Guest Editorial

It all started years ago when the people of Everytown began to play the stock markets. After all, if you could make money doing nothing, why not? Then they noticed that property values were increasing even faster than equities. 
The Everytown City government officials were influenced by personal desire to be in office, their own material well-being, how they were viewed by the citizenry, and powerful outside forces in the community. They wanted to encourage the housing and banking sectors in the local economy. The city created a fund called Freddy’s Fannie that provided guarantees that would encourage banks to make loans to people who would otherwise not qualify for a mortgage. Most banks saw this as a tremendous opportunity and approved large numbers of these guaranteed loans at variable rates. Nearly one out of every four families in Everytown took advantage of the opportunity and significantly increased their debt.  Everyone in business, schools, government appeared to benefit from this spending boom in one way or another.
Housing supply eventually caught up with demand. Prices began to stabilize, then decline. People began to default on their variable rate loans.  Everytown banks were not concerned.  After all, Freddie’s Fannie was standing behind the loans and that fund was backed by the good faith of the City Government (the taxpayers of Everytown). Nonetheless, the portfolio of loans at Freddie’s Fanny eventually approached a tipping point. Hundreds of non-performing loans were clogging the system and Freddie’s Fanny stopped guaranteeing new loans.
Everytown banks were holding non-performing loans on which they could not collect. Banking rules prevented Everytown banks from loaning out more than a certain multiple of their assets. So, they had to reduce the credit they could extend to home buyers, car buyers, businesses.  Whatever expenditures were predicated on debt began to slow down. That was serious because nearly 17 percent of the total annual budgets of the citizenry was spent to service one form of debt or another. The population lived on debt. An alarm was sounded:  “The credit market is going to dry up!  People won’t be able to borrow to buy things! The companies who make those things will have to lay people off!  The market value of retirement funds will shrink. We have to do something!” Many in Everytown agreed. Especially those whose businesses were dependent on people spending more than they earned.  
In just a few days Everytown leaders came up with a plan. They calculated that it would take $70 million in additional debt liquidity to solve Everytown’s crisis. This was more than twice the annual city budget, but there was nothing that could be done about that. If $70 million in new debt liquidity could be made available somehow, then people could borrow and spend more, businesses would have customers and the city would have adequate tax revenues.
The people of Everytown voted to authorize the city to borrow $70 million for which the citizens would be fully responsible, backed by the non-performing mortgages. 
A high school student looked up from his book of short stories and asked his teacher, “How can property that is carrying loans  greater than the property is worth somehow back another $70 million? That sounds like a deal my older brother tried to pull on me last year.”
“It is just simple economics,” said his teacher. “Here is how it works. We will take on $70 million in new debt and lend it to those who need it. They will use it to keep up with their mortgage payments and spend the rest of it on all kinds of things. This will drive property values up. We will foreclose on any of the mortgages that are still not being paid, sell the property at these higher values, pay off the loans and the $70 million will make a profit.”
“I get it,” said the student, “the Everytown families who have acted responsibly will be picking up the tab for those who have acted irresponsibly so that those who acted irresponsibly can continue to do so? And this will save our economy.”
Though he had some doubts that the adults who created the problem in the first place could be trusted to solve it, he went back to reading his book of short stories. At the top of the next page was the title, “The Emperor’s New Clothes.”

Editor’s Note: This Guest Editorial is provided by Dr. John Cragin, CEO of the Vertical Learning Curve.