This weekend, the Republican federal government will nationalize the financial system by taking over Fannie Mae and Freddy Mac. Richard Nixon once famously said, "We are all Keynesians now." Scratch that: We are all fascists now.
Last fall, when I wrote about the developing financial crisis, all of my instincts told me we'd end up here. But it's not something I really wanted to believe. The implications were too worrisome. But here we are. Believe it: The U.S. has taken a gigantic leap toward fascism by putting a right-wing government in charge of the biggest component of our financial system.
Some people would argue that we've been fascist since 1913, when Woodrow Wilson created the Federal Reserve System, which essentially ceded control over the coinage of money to the banks. But for most of its history, the Fed has been a hands-off player, confining itself to accommodating economic growth and contraction by managing the money supply.
That began to change in 1987, when Alan Greenspan created a so-called "plunge protection team" to rescue the stock market from that year's crash. For the last 20 years, the "PPT" has operated in the background, keeping financial markets stable during crises, including the 1998 bailout of the wildly misnamed hedge fund known as Long Term Capital Management, the NASDAQ crash of 2000-2002, and the aftermath of the attacks of Sept. 11, 2001.
In those situations and others the "news" media hasn't told us about, the Fed stepped in not just with liquidity -- its historic role -- but to manipulate markets and arrange bailouts. Not of individuals, but of corporate entities.
That's the difference between socialism and fascism. Socialists act on behalf of individuals against the interests of corporations; fascists act on behalf of corporations threatened by the actions or interests of individuals. In the end, the two approaches wind up looking similar to each other, but it's always worth remembering their differing roots.
Bailout: The mask is removed
Now, the federal government will directly control the mortgage finance system. Fannie and Freddie are bankrupt, so Uncle Sucker will guarantee their debts and take over the management. Not that the 9-figure bonuses -- to the left of the decimal point -- paid to their CEOs when those entities were "private" will be recovered.
That would be socialist, and this isn't a socialist government. The bonuses will remain in the hands of those who took them. We have a fascist government, and that is what fascists do. If Barack Obama should happen to win the November election, the fascists will prevent his government from seizing the loot. Just wait. You'll see.
The news media, such as it is, reports that the bailout will cost tens of billions of dollars. They are off by a factor of roughly 100. The direct cost will be several trillion dollars. The indirect cost will be yet higher: In case anyone hasn't noticed, the collapse of the residential real estate bubble is rapidly spreading, as I predicted last fall when I wrote about a pessimistic disaster scenario.
Home values are down an average of about 20% from the peak, which means that people can no longer use their home equity to fund consumption. The Fed's attempt to paper all of this over (more on that in a bit), has killed the dollar, which in turn has ignited inflation, especially in energy and food.
Other consumption is falling, which is causing unemployment to lift off the launch pad. State and local governments, historically a counterweight to economic swings, are in trouble. California's government is in an outright crisis, and we all know where America's trends start.
My own cycles of optimism and pessimism
Before I go further, I'd like to tell everyone that, in the early 1990s, I was an optimist about the economy. At the time, I thought that inflation was tamer than generally realized, leaving plenty of room for interest rate reductions. The technology sector was in the early stages of a boom.
When Bill Clinton took office in 1993 and unveiled his economic plan that included a small tax increase on the wealthiest earners, I became extremely optimistic. Plenty of people thought I was a little crazy, but I predicted that federal surpluses would be so large that, at some point, the prospect of the complete retirement of the federal debt might become a challenge to the Federal Reserve's ability to perform its traditional functions.
I say all of that not so much to crow about having made a good call back then, but to point out that I've been an optimist. I'm not one of these people who's always been a pessimist about the economy. I was pessimistic in the 1970s, increasingly optimistic in the 1980s, and unboundedly optimistic by the mid-'90s. I started changing my tune in 1999, and by mid-2001 I was once again a pessimist.
As I've grown older, and more educated about the financial system and the economy, I've tended to be earlier on my calls. Hence, my 1999 pessimism was very much out of line with prevailing wisdom, and I missed the chance to cash in on the real estate mania of the first half of this decade. I was waiting for the bubble to burst.
