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Jan 16, 2009

Jefferson Warns about Debt: Discussion

This is a discussion about the post
Thomas Jefferson Warns Us About Debt

Intplee commented on 01/16/09 as quoted:

One problem for the U.S. is that many foreigners invested their dollars in mortgage backed securities and government bonds.
Government bonds are promises by the Treasury to pay back an amount plus interest. The government borrows to do the things that "we" supposedly want to do. That is not a bad thing in itself.

Raising taxes to pay back the money plus interest is a burden on the productive members of society. The bad part is that government is effectively raising taxes without the discussion and resistance that would go along with trying to raise taxes immediately.

It is like overspending on a credit card. It is easy to spend too much, then face the misery of high repayments.

Mortgage backed securities were pioneered by Fannie Mae and Freddie Mac, which were/are government agencies pretending to be private companies. The problem is that our government guaranteed the repayment of these bonds. Fannie and Freddie used the money to buy massive amounts of sub-prime mortgage loans ($1,400 billion), which helped create sub-prime losses and the financial crisis. See "We Guarantee It".

The losses on sub-prime lending became losses of the US Government. There are a large amount of other sub-prime bonds not guaranteed by the US, bought by foreigners and US institutions, and they are trying (successfully) to put the losses back on the US government.

More dollars have been leaving the U.S. to buy imports than returning to buy exports: the trade deficit. Some have collected overseas and used for trade in lieu debased currencies, while others have found their way back to the U.S. to invest (since this return of dollars does not represent the purchase of exports, it does not reduce the trade deficit). Everything seems okay: foreigners are using the dollars they receive for imports to invest in the U.S., that must be good, right?

I agree with your insight. Another word for Trade Deficit is Foreign Investment. People and institutions on US land buy products from companies on foreign land and invest in foreign companies. Foreigners do the same in reverse. If they invest in the US more than we invest in them, we choose to call it a Trade Deficit. It could be called a Foreign Investment Surplus.

It seems to me that many of these dollars were invested in mortgage backed securities and government bonds. For the economy as a whole these represent malinvestments, and therefore, are not good for the U.S. economy.

The investments were a mistake, because the US built more houses than people could pay for, financed by sub-prime loans with tricky requirements like interest rate-resets. Malinvestment in housing (too many houses) has had the side effect of decreased housing prices, which will continue for a few years until the extra houses can be sold.

Ordinarily, a businessman might sell stocks and bonds to fund expansion, refurbish or update equipment, or whatever else. The idea is to use any money borrowed to increase future productivity. These are real investments in the future of an economy; they forego consumption today for more tomorrow.

But it seems to me that many foreigners were investing in mortgage backed securities and government bonds. For the economy as a whole these represent malinvestments, and therefore, a burden.

The foreign investors (like domestic investors) are worse off because they have lost money directly on the bonds they bought.

All investment is a risk. People open restaurants that fail and lose money. Building houses is a good thing if people can afford to buy them, and investing in this activity can be good. Our current problem is that our government encouraged and enabled investment in building houses that could not be paid for.

The burden is that the government made US taxpayers invest in more housing by guaranteeing repayment of what was borrowed. Now we are on the hook. This was a massive, off budget, government borrowing operation, that US taxpayers are supposed to pay back.

The government put up a sign at Fannie Mae "Invest here. Repayment of interest and principle are guaranteed". Of course investors responded, but they are not the ones who lost the money.

Sure the investors get paid back by the government (so far), but how often is that money spent increasing future productivity? And the real cost is everything that private businesses could have achieved with the same resources.
Correct, the cost of a bad investment is what you could have done that was better. The investors in Fannie Mae bonds will be repaid by the government, and the bailout is repaying a lot of the other bond buyers. Some will suffer losses, and some will have their money back to invest again.

US taxpayers are not so well off, because we will be paying taxes to cover the losses from Fannie Mae and the wider bailout. The loss on housing has been put onto us. Government has effectively taken private wealth through the promise of higher taxes and spending and diverted it to housing. Fewer things have been created that people can afford.

Real investment has to compensate for the burden and waste of government debt to keep future output high. By "investing" the U.S. Government, foreigners have actually harmed the U.S. economy in the long run, by redirecting capital assets to wasteful government programs and away from real investment in the private sector.
Investors don't want to lose money, and they didn't harm us by investing in US government sponsored projects. The projects were risky and wasteful, and attracted investment by offering guarantees and getting AAA ratings. We have to stop our government from taxing away our resources to spend on wasteful projects.

We have given our legislators the power to borrow whatever they can, guaranteeing repayment with interest, using taxpayer's productivity as collateral. It is impossible to ask investors, foreign or domestic, to save us from the stupidity of our representatives by refusing to make those investments.

1 comment :

intplee said...

Thank you for the thorough response.

I wish to qualify: My final comments could be construed as being xenophobic (though living in the U.S., I am actually English). I did not mean to suggest that foreigners willingly harmed the U.S. economy, but rather by funding Washington's irresponsible spending have done so. The blame lies firmly with those officials and supporters thereof who enabled and encouraged it.

Unfortunately, a substantial amount of the U.S.'s 'foreign investment surplus' has went toward mortgage backed securities and government bonds. Neither of these increases the U.S.'s ability to pay off its debts, and therefore do not represent real investments in the economy i.e. increases future productivity. Both devalue the dollar in the long term.

Malinvestment in real estate also trickles into other areas of the economy. While spending under the illusory spell of the bubble, many have encouraged further malinvestment in other industries. For example, it occurs to me that Sony's investment in Blu-ray technology might have been postponed had these developments been anticipated by management.

Lee Kelly

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