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Notes to myself, possibly of interest to others.
-- Bill Northlich

Wednesday, October 8, 2008

Sussinct recapitulation of the crisis

Commentary by Frank Holmes, CEO and Chief Investment Officer, and John Derrick, director of research, US Global Investors, 9.26.08

As Congress debates the merits of the $700 billion bailout, the blame game is in overdrive. Apparently, the average U.S. citizen on “Main Street” is vehemently opposed to bailing out “Wall Street.”

This crisis has been cast as a Wall Street crisis, but that is not really the whole story. It is just as much a Main Street bailout, given that much of the pain is linked to mortgages issued to everyday Americans. Over time, the government has put policies in place to facilitate homeownership with the idea that it is part of the American dream. The government made it cheap and easy for people to borrow money and leverage their personal balance sheets. At the same time, it set up tax breaks and complacent regulations for financial institutions.

Fannie Mae’s and Freddie Mac’s dual mandates reflected both the government’s desire to encourage affordable housing and their duty to equity shareholders. Loans were made to people who could not afford or manage them. In retrospect, it is unsurprising that all of this has come crashing down.

U.S. household debt has grown from 80 percent of disposable income 20 years ago to 130 percent today.

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Over the past 20 years, the government has emphasized consumer spending as the path to economic growth. The pattern has been that when the economy slows down, the government cuts rates and levers up. Americans became the consumer of last resort, and a strong dollar and cheap energy helped fuel this spending spree. At some point, American consumers must deleverage, and it appears that day is upon us.

In an interesting twist of events, it is now the emerging market countries that have the strong balance sheets and are providing capital to U.S. institutions. In China, a first-time homebuyer must have a 30 percent down payment; 80 percent of new cars in that country are paid for with cash.

The U.S. government needs to shift its focus to capital formation policies, creating wealth and increasing savings to provide a balance between saving and spending. Examples of policies that would encourage this include increasing contribution caps on 401(k) programs and IRAs, as well as lowering capital gains taxes.

This crisis developed over time, and all parties share the blame: Republicans, Democrats, Wall Street and Main Street. But the real villain here is leverage, which is the driver behind most financial crises.

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