Derivatives as Deficit Spending

There is much talk in Washington these days about reducing deficits in order to manage the public debt. However, there has been insufficient processing of the recent recession and no mention of derivatives increasing the marketability of questionable loans and therefore the liquidity of the credit markets has been made. Essentially, taking a junk mortgage and tranching it at AAA is printing money. The underlying economic conditions that would normally be reflected in a AAA instrument do not exist so essentially the difference in marketing the AAA from the junk is new money. Nobody has noticed that.
It is, in fact, borrowed new money since the consequences of mortgage default are amplified and must require extra reserves and possibly public financing. We learned that lesson in the last five years. We just haven't managed to adequately characterize the phenomenon. It is a form of deficit spending.
Now, the Federal Housing Agencies, which effectively are what Fannie Mae and Freddy Mac represent have proposed a derivative for multiunit housing to shore up demand. If it bubbles and bursts we'll all be liable for it and it's completely off ledger. When Pandora's Box was opened, derivatives were found inside.
Driving this insanity is the postindustrial concept of magic money. Everybody should have a nice house in a gated community. Therefore, everybody will have a nice house in a gated community. This is Disneyland after all, isn't it? We do, as a nation, prefer trial and error to doctinaire approaches and we are in the process of proving absolutely that Disneyland is a nice place to visit, but you wouldn't want to live there. You have to pay for those rides and, as the old saying goes, money doesn't grow on trees.
Be well and do good.

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