Just how bad is this going to get?
May God help the next president. We're in for the worst times since the 1930s. Unemployment will be above 10%. Banks will fail -- big ones -- and at least one of the American automakers will go out of business. Retailing is going to shrink, and in some places it will collapse. You'll see people living in their cars. There will be another several million foreclosures. The resilient service sector will shrink.
Crime rates are going to rise in a major way. Not so much because of the direct impact of the economy, but because state governments won't be able to afford to keep criminals locked up. And get ready for an escalation of the drug problem; governments aren't going to have the resources to go after your friendly neighborhood meth dealer.
Obama, temper your promises on health care, because the next crisis to hit the federal government is going to be Medicare. Regardless of who's elected we'll be lucky to keep what we've got, let alone expand anything. Restoring Clinton's tax rates won't even begin to pay for what you want to do. McCain, if you really think you're going to restrain federal spending in the storm that's about to land, you're even more senile than I think. Palin, if McCain dies then you'd better set up the mother of all prayer chains.
For those who remain employed, be prepared for a lower standard of living. Your compensation is going to be inflated away, and unlike in the 1960s and 1970s, hardly anyone has a union contract and its cost-of-living adjustments to keep that wolf from the door. And hope that you don't have to sell your house. Bid a fond farewell to newspapers. They're on their last legs anyway, and the retail crash will kill them off. But movies and books will get better, because hard times always make for much more interesting literary output.
How long will it last?
We will start to recover in 2018, or thereabouts. Between now and then, it'll be like living in a washing machine. On average, these boom/bust cycles last for 17 years. There was a bust from 1929 through 1942. There was a boom from 1943 through 1969. There was a bust from 1970 through 1982. There was a boom from 1983 through 1999. There was a bust from 2000 through ... through ... 2017.
The federal government will work like hell to keep it from turning into the 1930s all over again, but don't kid yourself. There is only so much they can do. The Federal Reserve, for example, can create all kinds of banking reserves to be lent out, but it cannot create the ability to service the loans. In financial-speak, we have a solvency crisis, not a liquidity crisis. In people-speak, we're broke, busted, and soon to be disgusted.
Saturday, September 6, 2008
Have We Always Been Financial Facists?
Have we ever been anything but financial fascists? Let's have a look.
We might hear the F-word or the S-word in a lot more places these days, but not in our politics. Call someone a "fascist" or a "socialist," and most thinking people will regard you as a kook with an axe to grind. But actually, in our "mixed economy" we've got quite a bit of both elements.
"National Socialism" In A Mixed Economy
Social Security is a flatly socialist, government-operated savings institution. The military-industrial complex is fascist. Big Agriculture is mostly fascist with some freedom around the edges. Big Healthcare is Yugoslavia. Everyone knows it's going to be completely nationalized; the only question is whether it'll be on a fascist model or a socialist one. In both systems, the government exercises managerial control, either de facto or de jure, as the Latin buffs would put it.
In a socialist system, the formal ownership of an enterprise, hence disposition of output and dividends, including reinvestment, is directly a government decision. In a fascist system, the structure of private ownership is left in place, but government socializes risks and has a great deal to say about management. The private "ownership" might be nominal, as with Germany's Krupp steel works by 1944, or not, as with Archer Daniels Midland, the agribusiness giant that, along with Monsanto and Cargill, pretty much dictates American agricultural policy.
In the Fannie and Freddy bailouts, these organizations will be placed in government "receivership." The details are yet to be sketched in, but I expect a period of close government control, followed by a loosening. Once the organizations return to profitability, the government will let them loose on us once again. Fascist, if you ask me. If it were a socialist model, the government would claw back the big bonuses from yesteryear under threat of prosecution, take permanent ownership, and defend the resulting monopoly with a return to interest rate controls and all the rest.
It would be like, say, the city streets, the Hoover Dam, or Seattle City Light, our municipally-owned power distributor. I lean to the Left, so if we're going to have government control of the mortgage business I want it to be socialistic rather than fascistic. But I'm also a free-market Democrat, so I do want to ask whether it's appropriate to nationalize that business to begin with.
