President Barack Obama and the financial sector’s stimulus plans aren’t working as well as they had hoped. Their plans are not lowering the unemployment and foreclosure rate.
If there is one thing we have learned in the past 18 months, it’s that small business and the middle class must be included in our economy’s recovery. Businesses will not hire or invest to increase production or services unless they see the number of customers willing and able to make a purchase increasing. The recovery program I am purposing will help long-term debt investors, the banking sector and main street. The advice given to President Obama by academia about using old-school Keynesian economics has not worked very well to lower the unemployment rate and stem foreclosures.
The deficit spending isn’t working because it’s not restructuring the debt of small businesses and the middle class, thereby causing the middle class and small businesses to go bankrupt. This creates the opportunity for the rich, investors and large corporations to obtain a larger potion of the economy and become larger and richer, consolidating economic and political power.
We have two major problems. Getting the economy restarted in creating private-sector jobs without creating more money, which would create high inflation and inflation psychology. The other problem is, how do we slow down the economy, after it is up and running again, without higher interest rates, which would cause the economy to collapse again?
What must be done to make our economy better for all of our citizens?
No. 1: Create a new mortgage that fits the current economic conditions.
The mortgage would have a starting interest rate of 3 percent. The interest rate would increase at a quarter-percent a year for seven years and cap out at 5 percent. The borrower must qualify at the 5 percent interest rate. This mortgage would be available to any homeowner who could qualify, even those people whose mortgages are underwater.
By lowering the mortgage rate to 3 percent, a person paying $1,500 mortgage interest per month on a 6 percent loan would see his or her mortgage payment drop $750. This would increase his or her disposable income by $750. If you multiply this by millions of people, the extra disposable income that has been created would increase demand for products and services, which would reduce unemployment facilitating an economic recovery. It also would reduce the number of people whose homes are going into foreclosure.
Republicans want to lower taxes to increase people’s disposable income. This plan would increase people’s disposable income more than any tax cut proposed by the Republicans. In the above case, the person’s disposable income would increase the first year by $9,000. The Democrats want to keep former President George W. Bush’s tax cuts for the middle class. Is that going to increase your disposable income? No. The tax cut is in effect right now.
Do you have enough disposable income, and if you do, do you have the confidence to spend it or go into long-term debt? Commit to a 30-year mortgage when home prices are decreasing? The government is restructuring its debt at lower interest rates. The big corporations can go to the Federal Reserve and the financial markets to restructure their debt at a lower rate. Where can the middle class and small business go to restructure their debt at a lower interest rate? The banks won’t do it. Read on: There is a way!
The Federal Reserve, the U.S. Treasury or a home loan corporation could buy or trade government bonds, as it did in the Great Depression, and modify the terms of the mortgages as outlined. They also could purchase the new MBSs until the housing market stabilized and then sell them all to investors when the interest rate on the securities increased to 5 percent and the value of the homes were 10 percentgreater than the mortgages. The mortgages that are held by the government housing agencies, Fannie Mae/Freddie Mac and the Federal Reserve and its member banks/community banks can be modified with a modification agreement. The rest of the mortgages would have to be refinanced to put them in new MBSs.
This mortgage would increase middle-class citizens’ disposable income and confidence, thereby increasing economic activity, which would reduce unemployment by increasing demand for products and services. The mortgage-backed securities the Fed currently holds would increase in value because they include mortgages that have a higher interest rate than the new mortgages would have. The Fed needs decide whether it would be better to sell the mortgage-backed securities they hold and use the funds to purchase the new MBSs, or sell them later after the economy improves. The purchase of the previous MBSs did not increase the disposable income of a sufficient number of people, to improve the financial condition and confidence of consumers to restart the economy.
No. 2: Mortgages that are underwater would have their unpaid balances reduced by an amount equal to 30 percent of the monthly payment for up to 10 years or until the mortgage equals the then current possible sale price of the home, whichever is less.
