"I try to do the right thing, which is to have a down payment and a job and to be fiscally responsible, and it basically looks like it's not going to pan out if this subprime bailout goes through."
That is a quote from Mr Casey Johnson, a 34-year old American biologist who works at the Salk Institue. Mr Johnson moved to San Diego three years ago. When he couldn't find a house in his price range, he and his wife rented an apartment and waited for the housing bubble to burst and house prices to come back to a level where they could afford (note - AFFORD) to buy. Now, Mr Johnson and his wife - and MANY other Americans like him - are feeling cheated, partly because profligacy is being rewarded while fiscal prudence is penalised, partly because the Bush plan to freeze subprime interest rates may furnish yet another artificial support under US house prices.
President Bush's plan - or more accurately the plan announced by President Bush - calls for freezing rates or providing refinancing for subprime borrowers paying adjustable rates and facing a contractual upward revision in those rates in the near future. It has been almost universally panned, for many good reasons. The most important one is that it makes a mockery of any concept of the "sanctity of contract". Another very important one is that it will greatly worsen the "credit freeze" by further eroding the confidence of the owners of debt paper, the precedent of negating the terms of the original contract having been set by the US government.
But the focus of the criticism, and of the righly-felt resentment of a lot of American mortgage holders who were NOT caught up in the subprime frenzy, is towards the people who Mr Bush calls the "homeowners". By this, everybody assumes that he means the people struggling to pay off loans which were beyond their means from the moment they borrowed from the banks and other mortgage vendors. But these people are NOT "homeowners". The homeowners are the financial institutions which lent the mortgage money in the first place. THESE are the people who Mr Bush's plan and Mr Paulson's plans and Mr Bernanke's interest rate cutting plans are intended to bail out. The sooner people come to realise this, the sooner some steps might begin to be taken to get at the REAL root of the problem.
The US credit expansion now on its last legs has been steadily increasing with hardly a pause for breath for the past 25 years. With the US government behind them either explicitly in terms of Treasury borrowing or implicitly in terms of the US Fed, the commercial banking system has been the main engine of the credit creation frenzy. The apogee of that frenzy, and the point at which all remaining fiscal considerations were cast overboard, was the real estate bubble.
Profligage credit creation is not possible where fiscal responsibility reigns, and fiscal responsibility reigns only when there is an ultimate curb on the desire of the banks to create ever more credit (make ever more loans) out of thin air. The curb is provided by Gold circulating as money or, to a lesser extent, by a money substitute like a US Dollar which is convertible into Gold on demand.
Once that curb is done away with, as was the case in 1971, then there is only one curb remaining. This is either a growing unwillingness to borrow or lend - and/or a growing inability for borrowers to repay or service the debt they already have. What is happening right now in the US and across the world is a potentially catastrophic combination of BOTH those factors.
Let us repeat, an individual who holds a mortgage of any size on a piece of real estate does not "own" that piece of real estate. The lender, the originator of the mortgage, owns it. The fact that the money lent to "buy" the real estate was in almost all cases created out of thin air doesn't matter - as long as the borrower is keeping up his or her principal and interest payments. But if the borrower won't or can't continue to do so - then it DOES matter. When millions of borrowers are in that position - IT REALLY MATTERS! For the lenders, an "asset" - the loan against the property - becomes a liability - a real economic good from which little or no income can be derived and the market value of which is either falling or plummeting depending upon how many borrowers hand their keys back to the lenders.
This is the potential catastrophe which Mr Bush's plan is a desperate attempt to avoid. A collapse in the commercial banking system means a collapse of the primary "machine" through which the credit expansion is fuelled. And, since economic "growth" now equates with the amount of money spent - most of which is borrowed into existence - any slowdown in the credit expansion means a slowdown in economic "growth". As has been said by many analysts about this bailout plan: "There are no ideal public policy options in the subprime crisis and the overriding goal is to head off a sharper housing downturn that drags the economy into recession."
To perpetuate the modern credit based financial and MONETARY system used in the US and everywhere else, borrowers must be able to service their debts. The limit to any credit expansion is the point at which they can no longer do so. For the US and for the rest of the world, that point is either here or is approaching very quickly indeed. Remember, borrowers in the private sector do NOT have the ability to create the necessary "funds" out of thin air. Only the government and their network of commercial banks can do that.
Tragically, the enemy of the modern financial system is any individual who lives within his or her means. The achilles heel of the system is that it is based on a "promise to pay". The world faces a situation in which those promises can no longer be kept. Whoever authored Mr Bush's plan knows this. Treasury Secretary Paulson knows it. Fed Chairman Bernanke knows it. But too few individual Americans (or citizens of any other nation for that matter) know it.
If they did, the "resentment" now being given voice by many responsible Americans would quickly swell into a paroxym of indignation. If they did, Gold would not be hovering just under $US 800 - it would be MUCH higher. The problem, for Mr Bush et al, is that even though the CAUSE of the credit squeeze can still be hidden from the vast majority, its CONSEQUENCES cannot. All the desperate measures recently announced are timed to keep the system functioning - for the rest of this year. There are just over three weeks left in "the rest of this year". What about next year?
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