Paulson Has a Christmas Gift for Credit Addicts

November 25, 2008 by  
Filed under Debt and Credit, Loans and Borrowing

Please Mr. Paulson – wake me out of this Bad Consumer Credit dream. 

I almost fell out my chair this morning when I saw this headline from the Wall Street Journal:  “New Facility Targets Consumer Lending.”  It seems that the U.S. Treasury is starting its own clinic for consumer credit addicts.  But instead of handing out Dave Ramsey books or some kind of credit methadone, this clinic will be distributing actual credit.  Yep.  $25-$100 billion of our tax dollars will be used to fund car loans, student loans, and credit card lending. 

Technically, the money will be lent to investors so that they can purchase securities backed by various consumer loans.  These will be similar to those mortgage-backed securities that have worked out so well for us.  And those “investors”?  Do ya think that Paulson remembers them from back in the day on Wall Street?  Of course he does – gotta be loyal to his old pals.

Remember the old saying “feed a fever, starve a cold” to treat certain childhood illnesses?   For Secretary Paulson and credit addiction, the treatment mantra is “feed those junkies whatever they want.”  Our economic leaders are concerned about “distress” in the consumer finance market.  That’s interesting.  Mr. ToughMoneyLove has been concerned about the consumer finance market for at least ten years, during which many of my fellow Americans used credit to pay for everyday living.  Now they are hung over or in recovery, a condition that our government cannot seem to tolerate.

Gosh – I hope the payday loan companies get a piece of the Paulson “credit facility” action.  We certainly don’t want any of those nice folks getting “clogged up” with bad loans. 

Mr. Paulson hasn’t told us where the jobs are coming from so that people can re-pay all of this new consumer debt.  But then re-payment isn’t all that important because the money is coming from taxpayers.

Merry Christmas credit junkies, straight from Secretary Paulson.  And for those of you who have been and remain debt free?  You’ll be receiving a nice tax increase in your stocking.  Bah humbug.


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5 Responses to “Paulson Has a Christmas Gift for Credit Addicts”
  1. kitty says:

    ” These will be similar to those mortgage-backed securities that have worked out so well for us.”

    These securities are already on the market. Paulson isn’t creating new ones. The money is to purchase them from the banks to somehow try to stop this spiral of more and more losses that cause more and more banks go out of business with no end in sight. This freezes lending and this freeze has already caused hundred of thousands of people to lose their jobs and is about to cause a lot more people to lose their jobs. This hurts other businesses. This, by the way, hurts taxpayers too – unemployed people don’t pay taxes.

    The idea is to encourage private investors to buy these securities from banks so that banks can actually operate normally. This raise price of these securities. Then more investors would want to buy them. This way government money can go a little further to help the economy. A bit cheaper than bailing out failing companies.

    Currently the market resale value of these securities is very low. There is a fear that with worsening economy there’ll be more and more defaults. Thus, the market value of these securities is considerably below what one would expect realistically from potential cash flow with realistic adjustment for expected number of defaults. Banks are required to report their “paper” value at current market levels rather than levels that take into consideration potential earnings and realistic risk of defaults (mark-to-market). Hence keeping these securities on books is dangerous for banks: if their value continues to decrease, the banks need to put more and more money in reserve leaving nothing for lending or worse having to claim insolvency (while having piles of cash in reserve). This causes banks to sell these securities at bottom prices even if they would’ve preferred to just keep them and collect interest from good loans. This drives price of these securities even lower. It’s a cycle. As banks need to put more and more money into reserve, they have less and less money for normal lending. They have to report lossses, they have to lay off employees. Since each bank doesn’t know how many of these securities are on the balance sheet of another bank, they are even afraid to lend to each other. I know you are against credit, but do you realize that credit is what enables banks to actually exist and pay interest on your deposits? If banks don’t have money to lend or are afraid to lend, they cannot exist. They aren’t exactly in charity business. Not to mention that every other business in this country is affected.

