise
the national debt limit to US$10.6 trillion. Who says that politicians don't
plan ahead?
Once signed into law, the budget-busting legislation will hand the
administration a blank check to prop up the ailing home lenders. The ultimate
cost is anybody's guess. I believe that the price tag will be higher than just
about anyone imagines. Treasure Secretary Henry Paulson's Bazooka will be
locked and loaded
with enough fire power to blow what's left of the US economy into the dustbin
of history.
Though the government and Wall Street assure us that these bold moves will save
the housing market, and the economy as a whole, from collapse, the reality is
that the solution is far worse than the problem. As painful as the failure of
Freddie and Fannie would have been, bailing them out will hurt even more. In
other words, it's not the disease that will kill us but the cure.
Ironically, while government is rightly criticizing mortgage lenders for
ditching lending standards during the boom (well after the horses had left the
barn), the new law will actually encourage lenders to be even more reckless
than before.
By taking all of the risks out of mortgage lending (provided of course that the
loans are conforming), the government is telling lenders not to worry about the
loans they make because if borrowers do not repay, the government will.
Since this bailout eliminates all market-based deterrents to reckless lending
for conforming loans, the only checks remaining will be those imposed by
Freddie and Fannie themselves through the criteria they set for those loans.
And although they have taken some steps over the past few months to tighten
their minimal "standards", the political agenda behind the bailout will cause
this nascent effort to lose steam. In essence, the government's main goal is to
prop up home prices. Since American homes are still overvalued given the
fundamentals, their prices can only be pushed up with reckless lending and
inflation.
As a result of this bailout bill, the share of mortgages owned or insured by
Freddie and Fannie will likely swell from near 50% today to over 80% within a
year or two, turning a $5 trillion problem into a $10 trillion fiasco. If the
government succeeds in keeping real estate prices propped up, it will only do
so at the cost of sending all other prices through the roof. More likely, real
estate prices will continue to decline despite government efforts to levitate
them, compounding the problems and the losses.
The grim reality is that trillions of dollars were borrowed and spent that will
never be repaid. No government program can alter that fact. Someone is going to
have to pay the piper for all those granite counter tops and plasma TVs. The
price tag is staggering and for all the bailouts and stimulus packages, all the
government can do is exacerbate the losses and shift the burden through
inflation. Nor can the government resurrect bubble home prices and the fantasy
of real estate riches that went along with them. One way or another, rational
home prices will be restored and the myths of our asset-based,
consumption-dependent economy will be finally discredited.
CNBC once nicknamed me "Dr Doom", but compared with what I see coming now, they
should have then called me "Dr Sunshine". Take a look at a presentation I made
back in November 2006, at the Western Regional Mortgage Bankers Conference.
There are eight clips in total, and though the entire presentation is worth
watching, most of the real estate comments begin with the fourth clip. (Click
here to watch the video on YouTube. )
Every real estate prediction I made at that conference, which was considered
outrageous at the time by those in attendance, has already come true. As
confident as I was then about this impending crisis, I am even more confident
now that the government has just thrown gasoline onto the fire
Peter Schiff is president and chief global strategist of Euro Pacific
Capital. He is the author of Crash Proof: How to Profit from the Coming
Economic Collapse (Wiley & Sons, 2007) and his second book is scheduled for
publication in early 2009. Euro Pacific Capital commentary and market news is
available at http://www.europac.net. It has a free online investment
newsletter.
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