Trillions at Risk in Mortgage-Backed Fiasco

Housing Issue Basics

The money supply under Bush has approximately doubled. Now the cash stays mostly in accounts where it isn't spent, usually. However, during the housing boom, much of the money worked its way into the housing market. As home values shot up, more people borrowed on their equity. Subprime lending also skyrocketed as realtors were eager to sell into a bull market, to keep prices going upward. People with weak credit got into homes they're not able to afford. Attracted to teaser rates, many home purchasers wound up with too much houses and Adjustable Rate Mortgages (ARMs). These are expected to reset to much higher interest rates, which means people with marginal credit and lower income will be forced to pay even more of their income to housing.

Traditionally mortgage lenders established a fixed percentage of income to payment of housing. If for instance someone with $50,000/year income wanted a house, a more scrupulous lender would deny a mortgage application if the hypothetical payments on the loan--interest, principal, escrowed property and Private Mortgage Insurance (PMI)--were to exceed 30-35% of total income.

The 50K earner would be able to devote about 17K/year to housing, about $1400/month. Income caps mean a homeowner would be less likely to have to file bankruptcy. The 30-35% is not an arbitrary number, it's been calculated as a historically tested average maximum amount of income that borrowers can devote to their housing budget. While some people may be able to handle devoting more of their income to housing, with so many fixed expenses like insurance, taxes, car and loan payments, food, travel, as well as unexpected emergencies, increasing this amount is statistically imprudent.

Pushing past 40% is dangerous, but this became routine in the housing market bubble. Essentially, once the income threshold was crossed, this means the house payments would be less likely to be made, defaults and foreclosures would rise.

A rational and prudent lender understood that it was in their best interest to screen the borrower's credit worthiness in order to determine the likelihood that the mortage would be paid. Banks lose big when they have to take possession of a home--I've heard it said that banks want to be in the loan business, not the housing business.

In the irrational exuberance of the housing bull market, loan originators lost their minds. In the rush to cash in on the rising home values, issues like credit worthiness and ability to pay became secondary to the rising values of the homes, which most lenders and borrowers saw as rising so quickly as to make the long-term consequences of over-borrowing irrelevant. Borrowers could simply flip their homes and make huge profits quickly, and move on to the next better grade of housing.

Like all bubbles, equity or housing, this type of buying is simply unsustainable. Looking back with the benefit of completely rational hindsight, such buying and lending behaviors appear idiotic. Caught up in the moment, housing speculators enjoyed mind-boggling rates of return. Second and even third homes became common.

Limit on lending can be circumvented by faking the borrower's income, but this is mortgage fraud, a crime when and if the law is enforced. Under Bush, regulatory oversight of the housing industry--or any industry--has been woefully inadequate at the federal level. Still, assuming lenders and borrowers retain a shred of credibility, another method to get around lower incomes by creating a mortgage structured around artificially low payments. These include exotic mortgage products where the interest could reset later, or a giant balloon payment be required at some arbitrary point later, or a combination of methods.

Borrowers were eager to get into McMansions and other homes their parents could have only dreamt about at their comparable ages. They may not lied on their mortgage applications outright, but borrower incomes were undoubtedly inflated with full complicity by realtors and lenders. The idea was that everyone could benefit by taking the shortcuts. Lenders would sell their new homes quickly and buy new bigger ones, feeding the bubble to ever greater heights. To lenders and borrowers, the adjustable payments and balloons would never be an issue, as the steady upward housing prices meant refinancing in the future would be easy. And home equity loans could take care of living expenses--these loans would be available as long as the value of the homes went up.

The lender liked the riskier mortgages because they allowed them to sell more mortgages. The balloons required new loans to be taken out later. Balloon payments can require a borrower to find a whole new loan on a house that could easily exceed the value of the house--not a very easy loan to get.

Now the value of the house is a crucial consideration over the longer term. If the amount borrowed exceeds the house's value, the borrower is in a situation called negative equity. Every day that that the home's resale value falls is a day when the homeowner loses equity. Whereas during the bubble the higher values allowed homeowners to take out home equity loans, a crashing market meant that such loans weren't available and could not be secured by the difference of what is owed on a home and what it's worth.

The biggest threat of associated with negative equity is that the borrower would simply walk away from the house.

I am not a lawyer and do not provide legal advice, but the legal ramifications of walking away from a house need to be considered. In many states, a battery of fees could be levied to cover the costs of foreclosure in what is called a "deficiency judgment" directed at the departed homeowner. The costs of repaying a mortgage could be far lower once all the legal penalties are assessed.