    Lending is not all bad. Without student loans that you seem to be clamp together with consumer loans, only rich people will be able to become doctors, for example. Without business loans, businesses cannot expand, restructure or even pay your salary: it’s difficult for any reasonable sized businesses (other than maybe mom and pa business) to exactly match the timing between when they get money from customers and when they have to pay for their bills. I realize the article doesn’t talk about business loans, but when banks put more and more money in reserve to cover paper losses in the value of securities backed by loans, they have less money to lend businesses. The goal is to unfreeze lending and to actually get us out of this crisis. Have you ever listen to any economic reports? Do you know how bad all economic indicators are now? How is your 401K doing?

    “Now they are hung over or in recovery, a condition that our government cannot seem to tolerate.”
    They are not hung over or in recovery. The Libor rates came down a bit, but the credit markets are still tight. They started to unfreeze but after Paulson said he wouldn’t buy mortgage-backed securities it froze again. Citigroup announced plans to lay off 53000 people. Other companies are doing the same. Even companies that have nothing to do with this crisis – Hewlett-Packard, Google are laying off people. Automakers are close to bankruptcy. Do you think your job is safe? Think again.

    Yes, a lot of money is being spent and this is bad. Do you have a better solution? I can suggest suspending “mark to market” rule for loan backed securities, but at this point it may be to late. What is your solution? Hint: letting banks fail isn’t a good option – there are many banks that have these securities, maybe most of them. Even if some banks are OK, it doesn’t matter. There aren’t enough of safe banks to go around. Besides, investors don’t trust banks, so investors are dumping stocks of all banks, at least they were a couple of days ago. When a stock drops under $5, mutual funds are required to sell it. Then they have to sell a lot of other stocks which hurts other companies. When people don’t trust banks they pull their money out. So even “safe” banks can fail.

    “But instead of handing out Dave Ramsey books”
    Didn’t Dave Ramsey tell his followers not that long ago to invest all their money except for a few months “emergency fund” into stock market because it would give them double digit return? This was last year, right, when smart people were getting out of the market. Yes that turned out well. Brilliant advice. Good thing I don’t listen to Dave Ramsey. At least I kept 40% of my money out of the market. Still lost over 100K, but at least I got something left….

  2. Kitty: That is quite the comment. Thanks so much for your contributions. I will attempt to respond to those points where we may not agree.

    “These securities are already on the market. Paulson isn’t creating new ones.” I am not 100% certain that all of the securitized credit is old but even if it is, Paulson’s intent in lending our money to investors is to create new consumer credit flows, e.g., more auto loans, more student loans, higher credit card limits and balances.

    “The idea is to encourage private investors to buy these securities from banks so that banks can actually operate normally.” I am all in favor of the government assisting in unfreezing the commercial credit market. I am a small business owner myself. But, too many banks have engorged themselves on profits made from too much high risk consumer credit. That needs to stop – permanently – but Paulson’s plan is a transparent attempt to restart that cycle.

    “I know you are against credit, but do you realize that credit is what enables banks to actually exist and pay interest on your deposits? If banks don’t have money to lend or are afraid to lend, they cannot exist. They aren’t exactly in charity business. Not to mention that every other business in this country is affected.” Again, I am not against responsible use of commercial credit. There historically have been many successful banks who have done very well lending without completely immersing themselves in subprime and credit card markets. Those banks still exist, mostly as local and regional institutions. Those banks will not fail. The banks that assumed too much risk may fail.

    “Lending is not all bad. Without student loans that you seem to be clamp together with consumer loans, only rich people will be able to become doctors, for example.” That argument is fallacious. The rate of student loan lending has jumped astronomically in recent years, pumped by the real credit addicts: high-priced colleges and universities desperate to attract students who should not be there. The cost of attending college has increased at more than twice the rate of inflation and the student loan balances have increased as well. It’s shameful. There are plenty of ways to go to college without drowning yourself in debt but the greedy colleges don’t want young adults to think like that.

    “Without business loans, businesses cannot expand, restructure or even pay your salary: it’s difficult for any reasonable sized businesses (other than maybe mom and pa business) to exactly match the timing between when they get money from customers and when they have to pay for their bills.” Agreed but that’s not what Paulson’s latest plan addresses.

