Crisis Basics - It's the Real Estate, Stupid

The economic history of the last 35 years has been one of a series of financial frauds, each bigger than the last, amid a backdrop of stagnating industrial production and, along with it, a declining standard of living. Those failures unleashed an ethic of every man for himself. In a country that actually makes fewer and fewer things, the results have been predictable: paper entrepreneurship on an escalating scale.

The 1970s gave us Penn Central, Continental Illinois, and stupid farm lending. The 1980s gave us the Latin debt crisis and the S&L debacle. The 1990s gave us the dot.com frauds. The '00s almost gave us the theft of Social Security, but that was stopped at the last minute by what was left of the Democratic Party. Instead, we got Door #2, the residential real estate bubble.

Of course, there is also the Iraq War and the failure to deal with climate change, but those will have to wait for another time. The wolf at today's door is in residential real estate, where we've seen a speculative bubble in prices, fueled by reckless credit. While any discussions of "the residential real estate market" need to be tempered by recognizing the local nature of housing, the granting of credit is a national, even international phenomenon and therefore we can deal with this as a systemic fraud.

Something else: the crisis really isn't one of house prices but rather one of bad loans. It's the lending crisis that threatens to bring down the whole American economy. Prices are certainly an issue, but it's the inability of borrowers to service their loans that makes this the problem it is. Lenders abandoned their standards, allowing borrowers to abandon their prudence. It couldn't go on forever, so here we are.

Wasn't it the borrowers' fault, you might ask? To which I would reply, yes, of course it was. No one forced anyone else to borrow two or three times what they should have for a mortgage, relative to renting. But ultimately, the responsibility lies with he who is holding the wallet: the lender. So, if there is to be a bailout of any kind, we must be sure to reclaim the spoils from the lenders. All of them. Right up to, and including, the half-billion dollars worth of bonuses and stock options received by Angelo R. Mozilo, the reckless pig who runs Countrywide Financial, America's largest mortgage originator. Not to put too fine a point on it.

I digress. Housing prices peaked about a year ago, on average. Because markets are local, prices peaked before that in some places. Elsewhere (Seattle being an example) they're supposedly still rising. There isn't a Dow Jones House Index, so that's as close as we can get. But when the history of this meltdown is written, I think the top of the American housing market will be pinned in 2006.

Since then, we've seen growing signs of distress in credit markets. In the words of Creedence Clearwater Revival:

I see the bad loans a-risin'
I see trouble on the way
I see earthquakes and lightnin'
I see bad times today.

Chorus:
Don't shop around tonight,
Well, its bound to take your equity
There's a bad loan on the rise.

I hear hurricanes a-blowin'
I know the end is coming soon.
I fear rivers over flowin'
I hear the voice of the foreclosure auctioneer

Chorus

Hope you got your things together.
Hope you are quite prepared to move to a trailer park
Looks like were in for nasty weather
One CMO is taken for a thousand bad loans

Chorus

Okay, it doesn't rhyme. But you get the point. One month ago, it all came to a head. In August, credit markets locked up and the stock markets fluctuated while the sharpshooters in New York, Frankfurt, London, Tokyo and Hong Kong looked to see what the big central banks would do. On cue, Germany's Bundesbank, America's Federal Reserve, and some others stepped in to spread some quicklime on the rotting corpse, in the form of creating some money and reducing interest rates. Will it work? Call me a skeptic. To find out why, keep reading.