There is an old saying: a problem identified is mostly resolved.  It’s simply impossible to fix an unknown problem. That’s where we start.

The problems with the American market are simple. It’s:

  • over-regulated
  • over-taxed, and
  • over-leveraged

This can be seen by:

  • lackluster economic growth
  • high unemployment
  • weak currency

In a nutshell, the free market has little room to operate, and as such, is in recession. What to do?

Begin at the source of weakness; housing prices remain at rock bottom valuations and banks aren’t lending money. How can we fix that?

First, the Federal Reserve can stop paying banks not to lend. Yes. The Federal Reserve is paying banks 25 basis points on their cash reserves – in other words, paying them not to lend money (that’s their business, by the way.) And where does the Fed get this cash? They print it.

We need to stop printing so much money (it makes for a weak currency.) Besides, giving banks free cash isn’t a great incentive to take risk and lend. Stop paying banks to hoard cash and they might start lending it. It makes common sense.

Second, minimize Fannie Mae and Freddie Mac’s role in the housing market. For example, right now the Dow is around 11,400 – down some 20% from its all-time high in October 2007. Home values, as defined by the federal government via Fannie Mae and Freddie Mac, are down 40% – twice the rate of decline for the Dow.

Fannie Mae and Freddie Mac guarantee loans made by banks. Banks don’t loan money to consumers unless they have this guarantee. Many times Fannie Mae and Freddie Mac’s valuations are in complete contradiction to local governments assessments.  In my area, for instance, local government assesses my property value 25% more than Fannie and Freddie – which coincides with “the market’s” rate of decline.  My local government clearly has it right.

But it is not they who control money supply and the availability of credit.

By establishing these guarantee values, Fannie and Freddie determine how much debt can be obtained for a certain piece of property.  By so doing, Fannie and Freddie essentially control the price of housing.  It’s like government price fixing. They did the same thing during the housing boom, when money (debt) was too easy to get and housing prices skyrocketed.

Now it’s the polar opposite.  Money is impossible to get. This forces home prices down because credit cannot be obtained to purchase housing at higher prices – regardless of what a person is willing or able to pay.

This goes against free market principals and has caused a huge contraction in other kinds of consumer debt – like home equity loans, credit card loans, and small business lines of credit. All of this is bad for consumers, housing, and the Market in general.

My second recommendation to fix housing and banks — disband Fannie Mae and Freddie Mac.

Third, fix unemployment!

Stay tuned for that…