    “The goal is to unfreeze lending and to actually get us out of this crisis. Have you ever listen to any economic reports? Do you know how bad all economic indicators are now? How is your 401K doing?” I read economic reports every day. My 401k is doing poorly. The reason? Collapse of the real estate bubble caused by unsound consumer and mortgage lending practices. The problem is that the commercial credit markets need to be unfrozen first but the banks are hoarding capital. So now Paulson wants to place the recovery burden back on consumer spending by restarting the credit obsession engine.

    “They are not hung over or in recovery.” I think you misunderstood my point. For the first time in years, use of consumer credit is decreasing and saving is increasing. This is what I meant by recovery.

    “Do you think your job is safe? Think again.” No job is ever safe. It becomes less safe when the government becomes overly active in the free market, such as by insisting in a fit of social engineering that banks lend to millions of unqualified home buyers, boosting home ownership rates to levels far above any point in our history.

    “Yes, a lot of money is being spent and this is bad. Do you have a better solution?” Yes – allow consumers more time to adjust to living on what they earn, and not on what they can borrow. Otherwise, this cycle will be repeated. I agree with your proposal to suspend the mark to market rule, but not if Paulson is allowed to pump more money into creating even more derivatives on the books of greedy Wall Street banks.

    “Didn’t Dave Ramsey tell his followers not that long ago to invest all their money except for a few months “emergency fund” into stock market because it would give them double digit return?” I agree with you that, based on what he tells his listeners and readers, Dave Ramsey doesn’t know anything about investing. I used his name euphemistically. But he does know about the perils of debt-driven consumption.

    Thanks again for your excellent commentary.

  3. kitty says:

    You make some good points. It’s possible I haven’t read the article carefully and missed important details. You are right, Paulson wants people to spend money. I still think his main reason is to create market for existing assets rather than to invent new types of securities.

    I don’t know how many consumer loans-backed securities are out there but they do exist – I only learned about them a couple of weeks ago. If this were not the case, and he wanted to just create them now, I’d be in complete agreement with you – we don’t need any more securitization of loans. I just hope nobody sells Credit Default Swaps for these loans too.

    Yes, there are indeed good banks. The trouble is as I see it (and I could be wrong) there is not enough money in these banks to go around. A small regional bank doesn’t have enough money to lend to McDonald, for example. Besides, even banks who themselves used strict lending standards bought mortgage-backed securities from other banks thinking they are buying AAA-rated commercial paper. Why not? After all, banks in countries with very little credit and long history of savings like Japan also bought these securities.

    As to student loans. Yes, easy access to loans contributed to high costs. But at least in case of medical school, there really are no scholarships or any kind of financial aid at all. Even state medical schools are very expensive. It’s really is impossible to become a doctor without loans unless you are (very) rich. Also, even if stopping all student loans would eventually bring the cost down, it would take years before there is any effect. What happens to those who graduate this year or next?

    Yes, intervention is bad as well as all this spending (or printing, whatever they are doing). But I am afraid that if we just wait until this situation takes care of itself, millions can end up unemployed and it may take years before it ever gets better. I don’t know if what Paulson is doing is right. But doing nothing is wrong either. I do agree that if they suspend mark-to-market there has to be a fair way for pricing these securities. For some reason they don’t want to do it. May be they think it is too late to do it since investors have already lost trust in banks.

    Mainly though, I am really tired of seing market go down every day. I am 49, and I really don’t want to wait for 30 years for it to come back… It’s too late to sell. And while my employer has so far been largely unaffected by the crisis – except for stock price – it’s naive to think that it’ll continue to be unaffected. I also don’t have any bad feelings toward credit cards per se and have very little sympathy for those who confuse credit with spending money.

  4. It is great to have an intelligent lady like @kitty on this blog. She makes some good arguments without coming across as adversarial. Plus, I liked how she took responsibility for possibly missing some detail by maybe not reading the original post carefully enough. What a class act. The exchange between you both was far above what I normally see on personal finance blogs. Readers appreciate both parties showing class when there may be disagreement. Hats off to both of you.

  5. Kitty: I feel your pain. I am older than you and also anxious for a market recovery. But keep in mind that we don’t want the market to recover on a credit bubble or it may burst again when each of us is 5 or 10 years older.

    Stop Getting Cheated: Thanks for your nice comments. I agree that having Kitty around is good for all of us here at Tough Money Love.

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