In Defense of 4%

In Defense of 4%

I received another thoughtful email from my friend in Vienna who is still having a hard time buying into my 4.0% solution.  In defense of my solution, i wrote him the following.  It may be a bit lengthy, but i think it covers the main points.

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D—:  I agree that the issue at hand is who sets mortgage rates; however, i would not put too much faith in the theories put forward by the so-called economists or the wise men at the Federal Reserve.  Now consider this:

1. Inflation in the U.S. has averaged somewhere between 2.5-3.5% for the last twenty-five years, and there is no reason to believe that inflation will “average” above that rate in the U.S. over the next 20-30 years.  Why?  Because of globalization and increased productivity.  Although expected future U.S. inflation may be at the heart of the question, it is a question that i sure wouldn’t mind taking on to defend the 4.0% rate.  It is also a question that i have put forward to some pretty trusty finance people, including the likes of Tristan, who i think has a pretty good feel for such things.

2. Now let me ask you this.  What is so risky about a home loan mortgage to someone with a history of good credit history, a decent income, etc?  These are the people who would get the 4.0% mortgage–and that probably includes more than 80% of the home mortgages out there.  And that is the truth.  Just consider the fact that 95% of American homeowners kept making their monthly p&i payments through the Greatest Recession Since the Great Depression.  Those people are the ones who would be eligible for the 4.0% program.  Risk comes into play when you lend money to people who won’t pay back their debt.  That is not what i am talking about with the 4.0% solution.

3. A true “risk free rate” essentially has to beat the risk of inflation.  What you are saying essentially with a “risk free rate” is that your money can keep pace with inflation without risk.  It’s risk that sets the rate, not Greece, nor Spain.  And the U.S. is still the “Big Boy” in the world’s global economy–and i don’t think you can find any country that is less risky to invest in (including China, India, Brazil, U.K., etc.).

4. If you believe that the U.S. might go down the tubes and nothing is risk free, then you might as well believe in another Great Depression, which is hardly a scenario that is allowable in this day and age.  God only knows what would come out of a Great Depression.  And the 4.0% rate would not cause a Great Depression.  I hope you noticed that all the world’s stock markets dropped by 60% as a result of the U.S.’s economic problems, and even dropped more than the U.S.’s stock markets.  Under a Great Depression scenario, you might just want to keep your money under your pillow or buy gold, but in the long run, i don’t even think that would do much for you.  Under a Great Depression scenario in this day and age you would probably be better buying a few guns than you would gold.

5. If you don’t think you can sell the 4.0% U.S. “risk free” mortgage-backed securities to the world, then i would ask the question as to what is wrong with keeping them yourself.  I could easily run a program collecting 4.0% interest, keep up with inflation, and cover the costs of mortgage risk, especially if i had a real tight Underwriting system.  And i could do so without losing money.  And the money that i made could go towards reducing our National Debt.  I wouldn’t be passing my profits out in dividends like Fannie/Freddie did.

6.  Currently there exists about $11-12 Trillion in mortgage debt out there.  I don’t have the real statistics, but let me assume that the average mortgage rate on that $11 Trillion is around 5.5%–it could be higher and it could be lower, but that would be easy to find out (that is something anyone could calculate real quickly given the data which is readily available).  I think 5.5% is probably pretty close to being correct.  If anything i would assume the “average” might be higher than that.

7. Any way 80% of $11 Trillion is $8.8 Trillion.  Monthly p&i on $.8.8 Trillion at 5.5% = $605 Billion.  Monthly p&i on $8.8 Trillion is $508 billion (rounding off we are talking essentially providing an influx of $100 billion a month (or $1.2 Trillion a year) to the economy, and doing so without raising taxes and without increasing our National Debt through Government Spending.  And that is not just the first month, but every month for the next thirty years (discounted over time of course) once you implement the program.  Now remember, too–this is not a tax, nor does it increase our national debt like Government spending does.  To tell you the honest to god truth, the impact of this “new” refinancing” stimulus is even greater than it has been in the past thirty years for two reasons: (1) the amount of debt to refinance is greater than it used to be; and (2) the impact of refinancing at lower rates is greater than the impact of an equal rate change at higher rates.

