The Indonesian government announced on June 21 that it would eliminate longstanding fuel subsidies. Low-octane gasoline prices rose 44 percent, and diesel rose 22 percent, according to a report in The Wall Street Journal. The subsidies, a holdover from the Suharto era, were intended to help grow the economy. They did. And as they did, ownership of cars and motorcycles also grew, ratcheting the subsidies up to a fifth of the national budget. The government also announced it would give cash subsidies to poor families to help them transition.
In China, government support of industry has resulted in subsidies to business sectors that suffer from weak demand and overcapacity, keeping them running despite lack of demand. The Chinese government has been doing this for years, but while the economy was in growth mode nobody objected. The Peoples Bank of China is subservient to the government, but the ‘shadow banking’ – i.e. unregulated lending – industry is not, and it’s been attracting ‘hot money’ from newly wealthy Chinese investors looking for higher returns than the traditional banking system can offer. This puts the Peoples Bank in the position of having to follow, lead or get out of the way.
These two economies (and many others) are looking increasingly like the snake that eats its own tail. It’s time to ask this question: In developing and emerging economies, where does growth come from? Does it come from the creation of value-added products or services? Or does it come from inflated loans and subsidies? The crucial thing is the difference between the value of what you start with and what you finish with. With products and services, value of the item increases; with loans and subsidies, the value of the asset decreases relative to the growing amount of loans and fees associated with it.
But you don’t have to leave the developed countries to see the effects of subsidies and supports being used to offset weak demand. In fact, there’s no place like home.
Our own Federal Housing Finance Agency, which insures housing loans by banks, has come out with a new foreclosure prevention plan, the Streamlined Modification Initiative, that requires neither documentation nor proof of financial hardship. All borrowers have to do is to make three monthly payments on time to make the modification permanent, according to a report in The New York Times. Its goal – to get borrowers who claim distress into modified loans soon enough to avoid foreclosure. The amount in arrears is added to the new loan and the term extends to 480 months – 40 years. The program gives a break on 30 percent of the interest on the unpaid loan balance. It supersedes the HAMP program, which currently boasts a 40 percent default rate on the part of borrowers who received HAMP modifications in 2009, according to the Times report.
Didn’t we learn from the last time? A healthy housing market depends on healthy incomes, not giveaways and extensions. If we keep diluting the value of housing with loans that are difficult to repay, there will be no recovery.