Bankruptcy generally allows the home to be retained, but qualifying might be harder under changes in the law made during the Bush years. Many financially stressed home buyers may be unable to file a Chapter 7 because their incomes are too high. A Chapter 13 filing will require ongoing bill payments that may not be lower, which means the home may be secured but high debts loads remain.

A "deed in lieu of foreclosure" is a safety valve for debtors considering leaving their house. This legal maneuver avoids the fees that could come by just walking away and basically means the bank gets the house back and new terms can be arranged. Consequences might include damage to the credit rating, but certainly the overall financial damage would be far less than if a "deficiency judgment" were made against the borrower by the Court should they abandon a home.

Research your legal options if you're in over your head. Many people don't and suffer gravely in the Courts as a result.

Economic Impacts

Reducing home equity loans--which have skyrocketed over the past decade--has dampened consumer spending, but perhaps this effect is delayed. Before the loss of borrowing capacity is felt in lower consumer spending, new home construction will likely lead the economy downward. For decades new home construction has been used as the key benchmark for economic activity in the United States. If we are to judge our economy strictly by the demand for new housing, we're surely in for dark times ahead. Maybe the government is seeking a new economic indicator as we seek, so the picture doesn't seem as bleak.

There is of course the direct employment of millions at stake in a general economic slowdown, but specifically at greatest risk are all the service jobs relating to the mortgage industry. Buying homes generates a lot of work. If fewer people buy homes, it figures that there will be less employment. The housing and mortgage industries have contributed to about one third of all new jobs during the Bush years, so the stakes are high.

We've been told that the American economy is migrating away from economic cycles, that recessions and depressions are a thing of the past. Looking at the housing peak, and how dependent the US economy is on the housing market, we will see a serious drop in economic activity, GDP, and employment, which will of course lead to cascading social effects like higher poverty and crime. Divorcing the US from the ups and downs of the economic cycle would have been a great achievement, but this recent housing downturn will prove a serious test of any new economic paradigm that excludes recessions.

In truth, housing is cyclical--what goes up must go down. It's only the severity of the inclines and depths and heights of the peaks and valleys that are unknown.

While predicting the peak was impossible in the most recent bubble, predictable indeed was the notion that a peak would most certainly one day arrive. For this reason it's the lenders who bear the most blame for they knew the housing market would eventually stop going up. Accepting the inevitable and doing something about it are two entirely different options, though.

Looking for a Way Out

Printing money won't save us. As I said, the increase in the money supply is huge, but this isn't an indication that the money is being spent. It could be left in money markets or overseas, in the banks of foreign countries. The Fed can offer up huge sums for banks to lend, but if the consumer is tapped out, or economic conditions worsen, the banks will lend more but only at greater risk of default.

Government bonds compete with borrowing by corporations. US debt has grown readily and borrowing appears to be the method by which we pay for our wars and social programs. As a hardcore borrower, government has a vested interest in keeping the cost of its borrowing down by lowering interest rates. The same can be said of consumers, who are also heavily in debt, to the point any spending increases must come from more borrowing.

Lower rates means more borrowing, and borrowing, especially by consumers, is the leading source of spending. Unfortunately, Americans don't save much anymore, which means all income is devoted to servicing debt, taxes, and consumer spending.

Ignoring the obvious consequences of millions of baby boomers going into retirement, the lack of investments means our economy is dependent on borrowing. Our economy is based on lending--if lending shrinks, GDP shrinks. Less growth also makes it that much harder for lenders to expand economic activity, as sales revenues drop.

The Fed is now caught in a serious dilemna. To continue to lower interest rates will sustain the economy. Money will be getting cheaper and people and corporate lenders will be able to expand purchases and growth, by achieving rates of return that pay off the relative lower level of interest required by lenders. Eventually, though, the sheer quantity of borrowing will be so great as to make repayment of debt increasingly less plausible. In other words, the debt will become unwieldy, even if low interest rates suppress the real impact of the borrowing.

Debts will be so huge that increasing amount of money available to lend will simply sustain bad loans and other imprudent decisions. Banks could continually lend, but the asset prices used to back them may not go up forever. Then banks would be in the business of subsidizing hoemowners--a quasi-governmental function, not the exercise of caution in a free market environment which capitalism requires in order to function as intended.