8.  As part of my 4.0% solution, I am specifically proposing that no one should be allowed to “cash out”, which means that Mortgage Debt would not increase.  This is substantially different than what Fannie/Freddie did (and the Federal Reserve allowed) over the past thirty years and essentially caused the “housing bubble” in the first place.

9. If you are concerned about the stimulus itself causing problems, then you should know that you could easily manage the influx of this “stimulus” by controlling the rate that you implement the 4.0% solution, which i would assume would be done over a period of 1-2 years.  You could also encourage people to shorten their loan term, which would pay down Mortgage Debt faster.  Yes, shortening the loan term reduces the stimulus effect, but you still gain the benefit of reducing debt.

10.  Consider the difference in the “refinancing stimulus” of $1.2 Trillion compared to the stimulus of $1.2 Trillion in Government Spending.  Both essentially throw money into the economy, but one increases our National Debt while leaving our Mortgage Debt the same; while the other will reduce both the National Debt and the Mortgage Debt over time.  This comparison is not actually equal because the $1.2 Trillion in Government Spending actually does put people to work which the “refinancing stimulus” only does through the stimulus itself.  However, and this is a big however.  To keep the people that the $1.2 Trillion in Government Spending at work, you have to spend another $1.2 Trillion year after year, and it is the Government deciding rather than the free enterprise system, what those people going back to work will be doing.  And i would ask how efficient that is.  It sure goes against “free market theory”.

11.  BTW, the 4.0% solution is not something i just came up with yesterday, it is something that i have been proposing for more about a year and a half now.  And if we had started implementing it back when i first put this solution up on the internet back in Feb 2009, we would be much further along in our “recovery” which still shows high unemployment than we are today.

12. And ending now with an aside.  Lowering mortgage rates, increases housing values, thus even further reducing the risk of someone defaulting on their current home.

Now that leads me to your question as to why i think Bernanke and Gaethner should go.

a.  Bernanke and Gaethner have proven beyond a question of doubt that they do not understand Mortgage Debt which is as great as our National Debt and probably influences are economy more than the National Debt.  Now i don’t know if that concerns you, but it does me.  If you don’t blame the GSEs for causing the global financial crisis, you have to blame the Federal Reserve.  Nothing the “big banks” did would have happened if it was not for the GSEs, and the laissez-faire approach taken by the Federal Reserve regarding our out of control mortgage debt.

b. The funny thing about Mortgage Debt is most of the “big wigs” in both the private sector and public sector don’t have mortgages and therefore they do not also think in terms of mortgage debt and amortization very much.  Instead, most of the “big wigs” make enough money that they own their homes outright, and therefore, even the little common man understands the impact of “refinancing” better than the “big wigs” do.  This might be sad, but it is true.  It reminds me how upset i was myself watching all the smiling faces on CNBC as the economy was tanking.  Yeah, those smiling talking heads were losing money and maybe even more money than most people, but they did not seem extremely sad.  Whatever losses they were taking were no where near the “effective losses” of those people who were becoming unemployed, on fixed incomes, or retired.

c. Bernanke and Gaethner still need to explain TARP and the “panic” that ensued from their ignorance which dropped the world’s stock markets by about 60%.  As i have said a number of times, it was not Bernanke and Gaethner that saved the world from a Great Depression, it was the 95% of American homeowners who kept making their monthly p&i payments on their debt that saved the world from a Great Depression.

d.  It was “fear”, “panic”, and “ignorance” that drove the Markets down–not the loss of Lehman Brothers, Bear-Stern, etc.  The “banks too big to fail” were never going to fail.  That is a misconception.  The only thing that would have made the “banks too big to fail” fail would have been fifteen percent of the American homeowners with mortgages not paying their debt.  And that was never the case, nor did it ever look like it would be the case.  Unless of course, the information provided to the FDIC was totally in error, which knowing the way loan performance is recorded in computer systems and subsequently reported, is a bit much for me to accept.

ps.  D–, i want you to know that i continue to appreciate your questions and feedback.  It is because of thoughtful people like yourself that i continue to fire off my “daily Tristan” emails to about thirty cohorts.  And do you know what, as far as i know, none of them have completely discarded what i continue to say.

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