In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities.  For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.

Basically, people are refusing to believe that the toxic assets held by the banks are indeed worthless.  By continuing to back these assets, it’s just racking up a huge bill for the taxpayers that will keep snowballing until they cut their losses.  We’re basically playing with a martingale strategy — given an infinite bankroll we could actually break even since the toxic assets will eventually be valued correctly.  The only problem is that we don’t have an infinite bankroll, so eventually we could find ourselves at the point that we can’t double up anymore and we’ll have to eat a catastrophic loss. 

So what should they be doing?

What would I like to see happen? I’d like to see them let these people go bankrupt, let the bankrupt go bankrupt, stop bailing them out. There are plenty of banks in America that saw this coming, that kept their powder dry and have been waiting for the opportunity to go in and take over the assets of the incompetent. Likewise, many, many homeowners didn’t go out and buy five homes with no income. Many homeowners have been waiting for this, and now all of a sudden the government is saying: "Well, too bad for you. We don’t care if you did it right or not, we’re going to bail out the 100,000 or 200,000 who did it wrong." I mean, this is outrageous economics, and it’s terrible morality.

Unfortunately nobody will listen to him either, so responsible homeowners and taxpayers will end up shouldering the burden.  At least it makes me feel better knowing that I’m not alone in my views though.

I also don’t like the ability to force cramdowns through either.  The point of a secured loan is that the lender can take back the collateral if the borrower doesn’t pay.  If the lender sees a benefit to modifying the principle owed, then it should be up to them to modify it.  At the very least, if you had your principle reduced, any price appreciation up to the original loan amount should go back to the lender if you sell your house for a profit ever.  Oh well.  Punish prudence and reward recklessness.

Q. What is an Economic Stimulus Payment?
A. It is money that the federal government will send to taxpayers.

Q. Where will the government get this money?
A. From taxpayers.

Q. So the government is giving me back my own money?
A. No, they are borrowing it from China. Your children are expected to repay the Chinese.

Q. What is the purpose of this payment?
A. The plan is that you will use the money to purchase a high-definition TV set, thus stimulating the economy.

Q. But isn’t that stimulating the economy of China ?
A. Shut up.

Yup, that pretty much sums it up…

Asset bubbles swell when risk appetites are high and credit spreads are narrow. Had the Fed considered spreads in its policies for 2004 and 2005, its tightening might have been much more aggressive. Home prices might have cracked much earlier. And today’s recession might have been much milder.

Here is the grim reality about home prices: They remain elevated by just about every historical metric. Look at the median income to median home price, or look at the cost of renting versus the cost of ownership. Look at the inventory for sale, relative to 5 year trailing price increases.  The bottom line is that in much of the country, prices are still too high.

Any fixes you see being pushed through that prop up the housing market just prolong the problem and encourage reckless behavior in the future.  If people realize that houses bought for too much get their loans rewritten with minimal recourse, the next housing bubble will be far worse than this one ever was.  Hopefully more and more people see this and realize that the best solution is to let the housing market stabilize on its own.