Don t Expect Much Stimulus From The Government Stimulus Plan

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1 Overview/Analysis of the U.S. Government Stimulus Program The program is ambitious, but we do not believe it will work. Historically, most stimulus packages are undercut by substitution and pork effects, and the recently passed spending bill is largely the pork fest many predicted would occur. Isaac Commercial Real Estate Services, Worldwide. May 2009

2 Don t Expect Much Stimulus From The Government Stimulus Plan By Dr. Peter Linneman, PhD Chief Economist, NAI Global Principal, Linneman Associates In a purported attempt to stabilize the fi nancial decline in the U.S., the Obama administration proposed a fourpart recovery program. The fi rst part was the $787 billion fi scal stimulus bill passed in February 2009 to boost U.S. spending. The plan includes a federal commitment to healthcare and education; a shift to more sustainable sources from oil and gas; modestly high funding for infrastructure; tax breaks for some, higher taxes for the highest 5% earners; and an increased future debt burden. Combined with his initial budget proposal, President Obama proposes a complete overhaul of the U.S. economy, which will result in a near doubling of government spending, higher taxes and a staggering increase in the budget defi cit. Will it work? Overall, the Obama program is ambitious, but we do not believe it will stimulate the economy. After all, if government spending created growth or stimulated the economy, our growth over the last eight years would have been out of sight. The fact is that historically, most stimulus packages are undercut by substitution and pork effects, and the recently passed spending bill is largely the pork fest we predicted would occur. Following is our analysis of the plan: Education is a key point in President Obama s plan and a major part of the stimulus plan. The President wants to make education affordable, accessible and purposeful for all Americans. He wants to upgrade 10,000 schools and improve learning for approximately 5 million children, as well as triple the number of undergraduate and graduate fellowships in science. He also wants to modernize higher education and increase Pell Grants. Over $130 billion was targeted for this purpose and, unfortunately, much of this spending will merely replace local spending while expanding the reach of the federal government. A further $90 billion will to go to the construction and repair of the country s infrastructure. This includes fi xing and building highways, improving rail, transit, and water projects, and making federal and other public buildings energy efficient in the long run. Although this is the plan, few meaningful infrastructure programs are shovel ready. Most of the money will be spent on second- and third-tier impact projects or will merely replace state and local spending, again expanding federal reaches.

3 Some $50 billion will be spent on development of clean, though ineffi cient, energy sources. Targets also include research for alternative energy, repairing public housing and weather-proofi ng modest-income homes. The President would also like to expand the science and technology sectors in order to fi nd the next great discovery. However, this will not only replace state and local efforts, but will displace private efforts as well. Currently available alternative energy options are very ineffi cient, generally requiring oil prices of $200-$400 per barrel to be economically feasible without subsidies. The healthcare sector will draw about $25 billion. President Obama wants to make healthcare available and affordable for all. Much of this money will go toward updating healthcare information technology and evaluating the most effective treatments. A prevention and wellness fund was also proposed, as well as the building of more community healthcare centers and the training of primary care providers. Again, these efforts will replace private efforts and, to date, digital health records have proven both ineffi cient and expensive. A tax cut was proposed for 95% of American workers, as well as about $100 billion to increase benefi ts for the unemployed. Monies were also allocated for subsidizing defaulting home mortgages, community service employment for the elderly, alleviating hunger, state and local law enforcement, among others. Again this money will replace state and local efforts, not to mention that we do not believe in bailing out defaulters. The Obama administration s fi scal package also includes three proposals to try to stabilize the fi nancial system. These include the TALF (Term Asset-Backed Securities Lending Facility), the so-called PPIF (Public-Private Investment Fund), and the HASP (Homeowner Affordability and Stability Plan). We believe the TALF program offers a glimmer of hope. According to the Federal Reserve, Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated assetbacked securities (ABS) that are backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount (secured by the ABS) equal to the market value of each ABS, less some discount. The U.S. Treasury Department under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 will provide $20 billion of credit protection to the FRBNY in connection with the TALF. The PPIF plan combines the previously authorized funds of TARP and TALF, while additionally drawing upon the FDIC to guarantee new loans to purchase pre-2009 mortgages and mortgage securities. One program will work with a very small number of larger securities managers to purchase AAA mortgage securities, while its sister program will partner with a large number of private investors to purchase mortgages and mortgage pools. In each instance, the Treasury will invest up to 50% with these private partners on a pari passu basis Currently available alternative energy options are very ineffi cient, generally requiring oil prices of $200-$400 per barrel to be economically feasible without subsidies.

4 (subject to fees, warrants and promotes that are to be determined), while large amounts of debt will be provided by the Treasury (in the case of the securities program) or buyer debt guaranteed by the FDIC. The interest rate for this non-recourse debt is not yet known, but we anticipate it will be roughly 100 basis points over LIBOR. For the loan purchase program, it appears that debt at these rates will be roughly 85% of the purchase price, while for the securities purchase program the leverage may run as high as 92.5%. The PPIF program, one of the few Obama administration announcements that garnered any approval from the stock market, is a refi nement of the original proposal put forth by former Treasury Secretary Henry Paulson. The main difference is the introduction of private investors to assist the price discovery process, and the introduction of stunning amounts of cheap nonrecourse debt. PPIF will allow capital costs to fall to roughly 3.7% for the securities program and 4.7% for the loan program, even as equity target returns are 20% and 25% respectively. There is nothing like mounds of super cheap debt to reduce your capital cost! At these massively reduced capital costs, the value of the target assets will move back near par, even for those assets with impaired cash streams. We have long advocated the government insuring outstanding loans in exchange for a fee. By offering % non-recourse debt at massively below-market rates, this is effectively what PPIF intends to do. That is, the government is guaranteeing the current holder of these assets that they will get very near par value for their assets. HASP is a two-part subsidy. The fi rst part provides $200 billion to assist lenders in refi nancing safe mortgages and thus generating income for lenders, while the second part commits $75 billion to subsidizing mortgage lenders to lower their interest rates on new mortgages by 1-1.5% from current rates. As stated earlier, the Obama program is ambitious, but it will not stimulate the economy. The bill is long on special favors and short on long-term high net benefi t infrastructure. Of the $787 billion stimulus plan, $260 billion are earmarked for discretionary spending, a.k.a. pork. While there is much economic theory being exploited by fans of big government (e.g., communism theory was exploited by despots), there is no macro evidence that mass spending ever worked in stimulating the economy anywhere. It did not even work in the Great Depression when government spending was initially under 2% of GDP. The Obama plan is simply wasteful, non-stimulating, infl ation- and taxincreasing pork spending that will burden us one way or the other in the future. While there is much economic theory being exploited by fans of big government, there is no macro evidence that mass spending ever worked in stimulating the economy anywhere.

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