Wikinvest Wire

Maybe Ben Bernanke is onto something

Thursday, March 06, 2008

Today's Flow of Funds report from the Federal Reserve provides evidence that Ben Bernanke might be onto something with his idea to save the economy by having banks slash the principal owed by homeowners who are losing their home equity.
Things seem to work best in the U.S. when household assets rise faster than household liabilities - this is the very foundation of our consumption-based economy and life as we know it - so, if you can't keep asset prices rising (which seems pretty obvious now) maybe cutting liabilities at an even faster pace would be the next best thing.

If the red line could plunge down below the orange line
in the chart above, then the economy will surely get a boost - things would be back to normal, sort of.

The difference would be that, instead of assets rising faster than liabilities are rising (life as we've come to know it) liabilities would be dropping faster than assets are dropping.

It would have the same effect - homeowners would feel wealthier.

For example, suppose you bought a house in California three years ago for $500,000 and then you heard that the one down street sold for $600,000. Then the bank called and wanted to increase your home equity line of credit by $100,000.

That's the way things are supposed to work.

What's been happening lately is that houses down the street have been selling for $400,000 and then banks have been calling to tell you that they've reduced your home equity line of credit by $100,000 or they've cut you off completely.

That's no way to run an economy.

Under the proposed Bernanke plan, even after the house down the street sells for just $400,000, then the bank could call to tell you that they're increasing your home equity line of credit by $100,000 because they've just reduced your outstanding principal by $200,000.

Do you see how this could work?

In a worst case scenario, this process could be repeated over and over where homeowners' outstanding principal could be reduced in $50,000 increments "freeing up" more and more home equity.

Of course, there is probably a lower bound there somewhere as the bank is not likely to call you up and tell you that they now owe you - the homeowner - money.

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3 comments:

baddriver said...

hmmm, why do i get the impression that you are being sarcastic?

Nick said...

I like the sarcasm, but that's not exactly what Benny is suggesting. He's more suggesting that the bank reduce the principle of your $500,000 loan by $100,000 while removing any remaining home equity line of credit, to reduce the risk that you will default on both and leave them with a house they can only sell for $300,000 after $50,000 in expenses of foreclosing and 18 months of delays. And in reality, what the banks are likely to do is figure out how to reduce your monthly payment to the max you can afford while not extending you any more credit, and extending the length of the loan and/or adding a delayed balloon payment to compensate (so as not to reduce net present value of the loan).

It's either that, or fire up the helicopter and put the petal to the metal in the printing presses. If you can achieve 100% inflation, the scale fixes itself, and the government gets a huge tax influx from anyone with net positive assets as a bonus! What could possibly be wrong with that?

BSR said...

He has better luck inflating the $ so that that $600,000 mortgage appears like a $300,000 mortgage since everything else is twice the size. Then we are back in action. Now onwards, inflation (and concurrent depreciation/devaluation of $) is how this game will be played out. Welcome to bad old 1974-82.

Whoever wins the election, the next administration will be Jimmy Carter's.

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