“Yes, we can,” said Obama. “No, you can’t,” said the bond market. “You can’t borrow $1.8 trillion a year, subsidize the mortgage market, finance the asset-backed securities market, and do all these other things, not at a 3% yield for the 10-year Treasury.” So the bond market pushed the 10-year Treasury yield to 3.7% this afternoon, nearly double its 2% level of last January.
In order to keep mortgage credit cheap, the Federal Reserve has bought $430 billion worth of mortgage-backed securities during 2009 to date, as well as more than $100 billion of Treasury securities. The half-trillion increase of securities holdings on the part of the Federal Reserve are the equivalent of additional government expenditure, on top of the $1.8 trillion deficit that Obama already has projected. That doesn’t count another $160 billion of commercial paper (short-term corporate IOU’s) funded by the Fed in a special facility, $47 billion of loans to AIG, and sundry other accounts.
All told, the Fed has increased its credit to the economy by $1.3 trillion during the past year, on top of the Obama administration’s $1.8 trillion.
This means that home mortgage rates will rise, and home prices will remain low. With nearly one out of eight US mortgages in arrears, hard-pressed homeowners have an incentive to walk away from mortgages rather than pay, which will keep delinquency rates high, and keep the banking system in a zombie state. There simply isn’t going to be anything resembling an economic recovery.
Who is going to tell Obama, and how will he respond?
In a recent “Spengler” essay at Asia Times Online, I compared Obama’s economic and foreign policy initiatives to the kind of plastic surgery practiced in the South Park television cartoon, in particular the dolphinplasty (operation to make you look like a dolphin) performed on Mr. Brofnovsky. I wrote,
Like dolphinplasty and negroplasty, it has given us cosmetic solutions that we might call civitaplasty, turning a terrorist gang into a state; fiducioplasty, making a bunch of bankrupt institutions look like functioning banks; creditoplasty, making government seizure of private property look like a corporate reorganization;matrimonioplasty, making same-sex cohabitation look like a marriage; and interfecioplasty, making murder look like a surgical procedure.
There is a consistent theme to the administration’s major policy initiatives: Obama and his advisors start from the way they think things ought to be and work backwards to the uncooperative real world. If reality bars the way, it had better watch out. In the South Park episode, the plastic surgery underwent catastrophic failures too disgusting to recount here. Obama’s attempt to carve reality into the way things ought to be will also undergo catastrophic failure, perhaps in even more disgusting ways.
Every constituency that backed Obama feels empowered to demand a bailout. After the Chrysler deal, in which the UAW leapfrogged the senior creditors to end up first in line in a virtual shredding of the US Bankruptcy Code, how can the state and municipal employees of the bankrupt state of California expect less? What the bond market tell us, however, is that the price tag of future bailouts will increase drastically. The Federal Reserve can, of course, buy more Treasury and mortgage-backed securities, and it can do so all day long, but eventually the value of the dollar will crash and rates will go up in any case.
It’s banana-republic finance that eventually will lead to banana-republic consequences.
At some point Obama will realize that nothing he has proposed is working. Recently I tallied the failures in foreign policy that beset the administration. The US economy isn’t recovering; the Iranians aren’t negotiating; the Pakistani government isn’t suppressing the Taliban; and the Palestinians aren’t forming a peaceful state next to Israel. The administration is heading for a major crisis a few months down the road. It will be something to watch.
