Tax Rebate Checks Not Worth the Cost

After learning more about the stimulus package, and the state of the U.S. economy I am more convinced than ever that the tax rebate checks will be a monumental failure. The money spent on tax rebates could be better spent providing a backstop for the market where it really needs it, the mortgage insurance industry.

Mortgage insurers are in a precarious position, and their downfall will be our own. The proposed $250 billion tax rebate will do little to spur the economy because of the overburdened position of the American consumer. People have borrowed up to their eyeballs (and beyond) on credit cards, mortgages and home equity lines of credit for the last several years. Many of these people could ill-afford such debt load, so lending companies loosened the requirements, allowing hundreds of thousands of otherwise financial deadbeats to assume much more than they could afford. Mortgage insurers underwrote those mortgages and enjoyed several years of growth in their own industry thanks to these relaxed lending requirements and an overall boom in the residential real estate market.

For the same reasons mortgage lenders enjoyed such success, they may now become their downfall. It appears our government is doing little to prevent their inevitable demise. Tax rebate checks sent to a financially irresponsible constituency will likely be wasted on frivolous purchases such as Ipods and plasma televisions. The more frugal of us may use the rebate to boost our emergency savings or whittle away some credit card debt. Neither scenario provides any relief for the mortgage insurance industry, or Wall Street as a whole.

A run on the insurance companies will lead to a trickle down effect ultimately creating depression. Just as life insurance companies don't expect hundreds of thousands to file a claim on the same day, mortgage insurers were not prepared for such a monumental decline in the housing market. Declining home values combined with historic foreclosure rates have left banks holding the bag and looking to mortgage insurers to cover the gap. If these insurers go belly-up banks could be stuck with astronomical losses in their mortgage divisions, creating a ripple effect through the entire financial sector. The negative sentiment would gain momentum leading to massive withdrawals from financial institutions. With a lack of significant amounts on deposit, many small, regional banks would no longer be able to offset their lending write-offs, causing many to close the door leading to massive layoffs, decreased spending, decreased production and manufacturing, and increases in inventories. Sound familiar? It does if you were alive in 1929.

How could the government save the financial sector? By taking the $250 billion it is prepared to send taxpayers and use that money to guarantee the solvency of the large, private mortgage insurers. Similar to previous bailouts (airline industry, etc.) the government could essentially guarantee these insurers ability to make good on their policies by infusing the $250 billion "rebate money." The mechanics of such a plan are debatable, but would probably center around the government "buying the books" from these insurers and in turn issuing government bonds to offset the loss in capital as these policies are made good. The confidence gained on Wall Street from such a move would likely preserve existing capital in investments in financial companies. Coupled with a full basis point cut in interest rates (these are long overdue) the market would roar, and could be pulled back by modest increases to interest rates at a later time.

Politics will probably win out, at great costs. Lawmakers on both sides of the aisle will see to it that the tax rebate program is pushed through, and any attempt to use the funds for more long-term benefits will be scuttled. Why? Because politicians are interested in one thing - staying in office. How many members of Congress would actually have the guts to tell their constituents that they are voting down the tax rebate plan so an alternative stimulus package centered around protecting the solvency of mortgage insurers could be put in place? Zero. The average American is only interested in one thing, a short term rebate they can use to replace that old sofa with a leather couch, or that old tube television with a shiny plasma model. The short term gains to their bottom line could soon be wiped out from a financial market meltdown that erodes their retirement savings to next to nothing. Seems like a high price to pay for a new television.