Sunday, January 25, 2009

Altruism vs. Profits

I don't have a lot of time, or want to dwell on this much... But I want to emphasize the huge differences between this recession and previous ones. I have discussed this a lot in previous posts, but need to emphasize it here quickly.

In times of distress, people forget about profits. They shouldn't, because it's the only way to maintain human activity over time. If people don't work for a profitable company, their jobs are not sustainable.

Bank of America's credit team comments in his latest report:

At this point in the credit cycle, while offering the surface short term appeal of expanding credit, mandated lending may lead to unintended consequences of expanding the bad asset problem offsetting these short term benefits. Simply put, throwing more credit at a problem whose root cause is too much credit cannot be a sustainable solution.

So far, our responses to the economic crisis have been charitable rather than profit based. We try to help struggling homeowners, rather than finding a way to make owning houses profitable again. Instead of trying to "keep people in their homes," the government should modify the tax code to make being a landlord more desirable. If houses are plunging in value and facing major financing risk, it makes zero sense for ordinary people to step in front of that train, but investors can. If they had a framework that encouaged them to buy up large numbers of houses, it would restore a functional market.

This is based on Ricardo's notion of competitive advantage, probably one of the few principles accepted by every economist. It's the idea that it's best for people to focus on what they're best at. Ordinary people are not good at being homeowners. They're good at taking care of their families and being good citizens.. they're even able to make monthly payments. But it's not in their interest to take the significant risk of owning homes now that are falling in value. (The whole purpose of buying a house is it holds its value or appreciates slightly.)

As it becomes clear to ordinary Americans that their homes are worth less, the entire economy will face bigger and bigger problems. This financial crisis started as a mere scratch on an extremity, but now has grown infected and is threatening more and more of the body. We can deny it all we want and talk about "time," but this disease is not going to just get better. It's going to devour the entire body if it's not tied off and amputated. This crisis needs to stop.

One way to do that is to get the market going for homes again, and the best way to do that is to give INVESTORS an incentive to come in and buy houses. I would suggest changing the mortgage rules to encourage investor loans (rather than conventional owner-occupied loans). Investors have the wherewithal and -- more importantly -- the risk profile to get this market moving again. We need to stop pretending we're going to get the limb back and accept that we're going to have a stub, but at least we'll still be alive. It might mean dismantling some houses and letting investors buy others. Perhaps we should even let some "upside-down" houses be sold directly to investors and convert the current owners into tenants.

But we need to shed the myth that homeownership is the only desirable outcome. It's a false religion that is turning into a major long-term threat to the economy.

Also regarding altruism: U.S. non-profits face a danger like never before. In coming years, higher education, hospitals, religious charities all face a major cash crunch. This is going to squeeze institutions that we always thought were beyond the reach of normal economic headwinds. It seems that one of the few kinds of charities that will continue to do well and grow are the newest group in our country: Islamic charities. The implications of this are unclear, and merit further research.

One other realization I had today in a conversation about why the government is likely to keep growing and spending money: Being a conservative in government is like being the CEO of a company who wants to liquidate its assets. All enterprises want to grow. This means the only way to keep government under control is to somehow prevent it from printing money (the greates virtue of the gold standard) or to let it get so big it collapses in a giant fiscal supernova such as Zimbabwe today or Peru in the early 1990s, when inflation ran over 7000%.

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