A command control type economy will become unwieldy, as the Soviet model showed us. No matter how much lending the Fed can encourage, the dollars that are lent must be repaid. If at some point the loans appear unmanageable, creditors will cut off further lending. An end to the borrowing addiction is what the borrower fears most. This will happen to our government last, as our government retains very useful method to reduce the cost of repayment: inflation. It can simply spend faster than the rate of underlying economic growth, to the point the currency loses value. In other words, when too much money chases too few goods, and purchasing power erodes, paying off debt is easier.

In an inflationary situation, prices rise because money--a commodity--is both more plentiful and more in demand. Were the supply of money to be relativelyconstant--increasing only in proportion to how much overall production increases--it would be valued more and people would spend less. Yet the underlying money bubble that has emerged out of Fed monetary policies and housing price increases means too much money is already out there, existing somewhere, where it could be put into play and spent on goods and services--magnifying the oversupply of money. As long as money lies dormant and salaries stay flat and productivity is good, inflation is no problem.

Now if the economy were growing not too fast then spending the money might not cause inflation if more were gradually spent and production rose in response. But human factors shape economics--economics is after all a science based on the sum total of human behaviors. So when people have more money, they spend more. If too many people spend too much money, prices will rise too fast. Initially, the rising prices at first should discourage spending; this Christmas will be a good test as it's the first that has come at the end of the housing bubble. If after the slowdown in purchases, prices stay high or continue to go up, consumers might realize that prices are going up for good and spend more before prices get too high. This exacerbates inflation as more and more money is pumped into buying consumer goods.

Unfortunately all fiat currencies seem go this way eventually--or at least this is what advocates of a gold standard say. The discipline required to preserve the currency's value just erodes. There are two big contributory causes--government spending is the first. Congress must choose between fiscal discipline and disappointing their constituencies--the same people that they must please in order to get re-elected. Our spending has been skyrocketing. The second problem is that inflation is very tempting for heavy borrowers. The old debt can be paid off with newly printed dollars.

Inflation and the marketplace ultimately determine the value of a fiat currency value in terms of how much it can buy. Money is a commodity with a price, supply, and demand. If the Federal debt becomes unmanageable (many have argued it has crossed this point) then the Federal Reserve will end up selling Treasuries to itself, basically creating money out of thin air under the promise to repay its debts. The interest on the Treasuries will be simply printed up, a envious possibility denied all borrowers save governments which issue fiat currrency.

Now if governments were forced to base their currency on a real asset like gold, they'd be forced to make repayments out of tax revenues here and now. Such a government would be therefore less likely to lend, knowing the true opportunity cost and the fact that they only had so much gold in their reserves out of which they could pay their debts. Another technique is "starving the beast", or forcing governments to burn through their credit and slash spending out of necessity--see a description of this concept at the bottom of this post.

What Happened to our Money?

In 1913, when the Federal Reserve was created, Congress essentially outsourced its ability to make money--both literally and figuratively--, as the issuance of money is its right under the Constitution. The Federal Reserve lent to banks on behalf of the government, which then owed the Fed, which in turned owed the Federal Government. Banks could then charge interest on the money they borrowed at low rates from the Federal Reserve.

Traditionally the banks would make sure that the supply of money was constrained through two mechanisms: fractional reserves and lending risk. Lending meant the possibility of default--no banks would loan against its own best interest if it could avoid it. Reserve requirements also forced banks to keep some capital in reserve, which meant they couldn't loan out whatever they wanted (still the fractional reserve system does mean they can loan out virtually unlimited amounts of money just as long as they keep some--1/9th or so--back.)

Things have changed. Money no longer represent purely an asset, but represents a claim to a debt. Therefore when you have money you have nothing but a promise to receive money, in itself an odd concept. Into this upside down world, banks have created assets out of thin air, called derivatives. Rather than keep deposits, they can loan them out in exchange for a promise to be repaid. In their quest to increase returns, banks turned to risky mortgage-backed securities, which are bundles of mortgages that are promises to pay backed only by the value of the homes, which we know is falling.

Now how much derivates are there? Well, I've been trying to read a report called the Call Report, which gathers information on the "notional amount of deriviates contracts." As far as I can tell, the Top 25 Commercial Banks have about $6.4 trillion in assets and $152 trillion in derivatives. I might be misreading the report (page 22), because that number seems unbelievable.

On page 6, the report explains that "the notional amount of derivatives contracts does not provide a useful measure of either market or credit risks." It clarifies that 42% of the derivatives are from 1-5 years out, which would be a generally positive sign if they were a more conventionally structured form of debt. The derivates are also highly rated, but this could be misleading, as one recent sale of MBS held by E-Trade suggests (see Engdahl article below).

