The essential problem is this: if the FED wants to save the debtors, it is going to have to destroy the lenders --- or of course vice versa. If the FED wants to save the lenders, it will have to stand aside while borrowers get sucked into increasingly oppressive circumstances.
On the surface that looks to be the case, at least initially in the process. However it seems to me that under any scenario both the borrower and the lender will be wiped out.
Here is why:
1. Deflation - obviously the borrowers get into hard times and default one by one. But if enough borrowers default, the lender goes down as well (unless the Fed bails out the lender)
2. Hyperinflation - the lenders get shafted, but it seems to me that the only way for a borrower not to get wiped out would be to sell all assets, pay of the debts and shift into gold, just before the replacement of currency.
Here is how it would happen:
Joe 6-pack earns an average wage of 50K/year and buys a house in CA for 500K with a 450K interest only mortgage .
After a couple of years of very high inflation Joe's wage went up 2 fold while prices of everything went up 3 fold.
Now his house is worth 1.5 mil. The Fed works overtime to pump out enough money, keep interest rates low and keep housing bubble inflated. Inflation accelerates and as people flee the currency, temporarily his house is worth 5 million, but there are very few transactions taking place, because mortgage market ceases to function.
Now the currency collapses and the dollar is denominated by a factor of 10 and called "the New Dollar". So now Joe earns 10K new dollars per year has a 45K mortgage and a house worth 150K. So he came out ahead, right ? No.
The new currency, in order to be accepted. must be subject to tight monetary policy and lending standards must be tightened.
A buyer with a 10K/year average wage, 20% downpayment and 10% interest rate can only support an average price of a house at about 25K. So the market price of Joe's house overnight collapses to 25K (250K in old dollars-50% less than he paid). He still owes 45K on his mortage, so technically he is bankrupt.
And this scenario did not even assume that he cashed out any equity, which would make his situation even worse. |
