How Adjusted Mortgage Underwriting Standards Circulate Money and Kick Start the Economy

Money talks, and when it does, we listen. So we’ve all, undoubtedly, heard the sound of circulating cash. As the dollar moves between buyer and seller, an anticipatory “Cha…” sets the buck in motion, while a conclusive “…Ching” finalizes the exchange. “Cha-Ching!” – the chime of money in motion and growing prosperity. However, once the drowning noise of collection agencies disrupt the harmonious flow of currency, our stagnating money supply leaves only a melancholy echo from better days, leaving us as we are today… asking: where is the money? How ’bout a philosophical approach…

If a dollar falls in the woods, but no one is around to spend it, does it make a sound?

NO!

A Silent Dollar is a Worthless Dollar: When the buck is mute, it has no more value than a rotting leaf on the forest floor. Nevertheless, we value the dollar by its theoretical purchase power, pitting it against precious metals and competing currencies, leaving a nice, clean, silent, number we proclaim to be the “value of the dollar.” The name, a misnomer no doubt, would slide closer to descriptive accuracy as “the theoretical value of the dollar,” so as to avoid the flawed presumption that the “value” is a capable measure of overall economic wellbeing. Simply put, silent money is money unused, unspent, and utterly motionless; unusable money provides no more valuable benefit to the consumer than the dormant dollar in the woods, miles away from the nearest spender. In a sense, the may as well not exist. A dollar’s true value rests in the distance it can travel – how many times it can be spent, as the dollar generates revenue for a new person each and every time it is spent. Once someone decides not to spend the dollar, hiding it from the rest of the economy, the dollar stops circulating, and no one else may realize its value.

So what’s the point? How does non-circulation apply to the U.S. economy today?

EXAMPLE: the consequences of non-circulating money: Imagine standing in a circle with three friends with one dollar amongst you all. If you begin passing the dollar around the circle, than each person holds the buck and may use it to gain some benefit. Person 1 (that’s you!) borrows one dollar from a local bank and spends the buck on a home bought from person 2, who receives the dollar and uses it to buy food from person 3, who uses the buck to pay the salary of her employee – person 4, who uses the money to buy gasoline from you (Person 1), the upstanding gas station owner. As the dollar continues around the circle and gains speed, each person realizes more and more value from just one superfast dollar (Cha Ching!). Now, imagine someone loses the dollar; it would devastate the group of friends, as it could no longer be used to pay for mortgages, food, salaries, or gasoline. While the risk of misplacing the dollar is slim, eventually, Person 1 must repay the bank the one dollar borrowed, and unless the bank lends the buck back to someone in the circle, our group may be one dollar short of paying the bills, and then no one will lend any new money to our group of delinquent debtors. Instead being the powerful device that provides shelter, food, salaries, and fuel, the dollar is locked away in the bank, where it can provide no value at all. The dollar is motionless, silent.

How increasing interest rates froze the money supply, leaving American’s unable to pay their debts: Despite the simplicity of the example, you might use it to understand how money can only provide value when in circulation, and if so, you might realize why so many people have not been passed money and, thereby, cannot pass the money along themselves. Refer back to our example above, and pretend that Person 1 borrowed the $1 to buy the house with floating interest mortgage.

When interest rates rise, Person 1 suddenly owes $2 instead of $1 to the bank, and Person 1 can’t pay in full… the buck stops moving in the circle, as the bank is short $1 and can’t pay its creditors, so the bank has no more money to lend back into the circle. Without any money circulating between the four friends, none are able to get any additional value from the $1 that once circulated amongst them. The example is a very simplified display of what happened during the housing collapse, and how the collapse affected other areas of the economy, as the missing $1 prevented Persons 2, 3, and 4 from paying for food, salaries and fuel, respectively. The original $1 in circulation still exists in our example, but it merely ceased circulating, and no one could then realize the value of the dollar by receiving it and, in turn, spending it. Hence, the dollar’s value lies in its ability to be spent and passed along in circulation.  The value of a dollar is not only the amount of gold it may purchase, but it is the amount it can purchase multiplied by the number of times the dollar can be used and re-used to make such purchases. Even if the dollar in the woods is worth two gold bricks, it can be used Zero times to actually make that purchase,  and two gold bricks multiplied by zero equals ZERO – the dollar’s true value.