Now a good chunk of the derivates might be offsetting, where one group of forwards to buy is counterbalanced with another group of forwards to sell. So we can't assume the size of the derivates market is an indicator of the risk. But the sheer amount of derivatives makes me seriously question the stability of our banking system. Some banks are worse than others--JP Morgan Chase has $79 trillion in derivatives and only $1.2 trillion in assets. Even if 90% of the derivatives could be liquidated without any losses, the bank would still be forced to cover $7.9 trillion with only $1.2 in the bank.

The huge imbalance might reflect the fractional reserve system where 11 cents are kept in reserve for every dollar lent. One dollar of assets under such a system could create many times more in borrowings. It may be that the $79 trillion to $1.2 trillion ratio reflects the maximum extension of lending under the reserve system, where 8/9ths of all money lent is lent out in turn. However the amount of derivatives relative to assets varies, and some banks elect to avoid derivates. Regions Bank has a ratio of approximately 3 dollars in assets for every dollar of derivates, as does the US Bank Association of Ohio.

A lot of the derivates are based on--you guessed it--housing loans! So the banks future revenues are very much tied to the ability of homeowners to pay their mortgages in the future. And because of the fractional reserve's mutliplier effect, the effect of one bad loan could be magnified many times over because the bank has sold off its future rights to receive mortgage income. In other words, the mortages have been packaged and discounted in the present based on the assumption of the repayment of principal and continued interest, as well as certain rates of default.

Even if the bank hasn't sold off its future income stream, it likely owns mortgage-backed securities from other financial entities. Therefore, the financial system is very vulnerable overall as derivatives might only be worth a fraction of their value as stated on the books. To make matters worse, many derivates based their value on other derivatives, so the collapse of one card could send the whole pyramid crashing down as the credit contagion spirals out of control. Subprime defaults might be the catalyst to a wider crisis involving higher rated debt instruments, which might be outside the mortgage markets entirely, seeded in presumably safe money markets and the like.

Many banks are also responsible for insuring the mortgages as a condition of their sale. So even if they no longer own the security, they could be on the hook for losses. Non-bank insurers would quickly collapse without access to infinite capital offered through the Federal Reserve, so don't expect financial relief from them.

The crisis could quickly escalate. The price tumble on some bond funds in August was not revealed in the mainstream media for good reason. I saw that the value on many fixed income funds had collapsed 50% in one week! It was early or mid-August, I believe. I don't know how closley you follow the markets, but a one week collapse of that magnitude gives one reason to pause. Fixed income is viewed as safer and a good choice for retirement investments, but risks may be far higher than most investment managers would admit. While mortgage-backed securities may offer income, the underlying principal may be eroding as the result of a deteriorating housing market and problems with defaults. As defaults rise and insurers are overwhelmed, the value of these debts--stacked atop each other as they are--can crumble.

The massive "injection" of Federal funds coinciding with the fixed income price depreciation appeared to stabilize the rapid spiral toward asset liquidation, but the potential for a similar meltdown remains today. The Fed basically offered money at ultra-low rates to banks so they could pay off the people who wanted to liquidate their investments. Rather than prevent a run on the banks like what happened to a major British bank (Northern Rock) last summer, the Fed opened up a dsiscount window with over $100 billion to lend cheap.

I don't give investment advice, but I'd be extremely careful with bonds and fixed income and financial services stocks. Well-informed investors have sought to diversify internationally. Going outside the US might not save you, as one example shows that the shaky debt was sold to firms overseas.

Bill Engdahl's "The Financial Tsunami: Sub-Prime Mortgage Debt is but the Tip of the Iceberg" brings up a court ruling against the US branch of Deutschbank.

The Judge asked the Deutschbank's US subsidiary to show documents proving legal title and the bank could not, Engdahl says in his article. Apparently the "global securitization" of bundled mortgages means that no one bank owns any one home but rather the homeowner debts are spread through a basker of lenders, of which Deutschbank's US branch is merely one stakeholder. According to Engdahl, no single house that is part of a mortgage-backed pool can be claimed as the exclusive property of a single lender.

Some mortgages might default within the portfolio, but no lender can do much to take possession of the properties until foreclosure has run its course. Foreclosure might punish the borrower, but it hurts lenders because they can struggle to liquidate foreclosed homes. The subprime portions of these mortgage-backed securities may be worth pennies on the dollar. And to make matter worse, the more foreclosures worsens the housing glut and pushes price down. Lenders might require higher interest to compensate for their higher risks.

