spent too much and now not being able to repay the money they bo

It's a Shoe In
by Peter Schiff


The currenteconomic debate really boils down to one essential question: "Willthere be a recession?" To me, the question has about as much vitalityas debating whether Roger Clemens will be inducted into the BaseballHall of Fame. (With over 300 wins and more strikeouts than any otherpitcher besides Nolan Ryan, the Rocket is a sure thing forCooperstown). Similarly, a recession is not a question of "if" butmerely of "when".

Most on Wall Street believe that a recessionis unlikely because U.S. consumers can maintain their current spendinglevels. Given that vanishing home equity and escalating mortgagepayments are now an undisputed fact, this faith rests on the beliefthat Americans will be able to go deeper into debt. However, the recentcredit market contraction is a clear indication that those doing thelending are not signing on to the program, and that America's spendingspree is over.

After years of easy credit, many on Wall Streetsimply can't conceive of a world in which credit is not available toanyone at any price. They do not understand that our current problemsare the result of Americans having spent too much and now not beingable to repay the money they borrowed to do so. The sooner Americansincrease their savings by restraining their spending, the sooner we canbegin to put our economic house back in order. The fact that such ashift will create a recession is unfortunate. Nevertheless it isnecessary and inevitable.

Some high profile individuals havemanaged to put two and two together. This week in an interview on CNBC,Angelo Mozilo, CEO of beleaguered Countrywide Financial, connected thedots when he forecast a recession. The well-bronzed mortgage giant toldMaria Bartiromo, "I can't believe that when you're having a level ofdelinquencies, foreclosures -- equity has disappeared, equity is gone,the tide has gone out -- that this doesn't have a material effect, A,on the psyches of the American people, and eventually on their wallet."

Others,including Ben Bernanke, claim to need more economic data beforereaching a conclusion as to the fate of the economy. This is likewaiting for the ship to fully submerge before admitting that there is aleak. To their credit however, the Fed has indicated that the overalleffects of a recession can be healthy for the long term economy.However, from Wall Street's perspective, any recession is immediatelytoxic as it will lead to lower earnings for the financial sector.

Interestingly,many of the financial luminaries sounding the loudest alarms areproposing solutions that will only make the situation worse.

Inorder to breathe life into the dying secondary market fornon-conforming mortgages, some have suggested that Fannie Mae andFreddie Mac be allowed to buy jumbo mortgages. This overlooks theproblem that many of these larger mortgages also feature adjustablerates that will likely show greater default levels when payments resethigher. Allowing Fannie and Freddie to buy larger loans now merely setsup a more expensive Federal bailout down the road, as both of theseentities themselves will likely need to be bailed out when theconforming ARMs they already insure go bad as well.

Others, suchas bond guru Bill Gross, have suggested that the Federal governmentitself establish a fund to bail out homeowners who can not afford theirmortgages. Gross maintains that such a move would be necessary toprevent the biggest real estate price collapse since the GreatDepression. If he truly harbors such fears, then he should know thatcreating such a fund will not prevent the disaster. Even if it meansthat millions of foreclosures do not occur, real estate prices willstill have to fall substantially to return to normal levels and to bein conformity with traditional lending standards.

Setting asidethe constitutional or ethical arguments against it, the cost of such abail out would be staggering. My guess is that the price tag wouldexceed one trillion dollars (Gross estimates the cost at only around$200 billion). Even if Gross' numbers are accurate, it still representsa significant sum which we would likely have to borrow from abroad.What Gross fails to consider is the moral hazard implicit in such abail out. Were the government to create a program whereby anyonefalling behind on their mortgage could have their loan restructured tosome lesser amount with lower payments, one would have to be an idiotnot to take advantage of it. If such a nutty plan were everimplemented, it would not be 2 million homes going into foreclosure asGross fears, but 20 million.

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