Freeze Reset

Several have asked me my opinion on the interest rate freeze and the other Paulson's initiatives. The truth is I really don't have a strong opinion one way or the other. The governement so far is not giving tax payer money and from what I have seen it actually benefits investors in the mortgages. So it is capitalisma at work with government getting the people in the same room to compare notes and make a decision a monoplist would make anyway. I understand why it is happening, I understand what he is trying to accomplish, and I think I understand the overall basic outcome though that could have some interesting twist and turns which I will talk about below.

First the why - political - duh. If Sept 11th never would have happened and especially Katrina the reaction may have been more muted and slower. How much criticism has the Bush administration received for slow and inadequate reaction time with various crises? Throw in the election year, the first non incumbent from the current administration not running for office in like 40 years and you have a lollapalooza effect of government trying to save the United States from any kind of normal economic pain that would normally and probably needs to be felt. (This is by the way why 5 to 10 years out I am shaking at the potential consequences. What I see as a lollapalooza in government reaction will have dire consequences later).

Second - what is he trying to accomplish. The Fed and government are desperate to slow down the decline. This is probably the one redeeming factor in all of this. The reason is because a panicky sudden reset to appropriate value can have unpredictable outcomes. If all this maneuvering really does nothing but extend the pain 3 to 5 years to a much more slower measured slowdown they will have felt like they accomplish what they were trying to accomplish. Though few will say it, everyone knows that housing prices need to get back in line with affordability and if you cause that to happen over 5 years versus 2 years you could save alot of potential problems.

Third - the outcome. In general I think this is the best attempt at something that actually may have an impact that the stooges of government have tried. It shows promise at actually doing something constructive besides just throwing money out the window hoping the right people catch it. I think it will have the affect of actually slowing things down the demise which as I said above I think would be a positive. Ironically where I think you could have the biggest backlash and unintended consequences is political. I am not convinced this is a political win for the Republicans though I have not heard anyone say otherwise. America is built on individualism and either succeeding and failing on one's own personal decisions in life. It is bred into our social DNA. Now when things go wrong we will complain and beg for a bailout and we will take it if it is handed to us but it is not something that is necessarily expected (though that is changing as the Fed continues their antics). Anyway many Americans are seeing this as vastly unfair. You can have one person not get a reset and the house next door get a reset. This does not sit well with many people even if from a utilitarian perspective it is beneficial. One of the strongest drivers of human behavior is envy. Buffet has talked about this many times. This freeze will not affect alot more people than it will have an impact on. As a result you have the potential for many more people thinking they are getting cheated or treated unfairly than people who will benefit from it. This is a recipe for alot of bad will. If I have a credit card and can't afford to pay the bill that month and have to pay a 20% interest rate and my neighbor gets help by not having to pay a higher interest rate on a contract he signed, I would be rather upset. Anyway politically I think the ingredients are there for this to actually be a big loss for the Republicans.

To summarize. The overall impact I think will be minimal besides the timing. I think it will actually benefit investors in this stuff because foreclosure is more costly than not changing the interest rate from 8% to 11. My guess is the number of foreclosures will not go down that much it will just be spread over many years. If things really pick up my understanding so far is it is not binding and so you could see the coalition fall apart. The biggest unintended consequence I think could very well be political.