Friday, April 23, 2010

Unintended Consequences: The Feudal Divide

While bailing out banks served to keep the ruse of fractional lending and the functionality of the financial system alive, an unintended consequence of last year's extraordinary activities will be a more clearly defined stratification of American social classes.  Why?  Through financial engineering the government has propped the markets in order to drive sentiment in lieu of improving fundamentals, the burden of this engineering will be felt greatest by the middle class via inflation and taxation, and the penalties for a typical lower middle class family operating in manners similar to the banks are much more severe, and lasting.

In order for the government to supercharge the recovery a campaign was conducted of 0% borrowing in tandem with, I speculate, a calculated and concerted effort to use the money for buying and supporting the markets.  During this time banks have been reticent to voluntarily improve their customers' financial situations.  Under the guise of "protecting shareholders" banks took the position that circling the wagons around the balance sheet for profit today instead of taking the long term notion that stemming total write-offs through principal or interest reductions protects the viability of the Country.  As if to say that moral hazard at the corner office is somehow different than the home office these banks have taken advantage of the whole of America.  So while the S&P may be running up the score, nothing has really improved for the middle of the middle class and lower.

Inflation and taxation resulting from last years' activity will squeeze what were formerly middle class citizens.  Though not an expert on detailed matters of money supply, today's PPI report validates my concern that inflation at the daily level has already set in.  While salaries are flat and unemployment remains high the pro-cyclical wave of inflation will continue to reduce recreational consumer spending.  The middle class's margins are to be squeezed until raises are effected, which may not happen for a while due to the unemployment levels.  Recognizing the implied demand for basics the price of basics will continue to increase.  Additionally, the taxation aimed at recovering the cost of the bailouts will be passed through to customers, and by the time the trader tax is enacted most of the Joe Sixpacks will have their 401k's stuffed with bloated stocks courtesy of the banks who were first on the ground last spring.  Of course, we will all see changes to the federal income tax structure over the next couple of years, and the middle class, as weighted by the cost of taxation against the difference between needed and discretionary income, will experience the greatest burden.  The results, then, will be ongoing low savings rates, and demand for consumer credit at usurious rates.  Great.

Finally, lower middle class families, many of whom abused the lending system and some of those abetted by irresponsible shills, face the toughest repercussions of all.  Upon losing a house, or missing credit card payments, a broken credit system penalizes these people for a period of up to 7 years.  Where the Country needs these people to have hope of starting anew, with the goal of keeping them off the government teet, the lower middle class shall spend a decade digging out, if they can find jobs at all.  Drunk with profits, shareholders are quick to forgive the banks and forsake the humble in a hell where retirement probably seems like a dream.  Without hope this group will be driven to government entitlement programs, where easy government money again jams the costs of basics.

Though the skeeball scoreboard of the S&P reads like a stuffed teddy bear payday none of the structural problems have been addressed and I feel that the repercussions of the repair will reinforce a growing fiscal feudal system.  What are the solutions?  Sadly, the more a government attempts to legislate morality and fairness, the less effective it becomes.  Therefore banks should be well partitioned such that none is too large or too well entrenched to fail.  A campaign of consumer financial education needs to be undertaken in a manner that the basic principals of not spending more than you have sinks in.  To do so with credibility this means that the government, and banks, need to stop behaving in a way that consumers are not supposed to.  Those with the means to do so must start taking an active interest in their local society rather than concentrating on the ghost of satisfaction from material wealth.

Above all, no matter how counter-intuitive it may seem, government and entitlement must shrink.  The post-Millenium decade must be marked by a return to manufacturing and production for export, rather than consumer spending based economy.  Today we are at an important point that will decide whether or not the narrow avoidance of calamity results in meaningful improvement in the structure of this Country.  Many of the above effects cannot be avoided over the short to medium term.  However, to make no changes, in favor of immediate payoff means that America continues as a going concern.  To choose wisely is to resurrect our standing as a peerless example of cooperative ingenuity and the results that stem therefrom.