But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future.

These state-level cutbacks range from small acts of cruelty to giant acts of panic — from cuts in South Carolina’s juvenile justice program, which will force young offenders out of group homes and into prison, to the decision by a committee that manages California state spending to halt all construction outlays for six months.

Now, state governors aren’t stupid (not all of them, anyway). They’re cutting back because they have to — because they’re caught in a fiscal trap. But let’s step back for a moment and contemplate just how crazy it is, from a national point of view, to be cutting public services and public investment right now.

Think about it: is America — not state governments, but the nation as a whole — less able to afford help to troubled teens, medical care for families, or repairs to decaying roads and bridges than it was one or two years ago? Of course not. Our capacity hasn’t been diminished; our workers haven’t lost their skills; our technological know-how is intact. Why can’t we keep doing good things?

It’s true that the economy is currently shrinking. But that’s the result of a slump in private spending. It makes no sense to add to the problem by cutting public spending, too. (emphasis added)

In fact, the true cost of government programs, especially public investment, is much lower now than in more prosperous times. When the economy is booming, public investment competes with the private sector for scarce resources — for skilled construction workers, for capital. But right now many of the workers employed on infrastructure projects would otherwise be unemployed, and the money borrowed to pay for these projects would otherwise sit idle.

And shredding the social safety net at a moment when many more Americans need help isn’t just cruel. It adds to the sense of insecurity that is one important factor driving the economy down.

So why are we doing this to ourselves?

The answer, of course, is that state and local government revenues are plunging along with the economy — and unlike the federal government, lower-level governments can’t borrow their way through the crisis. Partly that’s because these governments, unlike the feds, are subject to balanced-budget rules. But even if they weren’t, running temporary deficits would be difficult. Investors, driven by fear, are refusing to buy anything except federal debt, and those states that can borrow at all are being forced to pay punitive interest rates.

Are governors responsible for their own predicament? To some extent. Arnold Schwarzenegger, in particular, deserves some jeers. He became governor in the first place because voters were outraged over his predecessor’s budget problems, but he did nothing to secure the state’s fiscal future — and he now faces a projected budget deficit bigger than the one that did in Gray Davis.

But even the best-run states are in deep trouble. Anyway, we shouldn’t punish our fellow citizens and our economy to spite a few local politicians.

What can be done? Ted Strickland, the governor of Ohio, is pushing for federal aid to the states (emphasis added) on three fronts: help for the neediest, in the form of funding for food stamps and Medicaid; federal funding of state- and local-level infrastructure projects; and federal aid to education. That sounds right — and if the numbers Mr. Strickland proposes are huge, so is the crisis.

And once the crisis is behind us, we should rethink the way we pay for key public services.

As a nation, we don’t believe that our fellow citizens should go without essential health care. Why, then, does a large share of funding for Medicaid come from state governments, which are forced to cut the program precisely when it’s needed most?

An educated population is a national resource. Why, then, is basic education mainly paid for by local governments, which are forced to neglect the next generation every time the economy hits a rough patch?

And why should investments in infrastructure, which will serve the nation for decades, be at the mercy of short-run fluctuations in local budgets?

That’s for later. The priority right now is to fight off the attack of the 50 Herbert Hoovers, and make sure that the fiscal problems of the states don’t make the economic crisis even worse.

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American Express manages to get approval (from the Federal Reserve) to become a bank holding company in the blink of an eye. This kind of thing usually takes weeks or even months. And within 24 hours, the reason they did so leaks — they want to reach into your wallet and pull out some bailout money, too! Amex is reportedly seeking $3.5 billion in taxpayer funds.

General Motors operates for years churning out gas-guzzling SUVs and Hummers. Ford also stakes its future on big trucks like the F-150 — instead of choosing the same prudent path as competitors like Honda and Toyota, who focus on fuel-conscious sedans and compacts. GM (via its financing arm GMAC) even goes a step further. Not content to stick to car loans, it decides to branch out and make billions and billions of dollars of crappy mortgage loans. Then, when the utterly predictable consequences of this foolish corporate strategy come home to roost, GM and the other automakers come back to the trough like pigs looking for slop. Only in this case, we're talking real money - $25 billion or more.

Treasury Secretary Henry Paulson and Fed Chief Ben Bernanke urge Congress to create the Troubled Asset Relief Program - with as little debate and oversight as possible and a price tag of $700 billion. They warn of financial cataclysm if the government doesn't start buying up mortgages and mortgage related assets from banks. Yet just a few short weeks later, they totally change course. They say "Never mind - we're not going to buy up assets after all. We're going to buy up stakes in small banks, big banks, insurers, and God knows who else, with the money. We know the last 20 or so 'solutions' to the credit crunch didn't work. But this one will. Really. We mean it."

Fannie Mae and Freddie Mac make a huge deal about a new program to modify more mortgages. We get the mid-afternoon press conference, the intraday ramp in the stock market, the usual stuff.

Citigroup, JPMorgan and other lenders get in on the action too, issuing glowing press releases about foreclosure moratoriums and other plans to keep borrowers in their homes.

But in reality, many lenders and mortgage servicers have ALREADY been trying all kinds of loss mitigation strategies and loan modifications (loan term extensions, temporary interest rate reductions, and so on).

