November 15, 2010

Extend and Pretend

by Hal Gershowitz

Comments Below

That’s the new phrase commonly heard (with a nod and a wink) in banking circles when real estate loans are due but everyone knows they will be rolled over for renewal. It simply means the loan will be extended while the lender “pretends” the underlying current value of the property is sufficient to collateralize the loan. Everyone is happy.  The borrower doesn’t want his loan renewal rejected, the lender doesn’t want his balance sheet to take the hit that marking down assets to market value would require and everyone gets to pretend that everything is hunky-dory.

Extend and Pretend, sadly, is not a philosophy that is confined to real-estate financing transactions. Our government has been making a veritable art form out of extend and pretend for a long time.

What better example could there possibly be of the government’s extend and pretend mentality than the housing bubble that came so close to sinking the American economy.   Notwithstanding President Obama’s delight in blaming George Bush and the Republicans for “driving the economy into a ditch” the truth is that Bush 43 (as well as Reagan, Bush 41 and Clinton) merely continued a policy hatched by President Jimmy Carter to increase home ownership in the United States at any cost.  So far “any cost” (to the taxpayers who are stuck with the bailouts) is calculated to be in the many trillions of dollars and counting.  How could the aggressive extending of credit to borrowers who were clearly not creditworthy, by any measure, have become the policy of successive administrations, particularly the Clinton Administration where, by executive order, credit history was not to be a critical factor for banks to use in the mortgage approval process? Simple, extend credit and pretend there is no problem. As Barney Frank, Chairman of the House Financial Services Oversight Committee, stated with a perfectly straight face when pressed regarding the lack of oversight over those Government-Sponsored behemoths, Fannie Mae and Freddie Mac, the mortgages in their portfolios were “good as gold.” We’re learning the hard way that the government can’t will a sow’s ear into a silk purse.

In the private sector, otherwise known as the real world, most companies can only assume debt under rather stringent circumstances. Loans are made either with solid personal guarantees backing them or the loans are subject to very strict loan covenants by the lenders which, when violated, can produce an immediate call for more collateral or the calling of the loan itself.  Government debt is not similarly constrained.  When the United States government borrows money it provides the full faith and credit of the nation as collateral.  That used to count for something and, of course, it still does, but only as long as people in America and abroad have confidence in the fiscal integrity of the nation.  Should that confidence dissipate, the interest our creditors will demand will move up sharply.  It was the implied (implicit not explicit) full faith and credit of The United States that enabled Fannie Mae and Freddie Mac to extend and pretend and, in the process, enable Wall Street to sell packages or bundles of AAA-rated securities, the true value of which was sometimes the credit-worthiness of so-called ninja borrowers (no income, no job, no assets).

Private citizens use debt to fund all manner of wants and needs from life style pleasures to very basic necessities.  And while some borrowers are wise and some may be foolish, they all generally understand that when the bills come due it is they who have to pay.  That imposes personal responsibility on the borrower and, often, considerable stress as well.  The sense of responsibility, and the stress that can accompany borrowing is, ultimately, a restraining factor, and, sometimes, a needed reality check intervenes, such as when a collection agency calls.  Those restraining factors and the accompanying stress of borrowing are absent when our government makes decisions to run up trillions of dollars in deficits, which result in soaring public debt. They don’t experience that stress, because they pass it on to us. They extend by pretending that the problem will be resolved through ever increasing economic growth (from which they can extract ever increasing tax revenue) or through ever increasing demand for American debt, which would always keep future borrowing costs cheap (hence the bubble).

We run up huge deficits (and debt) by throwing caution to the wind and counting on a strong economy and low inflation, beginning next year and continuing, uninterrupted, year after year long into the indefinite future.  We’re spending our way into hock (mostly to foreign governments and investors) and rationalizing our way out by extending and pretending.  We pretend, based on past experience, that American debt will always be the world’s safest investment harbor.  But as Nassim Nicholas Taleb so eloquently illustrates in his recent blockbuster best seller, “The Black Swan,” counting on the past to predict the future isn’t always so wise and, sometimes, produces disastrous results.  We are, in essence, betting the proverbial farm, that the Chinese and the Arabs, and heaven only knows who else, will be there to bankroll us…to provide the wind beneath our wings.  We believe sound fiscal policy would be a far better bet.

