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Resets, Restorations, and Rising Tides (Sunday, May 23, 2010)

Attempts at resets while invoking rising tides oratory is generating systemic dysfunction.

Central bank behavior and actions to reset economies and financial systems are missing the marks in more ways than one. These attempts at resets or restorations of economic and financial conditions to pre-crisis levels are faulty. Reset by definition means returning to an initial or prior state or condition. Restoration means approximately the same thing. There is little or no accounting for other changes. Supersizing money supplies, monetary bases, or deficits do not return the system to a healthier environment. In fact, these actions can create new and more pernicious circumstances.

During the process of increasing different monetary factors and spending large amounts of stimulus funds has generated super-sized deficits. In fact, record amounts have been established in recent years. Nevertheless, unemployment is bleak, housing is impaired and various risks and benchmarks are being seriously mispriced.

Unemployment remains bleak because indicators such as sales or income tax receipts are in a downtrend. Many states and localities are considering if not instituting furloughs and layoffs. This makes aggregate demand suspect. Housing is impaired because of the decline in solid incomes. Two or more part-time job creations are not necessarily equivalent let alone superior to one good job with reasonable benefits. An early cause of housing industry problems was the sub-prime mortgage misadventure compounded by mortgages that exceeded the value of the property. And this was before “underwater” properties became more common due to declining real estate values. Recently, the relaxation of standards for mortgage modifications or even refis is creating new stresses. The critical factor is the ability to service a mortgage and/or other debt and not mask it momentarily. Unfortunately, “practices” that nurtured the crisis are being applied on a larger scale.

To better understand the situation against the background of enacted stimulus plans and monetary actions, you have to ask several questions. Among these are:

  • Are many real estate sales people are earning the same or more than just 3-5 years ago?
  • Are many mortgage brokers and traders earning the same?
  • Are many construction firms are experiencing boom times?
  • Have all or even most housing prices returned to peak levels?
  • Is the securitization market functioning as well or better when compared to a couple of years ago?
The simple, fundamental answers are: No or not really.

Furthermore, the securitization market is functioning poorly due to heightened concerns about the integrity of the component parts. There is a profound lack of trust and expectations due to former wealth destructive deals and current reduced accounting standards for valuation or pricing purposes. Basically, investors and private lenders do not believe the numbers anymore particularly if they had one or more bad experiences. Business and investing depends on reliance and not one-sided gimmickry. If standards have been lowered since the crisis, it is reasonable to assume that the quality of paper is even poorer.

In an upcoming article, we will explain the problem with rising tides and so forth.

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