If the dollars of the world are imprisoned by banks or hidden under frugal mattresses, they provide no value to the economy as a whole. No matter how many dollars enter into “circulation,” none will provide any value unless they actually circulate. The Federal Reserve Bank (“The Fed”) has the power to increase the amount of money available in the market, and recently, the Fed fully exercised this power, increasing the supply of money in our economy to the max. The Fed traded its cash for agency securities, so now the cash might reach the pockets of our population, but it hasn’t, and few people (if any) have experienced any value from the new mountain of money- it’s silent and motionless (what a waste!).

So, why is the money frozen, and how might we get our hands on it, add it into circulation to begin realizing the value of the money?

The key is the Real Estate Market!

There is no single cause of the massive, motionless, money supply, but we can isolate one enormous player in the matter – mortgage lending underwriting requirements of banks. If we focus on the role of lenders in the Real Estate market, we inch closer to an answer. The largest purchase of the average individual is that of her home, and is thus the best way for individuals to free the most amount of money from the grips of the banking system, spend it on a house, and inject the money into circulation. Homes are the largest asset of the ordinary person, and home purchases are the largest purchases the common person is likely to ever make. So, if the key to reviving our economy is the transferring the pile of motionless money into circulation, one might suggest that best way of accomplishing such circulation is by encouraging home purchases, sales, and re-purchases. That way, the most people put the most amount of money into circulation.

What’s stopping banks from lending to home buyers, certainly Americans would like to capitalize on low interest rates and low housing prices?

Understand this, banks must borrow money before they can lend it to home buyers, and in doing so, the banks must be able to pay back their loans. The only way to do so is to sell the mortgage to a 3^rd party at a profit. For example,

• Bank 1 lends Bank 2 $100, in exchange for 1% interest + return of principal to be paid within 24 hours;
• Bank 2 lends $100 to Home Buyer in exchange for a 30-yr mortgage note @ 5% interest fixed.
• Bank 2 then offers the mortgage note for sale, asking $105.

Once Bank 2 sells the mortgage note, it returns $101 to Bank 1 in satisfaction of the debt, while Bank 2 retains $4 profit for itself. If Bank 2 cannot re-sell the mortgage note immediately, it cannot pay back Bank 1 in the given time frame. So who buys these mortgages from Bank 2? Most of the time, it’s either Fannie Mae or Freddie Mac, and neither is willing to re-purchase the mortgages currently, unless the home buyer/mortgagee is amongst the elite in creditworthiness. Therefore, all the extra cash available in the economy wont start circulating until Fannie and Freddie decide to lower their underwriting standards, accepting mortgage notes from more borrowers.

SOLUTION: By adjusting mortgage-underwriting standards, Fannie Mae and Freddie Mac will open the available money supply to more consumers to make large purchases; THUS, more consumers may inject large chunks of cash into circulation.

Obviously, the sub-prime mortgage crises has the country risk-averse, unwilling to take a change on anyone other than the most prime borrowers; however, if mortgages are designed more securely, where borrowers will not be surprised by sudden increases in their monthly mortgage payments, than the risks will not come close to rivaling the riskiness of loans designed during the sub-prime lending frenzy. The lowering of underwriting requirements is a must, in order to kick start economic recovery.

Again, money is valueless unless it circulates; money is currently not circulating. The Real Estate market fuels the single greatest circulation of money in the USA, as home purchases are the largest purchases made by ordinary individuals in the country. Therefore, the key to fueling money circulation is to encourage home purchasing. The only roadblock preventing homebuyers from actually buying is the strict underwriting of mortgage re-purchasers. Therefore, the best way to ignite money circulation, allowing the value of money to be experienced by many through the process of spending, earning, and re-spending is to allow home buyers to extract motionless, silent money from banks in large chunks (and the largest chunks come via home purchases), beginning the cycle of spending, passing money from the hands of one on to another, as opposed to allowing the Great American Dollar to remain dormant, imprisoned in bank vaults. With more money in circulation, the road to economic recovery will significantly shorten.

Check back later this week to learn how YOU can benefit from this knowledge… I’ll explain a few options to pursue and explain how to identify the right time to take action!  

Tony Salloum