TJP

Economic Fear Mongering

By Byron A. Ellis-September 25, 2008

Hasn’t the fear mongering script been played already? It was called the urgency of invading Iraq based on false assumption. 

Secretary Paulson and Chairman Bernanke need to succinctly explain to the American public what caused the problem of illiquidity. However, their evasiveness inhibits clear and concise communication.

Liquidity is the ability to realize value in money. According to Van Horne (Financial market rates and flows), money is the most liquid of assets and is the measure by which the various financial instruments are compared as to their degree of substitution. Van Horne noted that liquidity has two dimensions: First, the length of time and transaction cost required for converting the asset into money, and secondly, the certainty of the price realized.

Today, housing back securities are difficult to convert into money and there is uncertainty as to the price that can be realized.

Van Horne noted that financial markets, including housing back securities, should be efficient, since the good involved is a paper claim not subject to physical deterioration. However, if securities are subject to deflationary pressures market failure is plausible.

Market failure is prevalent when there is uncertainty and inadequate information. And, today many markets, including the housing market are plagued with lack of transparency and uncertainty.

This does not mean, however, that sub prime loans, which are less that 5 percent of all housing loans, are the cause of the economic slowdown and liquidity problems.

If consumers’ disposable income were at the pre 2003 levels, market certainty and rising housing prices would be the norm. However, after 2003 crude oil prices started to rise. As a result, consumers had to reallocate budgetary expenditures to cover higher transportation cost.

Say that a typical consumer drives a sport utility (SUV) or truck and live 50 miles from where they are employed; daily round trip commute is 100 miles. If the vehicle consumes one gallon of fuel per every 15 miles, and the gas tank capacity is 17 gallons, the consumer consumes two tanks of gas per week or 34gallons.

When the price of gas was $1.41 (January 2003), the weekly gas outlay was about $48. However, when the price of gas is $4.25 outlays is about $145 per week or an increase of $97 per week or an added cost of $390 per month.

Thus, for marginal homeowners the increase in transportation cost due to high crude oil cost is significant. And, if we account for increases in food and other transportation related costs, the added burden to consumers would exceed $500 per month.

For many homeowners, the added burden prevented them from fulfilling mortgage obligations. So, it is disingenuous for the Administration, Congress, the Secretary of Treasury, the Chairman of the Federal Reserve and others to blame the sub prime mortgages and homeowners for the current economic debacle.

The graph below shows a clear correlation between the 2003 Iraq invasion and the steady rise in gas prices. Thus, the cause of the economic crisis is the war.

The Iraq invasion destabilized the Middle East causing uncertainty in the supply of crude oil, which allowed speculators from inadequate and incorrect supply and demand information.

Therefore, throwing more money at the current economic crises will not produce a lasting solution.

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