A Bailout Economy

Following World War II, American manufacturing thrived while many industrialized nations rebuilt themselves in the wake of the war. A nascent technology industry formed and expanded, to be duplicated by the rest of the world, and sometimes improved upon, but what was there mostly originated in America. The technology boom drove new developments in art and culture. In the mid 90's, from local bulletin board services and usenet servers, the Internet would arise, and around it whole new business models formed.

These were all good times for investors in the American economy which enjoyed steady growth and few pitfalls. But most of the new dot.com ventures had no clear plan for revenue, and many of those that did still failed. A few thrived—like Google, Amazon, E*Trade, and Ebay—but most would struggle or collapse. Such would lead to the bust of the dot.com bubble where the NASDAQ fell from 5000 at the peak in 2001, down to under 2000 less than 2 years later. One might have expected a return to normalcy from the manic highs of the dot.com bubble. But that never happened.

The economy was never permitted a deflationary correction. In order to keep the excitement alive the Fed collapsed Interest rates from a general average of 5-10%, down to below 2%. But rather than keep the tech bubble rolling, the easy and cheap credit instead went into the housing market, creating a new bubble right on the heels of the last one. Money that was lost on the Internet could now be recovered as Americans flipped houses from 2003-7.

In a climate of marginal lending standards, in order to encourage the origination of loans, lenders would offer teaser rates, where the homeowner would only pay interest, or even negative amortize, so long as the teaser period lasted.

The first challenge to inflated real estate prices happened in 2007. At that time, subprime loans, which had the shortest teaser rate of 2 or 3 years, were beginning to reset in mass. Defaults began to skyrocket once the very low teaser payments came to an end, and mortgage backed securites built on subprime loans were running into severe problems even in the safer tranches, and came to be seen for the toxic waste they are. At the end of 2007, still early in the wave of subprime resets, credit markets based on private capital froze. The U.S. government and Federal Reserve Bank saw it as their place to intervene.

During this time, the stock market was in a bubble of its own, and similarly would collapse from its peak in the 14000's in Oct. 2007, down to the 6000s by March 2009, before recovering to 11000 today. In the more volatile areas house prices fell by a similar percentage, but generally they have remained down. Any recovery today in the housing market is a tepid one.

In late 2007, the Fed initiated multiple lending relief programs (or facilities) in order to replace losses of private capital. The Federal Funds Rate had recovered to 5% by 2006, but steadly fell to an all-time low of 0% by the end of 2008. For the first time ever, our nation was ZIRP'd. The executive branch pushed through Congress the $700B TARP bailout plan, and later a $787B state stimulus package. Many billions were spent to rescue Fannie Mae, Freddie Mac, and the insurance company AIG (who insured many billions worth of toxic securities for banks).

The scope of the bailouts is unknown, and cannot be determined without a full audit of the Fed. An attempt is underway in Congress, but faces stiff opposition from the banking industry and lobby efforts from the Fed itself.

What is known is that an economy that was once driven by manufacturing and production, and then was later driven by developments in technology and the Internet, and when those came to an end was driven by artificial bubbles in the housing and stock market, then after those crashed the driving force spearheading the economy today is bailouts (from either the U.S. government or the Federal Reserve Bank; this blog will regard the two as economically separate). Wherever one sees elements of recovery, one also sees excessive government spending. Where one sees rising asset prices, one must compare that with exceedingly low rates on bonds, and thus the low yield expectations on riskier assets. While asset prices have risen lately, and risen well in stocks, yields and dividends have been greatly deflationary. Stocks now face little competition from bonds, since the Fed is lending money at zero interest.

In the present bailout economy, this blog asks: how long can this course be sustained? How long can the government keep doing it before it runs out of money? While the Fed never has to run out of money, at the same time it can't give it away—it can only lend it. The U.S. government can give money away, but one day it is going to run out, and that day is when it can no longer sell Treasury Bonds.

This blog will examine the coming of that day.