Kudlow’s Money Politics

Will Main Street Bail Out Wall Street?

The Wall Street brainiacs are panicked about sub-prime mortgages and the current stock market correction. But Main Street investors ‘” with their plentiful incomes and longer-term stock market horizons ‘” may ultimately bail them out.

Main Street rescuing Wall Street? It’s a compelling thought ‘” not only for the stock market, but the economy at large.

While Wall Street was busy conjuring up high-yielding bond packages that were heavily invested in unsustainable sub-prime mortgages ‘” and distributing these collateralized debt obligations to big institutional investors around the world ‘” Main Street was focused on the real economics of our nation. To this day, the American labor force is going to work, running the millions of small owner-operated companies that provide the wellspring of our prosperity. And Main Street is benefiting from an unprecedented global boom that is stocking our stores with affordable goods and creating plentiful new jobs as U.S. firms service the rise of new export markets.

With a record 146 million men and women working, and the unemployment rate at a historically low 4.6 percent, the American labor force has increased its after-tax real income by a whopping $257 billion. Nominal wages for non-supervisory workers alone have sprouted by $296 billion over the past year, according to Wall Street economist David Malpass. Average compensation per hour has grown 5.2 percent.

According to economist Joe LaVorgna, these high-income trends continue right to the present day. His tracking of employee tax withholding receipts collected daily by the U.S. Treasury shows 6 to 7 percent gains through early August.

All of this suggests that when adjustable rate mortgages are reset in the coming months and years, our large working population has the resources to handle it.

The pattern is the same for American business. After-tax corporate profits have grown $578 billion to $1.1 trillion over the past five years, which is why jobs, the economy, and the stock market have performed so well. Very simply, profitable businesses are creating the jobs that are providing the incomes for families to spend. It’s an enduring story: Second-quarter profits for S&P 500 companies increased more than twice what Wall Street expected.

Meanwhile, the Federal Reserve reports that businesses don’t even need new loans. Corporate cash flow is so strong that firms are generating $987 billion in funds internally, which is actually more than the $973 billion they are investing in capital goods for new plants, equipment, and office buildings.

Bottom line: While the sub-prime mortgage virus has temporarily infected banks, hedge funds, insurance companies, and other institutions, most of Middle America is doing just fine, thank you very much.

Sheila Bair, the very smart chair of the Federal Deposit Insurance Corporation, told me in an interview that 85 percent of the outstanding sub-prime mortgages at her member banks are being serviced on time. She also reports that the banking system is highly profitable and that capital adequacy is oversubscribed. Others report that less than 1 percent of the entire mortgage total in this country is in default, a minuscule amount.

The biggest problem in the stock market is that the sub-prime virus has caused a temporary credit and trading freeze. Markets have already devalued mortgage bond prices, but the banks are loath to acknowledge price drops that would translate into sizable third-quarter profit losses. This is silly and shortsighted. Countrywide, for example, the nation’s largest mortgage lender, has seen its stock drop by 40 percent; Bear Stearns has fallen 35 percent.

The sooner financial companies liquidate their losses, the faster markets will return to normalcy. The system is deleveraging, which in the long-term is a very healthy correction. Leveraged corporate loans are actually starting to trade-up once again, undoubtedly reflecting the money-good profits behind them.

Federal Reserve officials believe we have a temporary liquidity issue, not a solvency crisis. So, at the prevailing interest-rate target, the Fed and other central banks are prudently injecting $131 billion of new cash to ‘facilitate the orderly functioning’ of markets. Fed chairman Ben Bernanke has the story right.

And so does President Bush, who is arguing against government bailouts, which would wind up rewarding banks, hedge funds, and unscrupulous lenders for their poor judgment. (Do U.S. taxpayers really want to finance France’s BNP Paribas?) Market forces will see us through this correction. Mr. Bush is also on the money with his opposition to any and all tax increases, which would damage the work and business incentives that have been such a success in Middle America.

Nobody likes stiff stock market corrections. But if folks step back a bit they’ll see the many positives ‘” the jobs, the incomes, and the profits ‘” that will carry us through this difficult period.

They’ll see Main Street ‘” working and prospering.

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