Fiscal Stimulus: the Rest of the Story

You can lead a consumer to credit, but you can't make him borrow. What now threatens our financial system is a collective loss of confidence. Consumers will spend if they can count on future income to refill their wallets. Businesses will borrow to expand if they can count on future cash flow to service their debt. Investors will lend if they can count on eventual repayment of principal with a reasonable rate of return. They all need to share the faith that what goes around will come around--the velocity of money.

Because of massive borrowing and risk tolerance in recent years, the interdependency among all these parties is heightened, leaving them positioned like dominoes. If one falls, they all fall. Subprime mortgages were the first domino, and Congress, the Fed, and government regulators are scrambling like mad to stop the cascade before it really gets rolling. For starters, the new stimulus plan will lift the limit on Federal Housing Administration loans to $725,000. The previous limit had been $362,000 for Fannie Mae and $417,000 and for Freddie Mac.

This should relieve the pressure on banks and holders of mortgage-backed securities. Meanwhile, businesses need to be encouraged to create new jobs and keep those paychecks coming. The plan announced late yesterday would accomplish this by allowing corporations and small businesses to write down 50% of the purchase of capital equipment now, rather than wait for it to depreciate more slowly over time. Congress could also consider doubling the annual limit on Section 179 expensing from the current $125,000. This would make sense particularly in the technology sector, where product cycles turn over so quickly.

Make no mistake: the plan under discussion, if enacted, will blow a big hole in the federal budget. We are looking at a potential FY 2008 deficit of half a trillion dollars. All yours, kids!