We make health care for all (including those who are, by any reasonable insurance standard, uninsurable) seem affordable by requiring all adults to pay for health care service years before that service will be provided to them.  We pass a nearly 3,000-page healthcare bill that no lawmaker makes even a pretense of having read and which now has resulted in the first several thousand pages of what will be ten’s of thousands of pages of new regulations with which the American people will soon be saddled.  Thousands of new government employees immediately were hired to implement the new law…not doctors, not scientists, not hospital administrators, but new IRS agents.  And literally, quite literally, the Administration and the Democratic Congress having extended this monstrous entitlement on to the people, asks us all to pretend that it will save money and reduce the deficit.  Blessedly, according to virtually every poll, the public is digging in its collective heels and giving our new ruling class more “push back” than we’ve seen in recent memory.

Finally, let us touch upon the most sacred of all cows and discuss the dangerous game we are playing with our currency, the very life-blood of our dynamic economy and the hard-earned means every American individual and family counts on to procure everything from their most basic needs to their most discretionary indulgences.  Let us state, unequivocally, that our currency is worthless but for the confidence we and millions of people around the world have in its integrity.  For most of history something of intrinsic value such as precious metals or even precious stones were used to buy whatever those who possessed such commodities wished to purchase.  Until the Civil War, gold and silver were the primary coins of the realm.  Paper currencies, or greenbacks, have been a relatively recent entry as a means of exchange.

Twentieth and twenty-first century history is replete with examples of national economies getting clobbered as people lost confidence in their paper currency.  Think Weimar Germany, post-Peronist Argentina, Japan, Hungary, Greece and Poland (the latter three kept afloat by European central banks to avoid a collapse of the Euro).  It does not take an economist (least of all, an economist) to tell us that when a currency pays little or no interest, and its government is wildly printing money or borrowing nearly 50 cents of every dollar it spends that the value of that country’s currency will diminish. Money that pays no interest and is increasing in supply is not a prized investment.  We currently rely on a currency that is backed by nothing but the confidence others and we have in it.  We are currently attempting to devalue our way back to prosperity.  We question whether it can work.  We doubt that it ever has in the absence of sound fiscal policy.

Given that our public debt (exclusive of unfunded liabilities) is about the size of our entire economy, we might ask exactly what constitutes sound fiscal policy.  We know what doesn’t constitute sound fiscal policy. Look only as far as Greece, Portugal, Spain, Ireland, Italy, France, Great Britain, Iceland, etc.  Congress periodically imposes debt limits on our government, which is good…except Congress periodically raises those debt limits with complete abandon, which is bad, very bad.  That’s playing extend and pretend with our children’s future and our grandchildrens’ future and our great- grandchildrens’ future. Let’s take a closer look. We set a debt limit of a whopping $9 trillion just five years ago in 2006. The following year Congress raised the debt limit again, to $9.8 trillion, and then to $10.6 trillion in 2008, and again to $11.3 trillion a couple of months later and again to $12.1 trillion in February of 2009 and again to $12.3 trillion in December of 2009 and finally earlier this year to $14.3 trillion.  You get the picture.  We have a meaningless debt limit, because our Congress raises it at will.

We are flailing. Reduced spending and freezing taxes on all taxpayers, individual and corporate, in order to stimulate investment, and, hence, economic growth and job creation in the private sector would be sound fiscal policy, but such a course is anathema to those in government who are mysteriously and stubbornly enamored with the failed, redistributive policies of statist Europe.  They extend and pretend…. and we, all of us, will pay the price.

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2 responses to “Extend and Pretend”

  1. Zooty Z. Zoot says:

    This video says it all about the “last clear chance” to prevent the subprime mortgage mess:

    http://www.youtube.com/watch?v=hxMInSfanqg

    The burning question today is whether the government should eliminate the home mortgage interest deduction. In a sense, that deduction is a government subsidy, and a true “conservative” would arguably support the repeal of that deduction.

  2. RightWrite says:

    Those at the bottom get hurt the most in the lie of QE; commodity price maintenance, for the benefit of the Wall Street crowd, destroys the climb out of poverty. I screamed with delight with the real-estate crash, the market has been out of control for decades, and the fake wealth and fake appreciation has been building this house-of-cards. When those kids running the bank, have never been through a crash, and have been living on borrowed time, their pyramid-scheme is bound to collapse.
    Until we allow the market to correct itself, without the intervention of the Fed and the Socialist regulation, we will never return to Free Market equilibrium. When Progressives gave us the CRA (Community Reinvestment Act), NINJA loans and QE1, we were doomed to collapse; and now with QE2, we are being kicked while still down.
    Without QE1, gas would have fallen back to $1.75 a gallon, and for a person spending 10% of their income on gas, that is critical and heaven-sent. The Fed is so damn bent on preventing deflation, it’s circumventing the market correction for stability in the free-market.
    This whole marry-go-round with Progressives and Elitists goes to show how flawed and corrupt their ideologies are; Free Enterprise and Laissez Faire are the path to Liberty.

    I get such a headache when thinking of Progressives.

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