This is a message of prosperity rather than doom and gloom. Read through to the end.
A tremendous amount of homeowners are facing foreclosure. CNN Money reports foreclosures are up over 70% from this time last year. Banks are failing left and right, but let’s just take a look at the bailout concept in the most direct and extreme fashion for purposes of illustration.
The largest bailout possible
Imagine that every single homeowner that has less than 30% equity in their house at today’s prices receives from the Fed a check payable to their mortgage company that will pay their balance down to bring their equity to 30%. There is no more of a direct way to address the foreclosure and housing problem. What would the result be?
- Equity doesn’t matter. People got into mortgage loans that have payments higher than their income will support, and rising food and energy prices are lowering the household budget for mortgage payments. You could lower interest rates to 0% (forget about the market chaos that would create for a moment) and many people still wouldn’t be able to afford their homes.
- Home prices would fall because many would use the 30% equity in hopes of being able to sell their home and buy a less expensive home. This would accelerate the downward pressure the median home price. Many families would return to renting after touching the hot stove of home ownership. Of course, they would be seeking affordable rent which would also put a downward pressure on median home prices.
- I can’t estimate how many trillions of dollars would have to be created by the Fed for those types of bailout checks to be written… but you can be certain it would have a HUGE direct impact in raising inflation to levels unseen in American history. Injecting new money into the economy makes all prices go up. In this scenario, Americans would literally not be able to afford to eat if they stayed in their home. Home prices would crash almost to zero because three bedrooms and two bathrooms would become less important than food. There would be much larger social problems because, with this magnitude of inflation, food would become so expensive that theft, robbery, and violence would be the only viable means of survival for some.
A direct, swift bailout to cure economic symptoms would create very difficult times.
The smallest bailout possible
The smallest bailout is one that creates $0 new dollars and actually bails nobody out. It is one that forces people and corporations alike to harshly pay for their mistakes and learn from them. In this scenario, the entire banking system would have collapsed in October due to a run on the banks (banks are technically insolvent 100% of the time because if everyone wants to withdraw their money at once, they don’t have it – it doesn’t exist). Wall Street would have closed up before investors could have liquidated their holdings and withdrawn them. A ton of wealth would have seemingly disappeared in a matter of days.
Buuuut… I would imagine that a way would be found to keep the electricity, phone networks, and the internet running. Real wealth is ideas and action. Without the action of millions of American going to work, depositing in the bank, depositing in the stock market… none of these systems would exist. Without the action of Americans agreeing to use paper money, paper money would not hold value of function.
So the real wealth, ideas and action, would not be lost. In this scenario, I feel strongly that the innovation, intelligence, and good faith of a highly connected society of people would be able to construct a new system that takes care of human survival in the short term and subsequently create a sustainable economic and financial system. Nonetheless, this plan of action would create a period of very difficult times.
But what’s really happening?
The first scenario is one where the actual economic symptom of failure is cured wholly and directly. The curing of that symptom causes the whole system to collapse. The second scenario lets the whole system collapse naturally. A very different approach that is somewhere in the middle is what is actually being pursued.
A half hearted bailout of the culprit financial services companies themselves has convinced Americans to not make a run on the banks and stock market while doing little else. But doing so has still required over a trillion dollars to be created, so brutal inflation is still a certainty. If the plan works out, us citizens will continue to embrace banks, the stock market, the dollar, and employment… but the systematic loss of wealth through inflation is unavoidable for those who make no adjustment.
Everything will rise in price steadily and continually. Stock market returns will be positive when measured in dollars, but those returns (just as it has been for 8 years) will be lower than the rise in prices of goods and services. We will all grow our assets as measured in dollars, while our costs of living will rise much faster. In this trend, it is simply a matter of time before the people at large are completely bankrupt and poor. At that point, there will be no other devices available to defer a system reset.
What rock should I hide under?
None at all. One of the benefits of this half-hearted bailout plan is that people did not make a real run on the banks or the stock market. You didn’t lose everything, and you probably lost less than half of what you had at the beginning of the year. Be thankful, and get your wealth out of there while you still have some. I would suggest some geographic and international diversification into a variety of hard assets (gold, land, raw materials) and/or other investments that you can truly understand.
Is everyone doomed?
Probably not. That depends on what we do. We are being pushed and pushed and pushed by drastic events and forces. Those who react with escapism or fear will be not fare too well. Those who react with history proven strategies to preserve and/or grow their wealth will be the makers of their own destiny. What happens to the population at large depends on how many people pursue which path. The best thing that you can do for yourself is also the best thing you can do for the country. Make an educated decision to protect your wealth, and demand that your friends and family consider following in your footsteps. Remember the seven degrees of separation. Leading by example could turn our country around more swiftly than the acts of any politician or political party. Don’t fumble this one.
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