Second lien holders would be able to participate in this mortgage reduction plan. Their interest rates and terms would be the same as the first lien holder. A modification agreement could be used for mortgages that are held by the banks and federal agencies and have not been securitized. I believe that the investors that hold securitized mortgages would prefer this program over a possible foreclosure. The banks and Fannie Mae/Freddie Mac that hold securitized mortgages also should prefer this program to the short sale.
There is no need to mark the mortgage down to current market value of the home as long as the borrower has hope that the mortgage will, at some point, equal the possible selling price of the home. The homeowner would continue to make the reduced mortgage payment as the market stabilizes and the home starts to go up in value, closing the gap between the appraised value of the home and the mortgage during the 10 years allowed by the program.
With a 2 percent to 3 percent increase in the price of the home each year and a 2 percent to 3 percent decrease in the unpaid balance of the mortgage, the maximum amount the mortgage that may be discounted would be 30 percent over a 19-year period. If you add in the 30 percent increase in the value of the home, the total amount would be a 60 percent change in the owner’s financial position in the home.
No. 3: Enact the zero-inflation taxation policy.
This policy would decrease the chance of another bubble/bust economic cycle. It would stabilize interest rates so debt would not lose value because of interest rate increases. People would be more willing to invest in mortgage-backed securities and other debt, thereby maintaining interest rates at the lowest possible rate. Low interest rates would help the private sector maintain cost, and the government’s interest payments on the national debt would remain a smaller part of the budget, thereby not bankrupting our economy and the government, which would cause hyperinflation to be created.
The zero-inflation policy would decrease inflation psychology. Inflation psychology is the perception that rising prices are profitable and money is losing its value. When people are affected by this perception, they are unwilling to keep any part of their money in the credit system of our economy, to support long-term debt, which in turn supports increased production. People feel that inflation is eroding the value of their money and that it must be spent or invested in the products of the economy as quickly as possible before it loses any more purchasing power. Paper profit is the money people receive from inflationary investments — investments in housing, commodities, etc., purchased with credit that increase in price without making improvements or increasing supply.
The government has changed the way it figures the Consumer Price Index by removing the cost of purchasing housing. This doesn’t mean that we haven’t had high inflation in our economy. In the past 30 years, home prices have increased 600 percent or more. With the cost to rent a home in the Consumer Price Index, the cost of owning a home wasn’t reflected in the inflation rate. The inflation rate during the primary home bubble was fairly low, therefore the Fed didn’t take action to slow down the rise in single-family home prices.
The U.S. government does a lot — sometimes too much — to prevent a recession but very little to control a boom. A boom is very profitable for governments, but leads to a recession. When the Fed steps in with its high interest rate policy, the economy goes bust again and thousands of small businesses go bankrupt. We need this tax policy change before more people become government dependent. We need a new method to control inflation. It has become so big and electronically sophisticated the old ways no longer work. I submit that my idea is a real answer to this problem.
The long-term capital gains rate devalues the domestic money supply. One of the reasons inflation exists in our economy is that we have made it very profitable. Another reason is that we have made money investments (savings and bonds) compete with inflationary investments. Since inflationary investment income is taxed at 15 percent (long-term capital gains tax rate), money investment income, which is taxed at up to 35 percent, is worth 20 percent less.
In fact, to offset the capital gains rate on personal residences — which is at zero, and the home’s annual appreciation rate is 30 percent (which we had in 2004 to 2007) — interest rates earned on bonds and bank accounts would have to go up to about 48.5 percent to control inflation psychology. This is why the Fed’s interest rate policies wouldn’t have done anything about the single-family home housing bubble even if they had tried. The family home was the only hedge against inflation and tax shelter the consumer had left. Is it any wonder that so much money was moving into single-family homes, which helped create the housing bubble and the economic crisis?