Legal protection for individual homeowners means that the real market value of mortgage-backed securities is much lower than their initial value. The collateral on which the securities are based is unfounded and a rising number of foreclosures needs to be anticipated. Therefore in a secondary market, where the Collateralized Debt Obligations sold, they could fetch nowhere near the prices which they sold for.

In his article "Saint Joe and the impending global financial crisis" Mike Whitney explains the impact of one recent liquidation of mortgage-backed securities:

What is particularly distressing about the E*Trade sale is that over 60 percent of the $3 billion portfolio “WERE RATED DOUBLE-A OR HIGHER.” That means that even the best of these mortgage-backed bonds are pure, unalloyed garbage. This is really the worst possible news for Wall Street. It means that trillions of dollars of bonds which are currently held by banks, insurance companies, retirement funds, foreign banks and hedge funds will be slashed to 27-cents on the dollar OR LOWER.

To Bail Or Bail Out

The recent intervention is an effort to head off foreclosures. The so-called bail out for subprime mortgages is an industry-headed effort and takes no federal funds. Nonetheless, the effort has been heavily critized as interventionist, as meddling.

The criticism of help comes largely from the right, which loves to blame politicians and their predisposition to meddle with the free markets as the greatest source of problems in the markets, which they view as functioning best when left alone by government.

I sympathize with the leave-the market-alone people, but the human costs of massive defaults is staggering. Also, I think laissez faire economic is an easy choice when times are generally good, but almost no government can resist the temptation to start bailing out cherished industries which housing and banking must be considered. The anti-interventionists seem certain to lose--the Depression saw the rise of their much-despised social programs under FDR's New Deal. Later, we saw interventions with Chrysler under Carter, and tariff protections for the steel industry under George W. Bush. Political considerations trump economic ones in Washington, particularly during times of economic upheaval.

Government action may more of a threat than a benefit. Now helping out over-stretched buyers is a commendable idea and disproportionally helps minorities. Higher borrowing costs could come out of any intervention, though, if lenders are limited in their legal rights. It is after all their money they lend out, and no lender will be inclined to lend if it means their money isn't protected by contract law.

Mortgages subject to renegotiation are unattractive to investors. Mortgage-backed securities lose much of their appeal when mortgages are vulnerable to restructure in terms favorable to the borrower, which often comes at the expense of the lender and their shareholders and creditors.

The government--lender of last resort--likely steps in to buy mortgages no one else wants. Already the quasi-governmental corporations Fannie Mae and Freddie Mac have taken a beating on their MBS holdings. Unlike private lenders though, those companies have the strength of the federal government behind their obligations; if need be the money could be printed up and sent to their shareholders to cover losses suffered from investing in mortgages.

Crowding private lenders out could lead to a market for mortgage securities dominated by government, which would make the market for borrowers far less efficient in the long-term. Faced with the infinite quantities of money available to government at no cost, private sources of financing for home financing would dry up. This would be like a middleman competing with their supplier for the same customers; the Feds have the benefit of essentially free money. The banks pay interest to the Federal Reserve, which as the middleman gets its cut on any borrowing. Now the government could go direct, which would require cutting out private mortgage originators, and replace the bank, and take its profits and assume its risks. The banking industry would likely be crippled forever and the Fed proven to be unnecessary, which would be a wholly unacceptable development for those who profit from lending what is essentially our money back to us.

Interest rates on mortages--and therefore their attractiveness to investors--would be set not by what the market was willing to pay but what a government acting in the capacity of a command and control economy would determine. Little distinction might be made between risky and less risky mortgages if government caps were instituted, or the legal rights of lenders subjugated to government decree. Shouldn't lenders be allowed to control how much they get back in turn for their risk?

Maybe the comparison would be easier to make if you had enough money to lend yourself. Would you lend your own money out without any guarantee? Why should a bank or an investor lend money out if the legal contracts they use aren't honored? The risk of government intervening on the behalf of borrowers must offer a corresponding risk premium to the potential extender of credit. If the government controls the mortgage market ad nauseum, private lenders will be shut out and capital will flee.

Rather than abandon any intervention, I support earnest enforcement of regulations already on the books--an area of enforcement much neglected under Bush (see my "Wild Ride..." entry last month). Many rules have been avoided and laws flaunted under the idea that the best government is one that governs least.

While it'd be great to imagine that our free markets are so flawless as to punish every mistake, I think this credit crisis shows that the real cultprits will not be the ones who pay the greatest price for their mistakes. Those people will be off jetting around the Islands, leaving investors with mortgage-backed securities worth pennies on the dollar and millions out of work.

