Higgenbotham wrote:indyboy wrote:
I was playing the game in my head follows. There are two types of debts, those with collateral and those without.
a) For those without collateral (like the $2000 Prada purse the woman bought on her credit card), all the debt is forgiven. She was complaining she couldn't pay this back.
b) For those with collateral such as a house, the Fed pays he house owner the difference between the amount he paid for and the current market value of the house. I mean that the part Mr X, who bought the house for 600K and is now worth only 400K, is groaning about. The fed pays him 200K (which is the same as buying it from him for 600k at the current moment, so that would work too).
Ok, now shoot me now
I probably won't get all of this right or prioritized correctly, but will give it a try. There was someone who used to post here who might be able to answer it better. Some who work in the banking industry could almost definitely do better on certain aspects.
Starting with the debt without collateral, some of that is securitized, meaning it has been sold off to money market funds. In that case, then, we would need to assume that the securitized debt is paid off. The money market fund would now have dollars instead of securitized debt. The dollars wouldn't pay any interest. Likewise, if a bank were still holding the credit card, etc., receivables, they would receive dollars for those and would now have cash on their books instead of the receivables, and therefore would not be getting any interest (or income) on those. Any impending delinquencies would be replaced with cash instead of nothing.
All of this would have the immediate effect of improving bank balance sheets while reducing income. This then brings up question of the financial condition of the banks, as a substantial part of their income stream would disappear. If I understand correctly, the collateralized debt would still remain, and the banks would therefore still be receiving some interest payments. Only the uncollateralized income streams would be lost. I don't know enough about bank balance sheets and income statements to know exactly how this would impact bank profits as a percentage. Anecdotally, I understand that the banks derive a substantial portion of their income from credit card interest and, therefore, this plan would cause some reduction in bank profits and might at this point put some bank earnings back into the loss column.
Assuming that the debtors would have no desire to get back into debt at nearly the levels of debt that were discharged, I think the financial industry would shrink and some workers would be laid off. Also, the interest paid on bank deposits would have to be reduced, if that's even possible, and some banks probably would go completely out of business. Banks might use the cash on their balance sheets to try to stay afloat for awhile, but the generational aspects of people becoming more averse to debt won't make it possible for all of these banks to stay in business and this plan would probably hasten their demise.
I don't think this is a horrible idea, but it could do more overall harm than good. There are positive aspects for the debtors that I am not focusing on.
On the other hand, the plan to pay the homeowners the difference between their purchase price and currrent value probably wouldn't work too well, but we'll have to discuss that one later.
Yes, I did not talk about that. The scenario I mentioned does not prevent the earnings of companies from falling. Like you mention, since people do not want to get into more debt, the earning of the banks would fall since they make money only if people borrow. And that is not just restricted to banks. People would buy fewer iPhones because they do not want to run up their credit card. So the earnings of Apple would fall. By the same token, in the scenario I mention, all corporate earnings would still fall since people are spending less (hopefully, the people learnt some lesson if not as harsh as the 1930's). If the corporate earnings fall (a) more people would be laid off (b) stock prices would have to fall assuming constant P/E. Hence, wages would fall (more people on the labor market). Implies even lower spending. Vicious cycle can continue.
But the cycle would be MUCH less severe and the doomsday scenario may be avoided. Pisses me off like crazy, believe me, but I can see how the administration could get the voter mandate to do it. For example, if all debt acquired before a certain date, say 1/1/2009 is written off by the Fed then at least the problem of people not spending today because they are severely in debt would be solved. Of course, they would be still be spending less because they do not want to get into MORE debt which will have its own repercussions of shrinking the GDP nevertheless.
On another thought, that can also be solved ! Getting the people to spend money they do not have is a game that all administrations are really good at because it means GDP growth (+ more taxes + budget surplus + more Government spending, etc..) the prime indicator of whether the Administration was successful or not. Clinton left a the huge market bubble right before he left and yet every nincompoop I meet will tell me that he was really fixed the economy and balanced the budget. Our current administration would have no qualms about doing it.
So my point is that after having gotten people and institutions to pay off all the debt that the owe, the Government could start the cycle of inducing people to spend all over again with debt. Banks would start mailing those teaser credit cards again. And so on. And things would be just fine. Of course, the Central-Bank/Governement would be saying "I dont plan to bail you out EVER again so DONT DO it" but it would be wink wink. Kind of like legalizing all the illegal immigrants in 1986 and saying "Now we will never do this again, we had to do it this time because there were so many people already inside the borders illegally" and then knowing completely well that it would be done again if needed.
I am quite perplexed at my line of reasoning above, believe me. I have always thought that as a society we ran up debt and spent money we did not have so we must suffer dire consequences. It almost seemed to me like the law of conservation of energy - it cannot be undone. But over the last few months, I am thinking along the above lines. And it seems to me that the printing press can actually solve the problem at the expense of the "moral hazard" of paying one citizen free money over another. That is what is happening all the time anyways as my blood pressure continues to rise. Robbing one
Peter to pay three Pauls always works in a democracy because the votes are in your favor. That is the best reasoning I can find for why there is not as much brouhaha about QE. Because more people have to gain from it than lose. It seems to me Bernanke/Obama administration will get their way.
I am hoping someone will explain to me why my understanding of macroeconomics is completely off the mark.