Why Worry?

Those wacky Fed governors are at it again -- Bullard going on about how housing won't recover for years, and Williams pounding the table for aggressive stimulation (QE.)  Big surprise, but the dollar is plunging -- even as a House bill is introduced to strip the Fed of half its mandate (the stimulation half) and transform it into an inflation fighter/dollar protector only.

In Williams' back yard, Stockton, CA is mulling bankruptcy.  This city of 300,000 souls is California's 13th largest and a hub of the Central Valley's agricultural activity.  From 1998 to 2005, real estate values tripled.  Since then, they've crashed so badly that Forbes considers Stockton America's "most miserable city." Official unemployment stands at 18.4%, and the crime rate (2009) earned Stockton the distinction of being America's 5th most dangerous city.  Oddly enough, an $18 million cut to the police department budget hasn't helped.

If Williams has his way, the Fed will buy up even more MBS than it already has in Operation Twist.  It will drive down mortgage rates to the point where buyers will show up in droves, bidding up real estate and saving the economy.  The fly in the ointment, of course, is that lower interest rates mean a lower dollar.  A lower dollar means higher prices for such luxuries as gas for the Family Truckster (CL topped 109 a few minutes ago.)

Will the thousands of foreclosed-on families in Stockton (the highest foreclosure rate in the US) jump back in the market if mortgage rates come down 50 bps?  100 bps?  Will banks suddenly relax their underwriting criteria?  Will cities like Stockton, operating at huge budget deficits thanks, in part, to a mismatch between property taxes and profligate spending, suddenly wake from their financial comas?

As Bullard himself said: "central bankers are having difficulty crafting policy in this recession and subsequent recovery because this is the first in which debt levels were too high."  Do ya' think?  These bozos are caught between a rock and a hard place that they, themselves, erected.  Once the debt genie is out of the bottle, he's very difficult to stuff back in.  The only solution, as Stockton is learning the hard way, is to reduce the debt to the point where it's consistent with the ability of the underlying asset (the city) to service it.

Whether you're Stockton, Vallejo, Greece, Portugal or the good ol' US of A, taking on more debt won't fix the problem of too much debt.  At some point, the lenders who made all those stupid loans are going to have to face the fact that they made some very bad decisions.  They'll have to accept the inevitable and book the losses that are already hiding in their phoney baloney balance sheets.

It will be hard.  It will be painful.  Most banks, thanks to their servants at the Fed, will survive.  Homeowners, taxpayers and investors will get slammed.  But, hey, with the Dow over 13,000, why should we worry?