Academic

ON THE ECONOMIC FRONT, a coming ?panic attack?? UPDATE: A reader who requests anonymity writes: ?

By Glenn Reynolds

ON THE ECONOMIC FRONT, a coming “panic attack?”

UPDATE: A reader who requests anonymity writes:

I?ve given some thought to James Pethokoukis? ?August Surprise,? and I think he?s right that something like a bailout of underwater loans will happen soon.

Economically, however, there is little upside and a whole lot of potential downside. The worst of these loans are never going to be paid back. The ?owner? of a $200,000 Inland Empire home that he paid a half-million
dollars for, was never going to pay back the whole amount anyway. So there?s really no argument that the bailout will have a stimulus effect. There?s simply no additional spending created by eliminating an unpayable
debt.

But there are two potential downsides: one inflationary and one deflationary. Right now banks are sitting on many billions of dollars worth of unlisted foreclosed homes. The President?s action would give the illusion of a floor under housing prices and just might be all that it takes for banks to release their backlog. If all that shadow inventory hits the market at once, housing prices in the communities already hardest hit will be hit even harder. That?s the deflationary effect.

The inflationary problem is a little more obvious. As a practical matter, Fannie and Freddie debt is probably already being counted as federal debt even if it isn?t currently being accounted for that way. So that argues
that the effect of transparently accounting for the debt will be negligible. However, the rumored amounts being discussed for the bailout (between two and eight hundred billion) are far smaller than the loss of
value in the nation?s housing market. Bond buyers will have to ask themselves if another round of bailouts is coming. A bailout of this size (and one that circumvents Congressional authority) is a very visible signal that the Administration will do anything it can get away with try to prop up the economy. I can?t see how this risk wouldn?t put upward pressure on treasury yields?and thus, mortgage rates.

Now, imagine both consequences of this bailout hitting simultaneously: The bailout is followed by a temporary floor under housing prices, precipitating a deluge of backlogged inventory hitting the market right
about the time that mortgage rates start creeping up.

No upside and a big potential downside. So why do it?

Politics. Three of the four states with the hardest hit housing markets are California, Florida, and Nevada. All three could see Republicans elected to the Senate. Not just any Republicans: In Florida and Nevada,
the GOP candidates are Tea Party Republicans, while in California, the Democratic candidate is among the most liberal in the entire chamber. If purple states like Florida and Nevada will elect ruby red Republicans to
statewide office, and a deep blue state like California can?t retain a liberal Democrat, imagine the political effect over the next two years.

There will be a rightward sprint in both parties. Furthermore, if all three of those states go Republican, it?s likely that Washington?s Murray and Wisconsin?s Feingold are in real trouble too. That could bring the
GOP total in the Senate to 52. One party just doesn?t pick up a dozen seats in the Senate without the other party arriving at a little introspection.

And Barack Obama is deathly afraid of a little Democratic Party introspection under those circumstances. The fundraisers in the Democratic Party will find another nominee to back in the primary. He will be a lame duck within his own party.

To use a military term, California, Florida, and Nevada are Obama?s final protective fire. They are where all rounds of ammunition will be expended to stop the enemy?s advance. He will gladly commit the nation to hundreds of billion dollars of additional debt so that the people of those states feel just a little bit better–at least until they discover that even with a smaller mortgage, without a job, they can?t afford even that.

One hopes that the administration isn’t this cynical, self-centered, and unconcerned with the well-being of the country.

Full post as published by Instapundit.com on August 08, 2010 (boomark / email).