Wednesday, January 16, 2008

How to stimulate?

With everyone in the market focused on the possibility of a coming recession, the question in the air now is how to stimulate the economy. It's clear from history that one thing that doesn't work is scaring the consumer so much about the state of things that they pull back their spending well beyond what their financial condition warrants. With an election season on, however, some politicians can't help themselves. With many media outlets like CNBC that weren't of any consequence in 1990 when things looked like this, there's a significant media element that can't stay calm either.

Real actions being considered revolve around tax rebates, tax cuts and direct subsidies of varying types to create an immediate jolt to spending and pep business up again. Then there's the probability that the Fed will significantly cut interest rates at the end of January, and one could guess that the biggest impact would be if they surprised the market and made the move a week early. These short term solutions may be necessary or helpful, but they may have too much to overcome.

The biggest issue today is that the consumer credit securitization markets are barely functioning. The Wall Street Journal reported today that auto securitizations today require 4% more interest spread today than six months ago for good rated paper. That's a massive cost increase and essentially shuts down a large part of the car loan market. The economy has become accustomed to the efficiency of credit distribution which has created significantly deepened markets in auto, mortgage, credit card and student loan lending. The supposed stimuli will have little chance of any even medium term success until the credit markets regain liquidity.

What can be done about this credit gridlock? This may sound simplistic but part of the answer is to let the markets heal themselves. What that means is refraining from regulating rigidities into the market for political capital, refrain from setting up the securities firms as the deep pockets for the trial bar to attack, and don't legislate retroactive changes in the paper that already backs up asset packages. The securities firms are obviously absorbing serious losses due to excesses in the markets, but they are not asking for bailouts. They are engineering their future capacity to move the markets back to normalcy through obtaining private capital. The market is punishing them big time, but if the government undercuts the fundamentals of the system's liquidity process, recovery will be a long way off.

It may be necessary to cut interest rates to improve basic short liquidity between financial institutions in the short term. Cutting rates may make consumer credit slightly more available for those with solid credit, but without large liquid markets it won't significantly help those who actually need the funds now. Cutting rates will debase the U.S. currency further and be one more hurdle to rebuilding the deep global securities markets that had fueled the consumer economy. Rate cuts, unfortunately, may be necessary but they are not a long term panacea, quite the opposite.

You know, it may seem bizarre that such complex and multi-faceted issues are being addressed in this blog. These comments are superficial and they are simplistic for sure, but they also may be as close to being correct as any of the other opinions that many of the newspapers, bankers and pundits throw out there. Well, that may be a stretch but I just have to get these thoughts out of my system anyway.

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