Fighting Debt With... Debt?

This post first appeared on Minyanville and Cirios Real Estate.

Our elected officials appear convinced that Americans should buy stuff they don’t need with money they don’t have.

The Senate, in passing its version of the over $800 billion economic stimulus package yesterday, threw a great deal of cash at 2 industries whose products we have far too much of already. Despite the fact that we have too many cars on the road and far more homes than we do people to buy them, lawmakers are determined to prop up both the auto-making and home-building industries.

According to Bloomberg, Ford (F), General Motors (GM) and Chrysler, the latter 2 already suckling the government teat just to stay alive, will benefit from a provision that allows consumers to deduct car-loan interest payments and local sales taxes from their income tax.

Meanwhile, Centex (CTX), DR Horton (DHI) and other homebuilders are salivating at the prospect of a $15,000 tax credit for those brave enough to buy a new home. The new, more generous tax break replaces a $7,500 credit granted last year.

In what shouldn’t come as a surprise, Brian Catalde, the president of the National Association of Homebuilders (or NAHB) is pleased that his group’s intense lobbying efforts paid off.

“We’re pretty happy with the way the Senate bill is shaping up," Catalde said. "We think it will entice a lot of those people sitting on the sidelines into the marketplace.

”NAHB members nervously await the disposition of the final bill as their balance sheets remain bloated with unsold homes priced well above prevailing market prices.

Lawmakers seem determined to dig our way out our debt problem with yet more debt. By encouraging Americans to borrow more to buy the cars and homes irresponsibly manufactured by these industries in the first place, Congress and the President alike reward the very poor financial decisions that brought our economy to its knees in the first place.

To borrow the analogy from Professor Succo's piece yesterday, Economy: Code Blue, this is akin to handing an obese person a donut, telling them to munch away as long as they stay away from pizza. It just doesn't make any sense.

Among the Senate bill's numerous differences from the House’s version passed last week -- most notably the handouts earmarked for homebuilders and automakers -- it also excises more than $20 billion in funding for new public-school construction.

Once again, lawmakers display their unparalleled financial acumen: Only more McMansions will counteract the vast oversupply of schools this country is struggling to get out from under.

Credit Crunch Won't Pick on Anyone Its Own Size

This post first appeared on Minyanville.

Each day that the engine of economic growth -- credit -- is prevented from flowing freely, the crisis worsens - and its effects on the broader economy keep piling up.

Even as Congress rushes to pass the latest iteration of the bailout plan -- or emergency rescue plan, or stimulus plan, or whatever it happens to be called to make it sound politically expedient and palatable to confused and frightened Americans -- the economy is grinding to a halt.

After years of fudging the numbers to make growth look stronger than it actually is, policymakers may have to finally accept the fact that recession is inevitable. Weekly jobless claims rose to a 7-year high, new car sales are tumbling, and the stock market is gyrating wildly on an almost hourly basis.

The recession they promised wouldn't come is just around the corner.

There's a long-held belief that economic slowdowns allow small businesses to thrive, since larger competitors are scaling back and hunkering down to wait out the storm. Meanwhile, entrepreneurs -- who are typically less risk-averse than big companies -- can seize on the opportunity to expand, open new stores and comb through the ranks of unemployed to hire skilled workers on the cheap.

Banks are apt to rein in lending during a downturn as defaults on existing loans rise and cash becomes pricier. Credit standards tighten, loan amounts fall and lenders scrutinize applicants more thoroughly before extending loans. Still, small businesses are usually able to find enough money to continue their existing business strategies, at the very least - albeit with the higher risk associated with tough economic times.

The credit crunch, however, is throwing that assumption out the window.

Both the Wall Street Journal and New York Times ran stories this morning about how small businesses and entrepreneurs are "feeling the chill" as banks squeeze cash flow to a mere trickle. Mounting defaults on loan portfolios, fear about future losses and frozen short-term money markets are forcing banks to deny credit in droves.

As the banking system continues to jam years of consolidation into a few weeks, the survivors -- Wells Fargo (WFC), Bank of America (BAC), JPMorgan (JPM), Citigroup (C) TD Ameritrade (AMTD) and countless small, regional banks -- must choose between customers and shareholders.

Extending credit to customers and thereby maintaining sometimes longstanding relationships runs the risk of wasting precious balance-sheet space on what could be a losing bet. Washington Mutual and Wachovia (WB) both experienced firsthand what happens when banks load up on what turn out to be bad loans.

On the other hand, banks make money -- well, they used to, anyway -- by the simple business strategy of borrowing cheap (deposits), lending out at higher rates (mortgages, credit cards, construction loans, etc.) and picking up the spread in the middle. If they don't engage in this, their core business, future earnings prospects could be dire.

Banks must carefully balance continuing profit-generating business while protecting against future losses. And with the risk management track record many have racked up in the past year, it shouldn't come as a surprise if most choose prudence over profits in the years to come.

Meanwhile, back on Main Street, business owners who just weeks ago couldn't spell "credit default swap" are starting to learn why the tangled web of untested, unregulated financial derivatives that tied the world's financial system together matter to even the smallest of businesses.

It''s official: This is no longer just Wall Street's problem.