Month: November 2008

Should the Government Bail Out the Auto Industry?

Over in the real economy, perhaps the biggest story is the impending and highly likely merger of GM and Chrysler, in which GM would swap its 49% stake in GMAC, its consumer finance company, to Cerberus (which owns the other 51%), in exchange for Chrysler, which is currently owned by Cerberus. It seems that the deal may hinge on financial assistance from the government, at least according to six governors attempting to pressure the dynamic duo of Paulson and Bernanke to help out. Until Thursday, GM was seeking $10 billion from the Treasury Department’s $700 billion bailout fund – yes, the same one that has been used to recapitalize banks – but Paulson’s preference is that GM tap a $25 billion low-interest loan program set up by the Energy Department in September.

It’s easy to argue for bailing out the auto industry, with its hundreds of thousands of factory workers, as opposed to the financial sector and its Wall Street bonus babies. (It’s less easy to argue for bailing out Cerberus, which is a private equity firm.) But I want to point out one difference.

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JPMorgan Joins Mortgage Restructuring Party

JPMorgan recently announced a program to offer loan modifications to 400,000 homeowners with a total of $70 billion in mortgages. The program is roughly similar to one announced by Bank of America as part of a settlement with state attorneys general of investigations into Countrywide (acquired by B of A): JPMorgan is offering to convert option ARM mortgages, one of the most poorly-conceived and worst-performing products of the housing boom, into fixed-rate mortgages at lower rates and potentially with lower loan balances. From the WSJ article:

The mortgages affected by J.P. Morgan’s program represent 4.7% of the home loans it owns or that are serviced by one of the bank’s units, EMC Mortgage Corp. While the program to give these mortgages easier terms is likely to cost J.P. Morgan billions of dollars in interest payments and loan fees, it is also likely to save the bank from the costly and lengthy process of foreclosing homes and selling them.

This is more evidence that banks see mortgage restructuring as being in their own economic interests, for reasons I’ve described earlier. (As an aside, Yves Smith wonders why banks are only offering modification programs now, when it seems like the government is about to act.) Unfortunately, it’s also more evidence that modifying whole mortgages owned by one bank is easier than modifying securitized mortgages owned by many parties who may have competing interests; this program is only aimed at mortgages owned by JPMorgan, which are a tiny fraction of the volume serviced by that bank.

Given the small scope of the program, government action is still almost certainly necessary. But private action has at least one advantage over government programs. When the government acts to encourage loan modifications for delinquent mortgage holders, millions of “responsible” homeowners who are not delinquent on their mortgages will scream. No one expects private sector banks to do anything other than act in their own interests, and so they don’t have to worry about being seen as fair.

To Buy or Not To Buy …

Judging by the traffic on the Planet Money blog, many people are wondering if now is the time to be spending money. On the one hand, we hear that the economy is crashing because of a decline in consumer spending. On the other hand, we hear that the economy is crashing, which frightens us to consuming less and saving more for the rainy days ahead. Real economists worry about these things, too – see Paul Krugman and Tyler Cowen, for example. But at the end of the day, all economists can do is speculate and watch what happens, because aggregate consumption is just the sum of hundreds of millions of individuals making their own purchasing decisions.

I’m not a personal financial advisor, but I think this can be broken down logically. Let’s assume that, before the current downturn, you chose with your level of spending (and, by implication, your level of saving) rationally. Then there are three main reasons why you might want to reduce spending today: (1) you don’t have the purchasing power you need to maintain your spending; (2) you are going to lose your job (I know there’s a problem with that statement, and I’ll come back to it); or (3) the assets you are counting on for retirement have fallen enough that you need to increase savings in order to replenish them.

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