Seeking the Simple Solution

Note to our readers: We originally published the following commentary on February 24, 2009. It lays out Joe's suggested five-step plan toward recovery. We are now more than a year forward and we have yet to begin step one, though there are some rumblings regarding a debate on mortgage market reform.

It doesn't matter what you do or say
Just forget the things that you've been told
We can't do it any other way
Everybody's got to rock and roll.

- KISS

I'm a firm believer in the "KISS" methodology: Keep It Simple, Stupid.

So, when I think about the overall economy and the mess we are in, a simple solution naturally pops into mind. I haven't been able to discredit it, so I must share it with you. Please tell me if I go off track:

Step 1: Determine what to do with Fannie Mae and Freddie Mac.

Without diving into actual solutions, several decisions must be made. Unfortunately, Congress is dragging its feet as it does not want to kill these cash cows, if at all possible, and every viable solution seems to include doing so.

Step 2: Other large private institutions will determine how they fit into the new mortgage market.

If you were the CEO of a Wells Fargo or a Bank of America and woke up tomorrow with an undeniable desire to reenter the mortgage market in force, you would not do so. Why? Because Fannie and Freddie make up about 45 percent of the total market and until Congress points them in a general direction, you will not step out in front. Fannie and Freddie must take the lead, but other large institutions will surely follow as there are tremendous fees to be made in this $13 trillion market.

Step 3: Housing prices will stabilize.

With a functioning mortgage market providing loans to qualified borrowers in reasonable terms, home purchases will rise and home prices will stabilize. Without a functioning mortgage market, home prices will never stabilize at levels that require leveraged purchases.

Step 4: Consumer confidence will return.

Once home prices feel solid and perhaps even poised to rise at a reasonable pace, consumers will return to the shopping malls and the velocity of money will increase. This is the ultimate goal of all the government bailout and stimulus programs today: to encourage consumers to consume and investors to invest. Which brings us to the final step.

Step 5: Corporate profits rise, increasing investor confidence.

Completing this step will turn the current vicious cycle back into a virtuous cycle. As consumers consume and profits rise, institutional investors will begin putting idle funds to work in order to capture excess returns that have been so elusive up to now. The desire to earn excess returns is still out there, it's the opportunities that do not exist.

I do not believe any one of these steps can occur without the previous, which means the first step towards recovery is deciding how Fannie and Freddie will fit into the new mortgage market. Congress has yet to have any serious debate and Patrick Lawler, Chief Economist for Fannie and Freddie's regulator, recently said it could be up to a year before this issue is put to bed.

Let's hope step one isn't really a year away!

Key Developments

Retail sales rose 1.6 percent in March, after a revised increase of 0.5 percent in February, the biggest gain in four months. Excluding auto sales, retail activity posted a gain of 0.6 percent.

The consumer price index edged up 0.1 percent in March from the previous month. Excluding food and energy, the core gauge was flat for the month. On a year-over-year basis, CPI was up 2.3 percent, although core CPI increased modestly at 1.1 percent over the previous year.

Confidence among U.S. consumers unexpectedly fell in April to the lowest level in five months. The University of Michigan preliminary index dropped to 69.5 from a reading of 73.6 in March, due, in part, to slow job recovery and health care legislation.