Multiply This!
This month has seen much in the way of financial news. There is far too much to cover in a single column, but I’d like to address the highlights and answer one reader’s question. So let’s get started.
Last week, the biggest news affecting mortgage rates was the Federal Reserve’s announcement at the end of their two-day meeting. As you know from my previous columns, the Fed has been purchasing mortgage backed securities (MBS) since January. That program was forecast to run through June and had a budget of $500 billion. On Wednesday, the Fed added $750 billion more to that budget. So that program should now run easily through the end of the year.
In addition, the Fed surprised the markets by announcing an additional $300 billion program to buy long-term Treasuries in order to further suppress mortgage rates. The initial reaction on Thursday morning was nothing short of frantic, as rates dropped momentarily to 4.5 percent. The reaction was so strong that most mortgage companies experienced widespread system failure, as the volume of lock-ins reached record levels. By Friday, most investors took rates back up to 4.875 percent despite the solid gains held in MBS. One assumes this was merely a defensive tactic, and I expect to see mortgages trade at 4.5 percent more regularly in the coming weeks. Let me stress that the time has never been better to purchase or refinance, if you qualify. We will likely not see rates like this again in our lifetimes.
Executive compensation was also in the news, thanks to our friends at AIG. Let me say that I was just as outraged as anyone at the effrontery this represented. However, it occurred to me that we, as U.S. citizens, should be equally outraged that our elected officials have doled $170 billion to a single company without any prior oversight. Now, of course, these same officials have proposed a punishing 90 percent tax on all bonuses paid, by any company, in all financial-related industries, whether or not they have received any bailout money or not. Let’s hope cooler heads prevail. If not, where will this slippery slope lead? Next thing you know, we will levy punishing taxes on former presidents who make $100 million a year on the lecture circuit or own baseball teams. Hmm … no, I am sure they will never go that far. The irony is that now we may finally have the political will to send AIG into bankruptcy—where it belonged all along (and no bonuses could have been paid, by the way).
Lastly, one reader chided me for being unfair in my review of the recent stimulus package. I guess, to some, I sounded like I was merely echoing the far right wing and was simply being partisan in my assessment. Perhaps I should explain that my degree in economics was really to blame. I probably could have been more optimistic had that degree not provided me with a basic knowledge of the “multiplier effect.” Simply put, the multiplier effect says that an initial amount of money spent by the government leads to an even greater increase in national income. However, this theory has produced very mixed results when it has been employed in the past, as you might imagine. If it were true all the time, then the government should just print a trillion dollars an hour and be assured of receiving 1.5 times that back in economic growth. So it is the kind of spending the government does in these instances that matters most.
For example, economists generally agree that it was not FDR’s New Deal that lifted us out of the Great Depression, but rather our entry into World War II. Since both of the events amounted to massive government spending, you may ask why one worked and the other didn’t. The answer is simply because one created a lasting industry for jobs and the other didn’t. We discovered that paying people to dig holes and then fill them was not a magic bullet. While it provided substantial temporary relief (unemployment did, in fact, drop with the New Deal), when funds ceased to flow, the effect was lost. World War II spending worked, unfortunately, because it left us with a permanent industry in the form of the military industrial complex. I say unfortunately because I, like many, feel that too many presidents since then have used short wars to revive our economy when no other national interest existed. But that is a separate issue …
“So what should we have done with $787 billion, Mr. Smarty Pants?” I can hear my critics ask. The answer is: capitalize a new industry. For example, there is a new technology that involves growing algae and converting it to fuel. It is carbon accretive (algae needs CO2 to grow) to such a degree that it could be mated with coal power plants and reduce their greenhouse gas emissions to zero. Further, by reducing our dependence on foreign oil, it would also reduce the trade deficit that threatens to financially ruin our country in the long term. So let’s say the government were to have spent this money and built these plants adjacent to coal power plants. They could have started in the most economically depressed areas of our country (Flint, Michigan comes to mind). That kind of spending would have created not just a lot of construction jobs, but also millions of permanent jobs working at these new facilities. The tax revenue generated would have paid the government (us) back within the next decade at a profit. Of course, there are a lot of other similar promising industries waiting for funding. Even the infrastructure jobs for highways, the electric grid, etc, would last long enough to get us through this period. But the “multiplier effect” only works in direct proportion to the permanency of the jobs created.
So I hope that explains why I was opposed to the bulk of this spending being used to fund social programs, which carry little or no multiplier with them. And after all, isn’t that more the type of change we were all really hoping for?
