Sunday, December 9, 2007

Treasury subprime plan much to do about nothing

A close review of the Treasury “plan” for the subprime mess suggests that not much is going to happen. The Treasury through its “Hope Now” plan facilitated some arrangements with banks to help standardize adjustments to loan arrangements through allowing for no change to lending rate. The number of borrowers this plan affects will actually be small. Also, the arrangement could have been made without the help of the Treasury and there is no current relieve planned for the billions that will be adjusted in 2008. In short, the financial system will have to work this problem out on its own. Foreclosures are going to build and home inventories in many markets are going to increase.

Paulson, who comes from Wall Street, will not take a populist approach of forcing moratoriums on investors as a solution. He is well aware that government intervention in the contracting of lending arrangements will not just hurt investors and affect the working of capital markets. At this point in time, protecting the capital markets from moral hazard problems is more important. This approach may change as we move through 2008 and get closer to the election, but right now, Treasury wants to look like they are doing something without being heavy handed.

This means that this crisis is going to continue for a long time and it will be the burden of the Fed to solve the problem through the use of the ineffective tool of lowering rates. Lowering rate is generally ineffective when there is an unwillingness to lend and the credit of borrowers is impaired. This solution also may be gradual because the lowering of interest rates will have negative ramifications on the dollar and we have not seen the signs of a recession in the rest of the economy. Expect the slow process of 25 bps cuts. The credit crisis will be one of the main themes of 2008

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