Treating symptoms is not cure for economic malaise

By DAVID MOON, Moon Capital Management, LLC
September 12, 2010


In a 1999 study, a number of pediatricians admitted to inappropriately prescribing antibiotics for children with viruses. Why? Because many parents with sick children expect doctors to "do something" to make the kids feel better, even if the proper course of action is to simply let the virus run its natural course.

Much of what our government officials have been doing with respect to the economy in the past three years falls into the “unneeded antibiotic” category. A TARP can only cover the problem, not solve it.

There are several possible fundamental causes for any recession. Some are caused by an unnecessary buildup in business inventories. Others are caused by a decline in consumer spending.

Neither of these is the core cause of our continuing economic malaise.

This current recession was rooted in an excess of debt, relative both to assets and income. Good and honest people can disagree about the culprit. It might have been caused by naive or irresponsible consumers or unscrupulous lenders. We can always blame that nebulous nemesis, Wall Street.

But our problems are not the result of too little spending. The recession was not caused by too few roads, airport runways or light passenger rail lines. Building more of those things won't cure our ills, either.

Our core economy won't be solid again until we fix its foundation: there must be more assets backing the outstanding debt. Stated another way, there must be less debt relative to the amount of asset collateral.

The solution requires debt liquidation, which, in this context, is a nice way of saying more bankruptcies and foreclosures. It means banks are going to have to increase their reserves and write off more bad loans. It means the recognition of more failure.

It also means that anything we do to prop up a loan that isn't backed by a satisfactory level of assets and income is a waste of our time and money. Those bad loans will default. The only question is when.

Propping them up doesn't even postpone the inevitable very long. Sixty percent of the mortgage modifications completed by banks in 2008 were in default a year later.

Why? Because even after the modification, 61 percent of those borrowers’ income was needed just to service all of their various forms of debt.

On an individual level, there are people with income problems. We can help a specific family by creating an otherwise unneeded job to ensure that someone performs some work in exchange for government subsidy.

But that simply treats a symptom.

Unemployment is not the cause of our problem. It is the result. Treating a child’s fever makes her feel better, but it doesn’t cure her underlying medical condition.

There are still billions of dollars in bad loans being held by hundreds of banks. The sooner the lenders and borrowers face the ugly consequences of this situation, the sooner our economy can reestablish a strong foundation.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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