Ben Stein blames fund manager greed for the problem:

It's now clear that some of the major players on Wall Street were making fortunes bundling junky subprime mortgage instruments and selling this garbage into the financial markets. The heads of some of the major brokerages and investment banks approved of this conduct and reaped the rewards when the market was hot -- i.e., when the market was fooled by what was being sold.

Now some of these people are being fired. But when they leave, they get immense pay and benefits packages that would leave the rest of us speechless if we got them for good conduct.

There's something drastically wrong when a conspiracy of men and women can do this kind of damage to the financial well-being of the nation and get away with it. On a local level, hundreds of thousands of borrowers were sold on mortgages with terms they barely understood. Now some of them will lose their homes. As far as I know, punishment for this sort of misconduct is barely meted out at all.link

Regulatory oversight is required to prevent certain abuses. The political aim to increase home ownership might not be what it is claimed to be (see Clive Crook's article Housebound in The Atlantic Monthly/ subs. req'd).

Politically, I'm supportive of trying to help strapped homeowners but economically, I think meddling in the mortgage industry is a big mistake. A government bailout could also send the message that irresponsibility by the lenders--extending too much money too easily and packaging the debt in multilayered MBSs--will be rewarded. Perhaps the best course of action long-term is to make the lenders suffer defaults and losses, take their punishment for lending out too easily. Perhaps investors should be punished for chasing the too-good-to-be-true rates offered by highly collateralized debt obligations.

But the MBS problem wasn't created by individual investors. Starting in the early 00's, under Bush, money markets began buying huge quanitites of Collateralized Debt Obligations. Have you ever tried to read a money market prospectus or annual report? Trying to understand what these debt securities were requires an advanced finance degree which is fundamentally a bad sign. I guess I prescribe to the Peter Lynch school of investing in that I think people should buy what they know. While I found the prolific legalese garbage worrisome, but what was I to do? Money markets are very large pools of capital, so the increase in CDOs was largely insignificant, then it grew and grew as fund managers sought any means available to repackage and sell mortgage debt. Eventually the securities bore no direct relationship to the underlying assets on which they were based.

So I, like so many other investors, just went along, albeit with not very much money invested. Am I therefore to be punished for taking more risks than I thought, for investing in something broadly considered to be the safest form of fixed income: the money market fund? The market isn't perfect; it doesn't punish perfectly, or even fairly. Despite the obvious imperfection of the capital markets, they remain the most efficient when left alone. Actions and regulations need to be pursued against lenders, but out of due diligence and routine procedural requirements, not as part of an ad hoc response to a crisis engineered by underregulated and irresponsible lending.

Concept (from Above)

"Starve the beast" is a pseudo-libertarian concept that the excesses of federal spending can be limited by drawing down the ability of the Feds to borrow. In other words, make borrowing harder so money can't be borrowed; spending should drop as a result. While great in principle, there appears to be no limitation on the part of the Feds to borrow at present, so it will take a total end to all borrowing to stop the runaway train. Since we are now borrowing about $1 billion a day to sustain federal spending, this cratering could one day come and stop the train, but it will also greatly shock the economy, in a way maybe not that different from shock and awe disaster capitalism, which could usher in a libertarian fantasy of limited government and pay-as-you-go spending, once the shock waves subsided.

Stopping our borrowing may in fact be impossible until we can no longer borrow, at which point money can be printed and spent, which could easily lead to hyperinflation and a rapid economic collapse like that seen in Germany after World War One, leading to the rise of Hitler. Trying to ignore the consequences of unrestrained and completely uncontrolled capitalism could destroy the American economy and cripple our way of life. Transitions need to be eased in; the shock of ending virtually all federal spending overnight could decimate the economy, especially considering how the federal government is our country's largest employer and how dependent on federal spending so many corporations have become.

Look at suppliers of our war machine, builders of submarines--not exactly a platform known for its counter-terrorist value--and the like. Appeasing the warfare state is popular on the right because militarism and nationalism are their sources of strength. By feeding the war machine, we sustain our economy, but the war and level of spending is itself unsustainable. Therefore the wars will have to one day end, out of necessity, as we will simply run out of money. As a progressive, I'd much rather see the war machine starved, but starving the beast is usually defined in terms of going after "social spending" and entitlements--the so-called welfare state--and very rarely refers to stopping the warfare state, which I believe represents a tapeworm far worse for our economy than "social spending."

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