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Saturday, February 28, 2009

Joy's Question About Consumer Credit

Joy's question was:
How much would it cost for the government to pay off the unsecured consumer debt of every American?

Would it cost more than this bailout?
The primary source of data here is the Federal Reserve's G.19 report. G.19 covers non-RE consumer credit. Now not all of that is unsecured. The bulk of it is secured, such as car loans (but somewhere around 25-30% of those are underwater). Technically, a loan that is secured by collateral can be partially unsecured if the value of the collateral is less than the loan balance. However, I think that is not what Joy meant.

Revolving credit (credit cards) is unsecured debt. This report gives numbers in the billions, and as of December, there was 994.4 billion in revolving debt. That is just about a trillion, which is considerably less than we are spending on the total bailout.

The stimulus bill alone is close to that (800 billion), but the money being pumped into banks, and into the agencies, used to buy stock in companies like Citi, and pumped in by TARP is far more.

So the answer to the second part of Joy's question is no, it would cost much less.

However, while paying off credit card debt would inject a huge stimulus into the economy, and would immediately dump a lot of cash to investors and into the large banks, it wouldn't take care of the bad mortgages.

I am, however, of the opinion that the best way to handle the bad mortgages is to let the servicers rewrite them where the investors agree, and otherwise let them default. I can see the point of the government funding the agencies (Fannie Mae, Ginnie Mae) to cover bad debt, because a lot of that bad debt arose from Congress pressuring the agencies to cover banks' bad mortgages.

But the bottom line is that you cannot sustain housing values by continually rolling mortgages. Housing values were inflated out of all rational proportion to homeowner incomes, and so prices must come down. It doesn't make sense to spend 500 billion or a trillion only to produce a slower rate of drop in home values where they were overvalued.

Now, the next logical question to ask is whether this would be more beneficial than what we have been doing. Here is some reference material for anyone who is interested in that question.

The latest data for total mortgages outstanding is in the Dec 08 Statistical Supplement, which has totals for mortgage debt outstanding through Q3 08.

For single-family, total mortgage debt outstanding was 11.16 trillion. For multi-family (condos, etc) the total was .89 trillion. So you can see that it is impossible for the government to do much with that debt.

For TARP (Troubled Asset Relief Program), the latest transaction report (10 pages, pdf) is here. The injection of capital into financial institutions (purchase of preferred stock or warrants) has so far cost 193.6 billion. However there is some value to the stock, so this is not simply money gone. There were additional expenditures. AIG got another 40 billion. The automotives have so far gotten 24.8 billion. A lot of that is just in notes. Citi & BofA got 20 billion each in a separate transaction, for a total of another 40 billion. Treasury got preferred stock in exchange. Then Citi got another 5 billion in the form of a guarantee. Not included in this report is the latest Citi deal, which is a bit complicated and is described in this article.

We have been throwing a lot of money at the problem. The next initiative is coming in the form of CAP (Capital Assistance Program). You can see the details at the Treasury page detailing the major initiatives on this page. The white paper explaining CAP (4 pages, pdf) is here. CAP is aimed at 19 large institutions with assets (loans) over 100 billion. These institutions are required to participate in the stress test. If they fail:
The capital provided to eligible banking organizations under this program will be in the form of a preferred security that is convertible into common equity2. Market participants pay particular attention to common equity as a measure of health in stressed environments, and regulators have long believed that common equity should be the dominant component of a banking organization’s highest quality forms of capital. The convertible preferred security provided through the CAP will serve as a source of contingent common capital for the firm, convertible into common equity when and if needed to retain the confidence of investors or to meet supervisory expectations regarding the amount and composition of capital.

The CAP instrument will be designed to give banks the incentive to redeem or replace the government-provided capital with private capital when feasible. Finally, with supervisory approval, banking organizations will be allowed to exchange their existing TARP preferred stock for the new preferred instrument. The CAP is open immediately. Eligibility will be consistent with the criteria and deliberative process established for identifying Qualifying Financial Institutions (QFIs) in the TARP Capital Purchase Program (CPP).
This will be pretty expensive, although eventually the government should get a lot of its money back. But this type of money would be spent regardless of any other stimulus program, because these "Qualifying Institutions" are ones in which the stock prices have collapsed and further hefty losses are pending, so these institutions have no way to raise money.

All of the institutions that got money originally under TARP didn't need it - the idea was that shoving the money into these institutions would help the general economy by preventing banks from calling loans. Now we are down to funding the bad banks.


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