The Federal Reserve in the early 1980s tightened the money supply enough to raise interest rates to 21 percent. Of course, this created a recession because normal production and consumption can’t continue under these conditions. Many people were thrown into the unemployment lines. Small and large businesses went bankrupt, and the government’s responsibilities increased as more people became dependent on welfare and other government programs.
A better way to control inflation psychology and maintain the value of money is by progressively reducing the interest deduction and the tax on interest income at the same percentage rate as inflation increases in our economy. The balance of our economy would be maintained. Whenever the interest earned on money investments became 15 percent taxable income, money investments would be as valuable as inflationary investments.
This zero-inflation taxation policy, when used during an inflationary period, would automatically take excess demand out of the marketplace, slow the economy and maintain the value of money as needed. The same thing happens when the Federal Reserve tightens the money supply by raising interest rates. But this action causes interest rates to go up, raising the cost of credit for consumers and producers.
Inflation psychology shouldn’t exist in our economy. People are not responsible for maintaining the value of their money; it’s Congress’ responsibility. If people try to protect the value of their money from inflation by investing in inflationary investments, they create more debt (money) and more inflation.
With enactment of the zero-inflation taxation policy, normal production and consumption would continue. It would have the money at the lowest possible interest rate it needs to maintain employment and raise the standard of living of all of our citizens. The long-term capital gains tax rate still would be in effect, but those people who make capital improvements and increase the real wealth of our economy would benefit from its existence. People would not be making inflationary investments because inflation would not be profitable, or making investments to protect their money from inflation. Their money would stay in the credit system of our country, supporting increases in production and normal consumption, thus maintaining low interest rates and inflation rates.
You might be thinking that mortgage interest rates are at a historical low. The spread between the cost of funds from the Federal Reserve and the current starting mortgage rate needs to be at least another 1.5 percent lower. Even then it would be at a historic high.
When interest rates went to 21 percent for a mortgage in the early 1980s, that was less than 100 percent above the inflation rate of 12 percent. We currently have home prices that are still declining, yet the interest rate for a 30-year fixed rate mortgage is 450 percent (4.5 percent for the most creditworthy people) above the home price deflation/inflation rate.
The banks can borrow money from the Fed at less than a quarter-percent interest rate. They can loan it out for mortgages at a 5 percent interest rate. That is an increase of 20 times between the cost of funds and the sale of funds to the consumer.
Let me give you an example. If an auto manufacturer produced a car for $20,000, the sale price of the car would be marked up to $400,000. The financial capitalist businesses can pay enormous bonuses because of these huge profit margins. The profit margin on other consumer and business credit is even greater, such as consumer credit cards at 25 percent annual interest rates, plus fees. That is 100 times the cost of funds. The price of the car would be $2 million. Yes, that’s six zeros.
Banks are not risk takers. They will only loan money when the collateral is maintaining or increasing in value. They are concerned with recouping their lost capital and have blinders on and can think only about balancing their books. They don’t realize that by improving the financial condition of the people that they will help themselves. There is more than one way to solve a problem. As the financial condition of the middle class improves, so will the financial condition of the banking service industry. A bank is only as strong as the financial condition of its customers and the value of its collateral and capital.
The sub-prime mess shouldn’t have occurred. We have to say it happened and move on and stop placing blame. Primary home prices are about what were they were before the credit bubble occurred. Since local and state governments rely on property tax values to pay for public services, they soon will have to start cutting services or raise taxes. Raising taxes would be the wrong thing to do in a recession, so they may decide to lay off more people, which would mean more foreclosures and government dependent people.
We are now getting down to raw meat, and the Great Recession is destroying small businesses and the middle class. People who were responsible homeowners and homebuyers, who put 20 percent or more down, are becoming unemployed and losing their homes. Something has to change or this economy is going to hell in a hand basket.
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— Leonard Tekaat is a Tea Party member, retired economic analyst, economic scholar, investor, businessman, financiers, author, and former California congressional candidate. He has been in the financial world for more than 40 years. He can be reached at firstname.lastname@example.org.