Yet ... they haven't managed to stop the nation's foreclosure rate from rising.

Why? It's Simple ...

1. All those modification efforts can't overcome the negative impact of surging unemployment.
2. Many borrowers lied about their income and their assets in the first place, meaning they can't even make the reduced payments their lenders are offering.
3. Others were speculators and second-home owners, who don't qualify for relief.
4. Home prices are falling so far, so fast, that millions of borrowers are underwater, owing $20,000, $50,000, even $100,000 more than their homes are worth. They have little financial incentive to stay in their houses, even at a lower monthly payment, because they know they won't breakeven for years, if ever. And many of them know darn well they can rent for less ... sometimes much less ... at a house or apartment down the street or across town.
5. Still others have loans that were ultimately sliced, diced, and repackaged into complex securities, now owned by various Ferrari-driving hedge fund managers who leveraged up to buy junky paper just a few months after they got out of B-school.
6. Because of the "miracle" of this financial alchemy ... which made Wall Street rich beyond measure ... these borrowers are stuck. Their loan "servicers" WON'T modify their loans because they're afraid of getting their pants sued off by the investors who own securities derived from those underlying loans, securities that in some cases can lose value if the loan terms are changed.

The Hole Keeps Getting Deeper ... And Deeper ... and DEEPER ...

How about the bottomless pit known as AIG? The company made a bunch of stupid decisions to insure crummy mortgage-related securities against default. It clearly had no idea what the heck it was doing, and managed to lose a whopping $24.5 billion in the most recent quarter. But instead of going broke, they get thrown a helping hand courtesy of, well, you and me. The tab for that bailout keeps on rising - approximately $150 billion at last count!

Then there's Fannie Mae and Freddie Mac. They take on hundreds and hundreds of billions of dollars of mortgage and interest rate risk. They pile headlong into the derivatives market, dig deeper into the riskier subprime and Alt-A part of the mortgage business, and continually operate on relatively small capital cushions.

Furthermore, they keep carrying billions and billions of dollars of dubious tax-related "assets" on their balance sheets and claim that means they're in decent shape. But soon after, the two companies are essentially nationalized. And those tax assets? Fannie Mae just slashed their value by 78% to $4.6 billion.

Why can't the government just cut the crap and level with us?

Sometimes I just can't help but ask myself that question. I mean, I know it makes for bad politics. But like the old saying goes, honesty is the best policy. And we're just not getting it from Washington and Wall Street.

Instead, policymakers and industry officials have been offering up a steady diet of B.S. about this credit crisis and the housing bust for the greater part of two years now ...

• "It's just a subprime mortgage problem."
• "There's nothing to worry about, the problem is 'well-contained'."
• "Major banks and brokers will never fail. It'll just be a few small institutions."
• "Home prices never go down."
• "It's a great time to buy or sell a house."

That's what you've been told by officialdom. And all of it - every last bit of it - has proven to be dead wrong.

On the other hand, we've been doing our best to give it to you straight the entire time, no matter the consequences. This morning, I'm going to do it again ... I'm going to tell you the brutal truth you won't hear from Washington or Wall Street. You can't just wave a magic wand in Washington and wish all this stuff away. You can't reverse years and years of reckless overspending, over-borrowing, and over-lending - even with hundreds of billions of dollars of taxpayer money.

You can't keep borrowers in homes they should have never bought in the first place.

You can give banks and consumers billions and billions of dollars ... but you can't make them lend and spend it. If they know the economy stinks, they're going to lose their jobs, or that there's just too much risk out there, they aren't going to do what you want them to do. Instead, they'll do what is PRUDENT - repair their balance sheets, hunker down, and rebuild their capital base over time.

The harsh reality is that the economy is cyclical. Busts follow booms. They have for hundreds of years. And those busts are healthy over the longer term, even if they're painful in the short-term. They set the stage for healthy, productive growth.

Unfortunately, the Fed has consistently gotten in the way of that curative process in recent years.

It went totally overboard under Alan Greenspan after the dot-com bust, driving the cost of money into the gutter. Thanks to that reckless monetary policy, and the reckless disregard for prudence throughout the lending industry, we experienced the biggest housing and mortgage bubble in the history of the U.S. We also saw too much dumb lending and asset inflation in the leveraged buyout business, in the commercial real estate arena, and in the emerging markets.

Now, we have to suffer the consequences. They're baked in the cake.

The government can try to ease the pain of that process. That's what all these bailouts are about. But in case you haven't noticed, they really haven't worked. We've gotten brief bounces in stocks, brief periods of economic expansion, temporary improvements in the credit markets. But they don't stick. They fail.

What to Do Now? I know this is a sobering big-picture view. But it has the added benefit of being true - unlike a lot of the garbage you're hearing from your elected and unelected leaders.

Someday, we'll see the depths of the recession's eyes. Someday, we'll get to the point where enough companies have failed, enough homes have fallen into foreclosure, enough lenders have gone under, and enough debt has been crunched to get a real bottom in the markets and the economy. Then we'll be ready for our country to grow in a healthy, sustainable fashion for the long term.

But we're not there yet. And judging from what I'm seeing, my outrage list appears doomed to grow.

by Mike Larson
November 14, 2008

http://www.moneyandmarkets.com/my-outrage-list-keeps-getting-longer-and-longer-28009

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