Is Mortgage Finance A Utility?
In my view, the only assets that should be on the list for government control are those that economists would call "natural monopolies," meaning facilities whose duplication would cause more harm than good.
Streets are a prime example. This or that gated community aside, do you really want a private company having control of the streets to the point of physical ownership? Notwithstanding this or that private tollroad in Texas or California -- projects that I am deeply skeptical of, by the way -- I think streets belong in government hands. They are a public utility, and you can only have one network of streets.
Electric distribution grids are another. You only get one of those in an area. One way or the other, these grids are under socialist management, as in Seattle, or fascist management -- in private hands, closely regulated by government -- as in most other places. Frankly, after seeing what happened with Enron, I'd lean toward more socialism in that realm.
And then there is the telecommunications grid. Anyone who's ever gotten up close and personal with the companies that own and operate our telephone, cable, and wireless access facilites, and their feeder and transport links, knows that it's often hard to tell where the companies end and where various government entities begin.
I have no wish to bore you with 100 pages on this subject, so let's call telecom another Yugoslavia: Mostly fascist with a pinch of freedom around the edges, owing to most of the system being comprised of natural monopolies or dupolies. The only reason it works better than health care is that the telecom grid is essentially one big computer, and the economies of silicon chips and fiber transmission cover a multitude of management sins. Let the growth of traffic slow down or stop, or technology improvement hit a wall, and we'll all find out just how brilliant these people are not.
But what about mortgage finance? Is there really only one way to skin that cat?
Here's A Thought: Maybe Debt Finance Has Been A Fascist System For A Long Time!
In my other essay on this topic, "We Are All Fascists Now," I greeted the government bailout of Fannie Mae and Freddy Mac as the rise of financial fascism. However, if you examine the background of these entities, there has always been an implicit government guarantee for their bonds. Could it be that this was never anything more than an example of badly managed fascism, now gone awry?
As I mentioned in that essay, you could argue that the U.S. financial system instituted a major fascist element, called the Federal Reserve, nearly a century ago, and that the searing experience of the Great Depression of the 1930s, and the desire not to repeat it, ensured financial fascism's continuation.
To the average citizen, the wild gyrations of the stock market seem about as free as markets get. Notwithstanding the mechanisms of regulation around the edges, there's a lot of truth in that impression. However, equity finance has always been the tail of the dog. When it comes to the world of debt and lending, government has always been a huge, and some would say dominant, player.
Heads You Win, Tails We Lose
I'm not going to launch into an Internet history of the financial system in great detail, but suffice to say that the supply of credit has been government controlled since the Fed was formed in 1913. Most U.S. interest rates were directly set by the government for roughly 35 years between World War II and the late 1970s. There was a lot of socialism involved; in many and sundry ways, government prevented wild risk taking, and attenuated the rewards available to those who worked in finance.
For reasons I explained in an essay here last fall, the floating of interest rates since the late 1970s led to the formation of a hybrid system. Private entities were given ever-greater freedom to make big gambles, while taxpayers continued to assume the risk if those gambles failed. Socialism gave way to fascism; if the cost of socialism is inefficiency and stagnation, the cost of fascism is moral hazard and insider trading.
So, here we are, soon to be left with the detrius of a fascist meltdown. The government will now impose discipline, but perhaps it's all for show. Once the "receivers" (of risk) go away, we'll be right back where we started, with private entities free to take enormous gambles with our money -- claims on our labor -- secure in the knowledge that they will reap the rewards and we will rescue them from their failure, because we have no choice.
We might hear the F-word or the S-word in a lot more places these days, but not in our politics. Call someone a "fascist" or a "socialist," and most thinking people will regard you as a kook with an axe to grind. But actually, in our "mixed economy" we've got quite a bit of both elements.
"National Socialism" In A Mixed Economy
Social Security is a flatly socialist, government-operated savings institution. The military-industrial complex is fascist. Big Agriculture is mostly fascist with some freedom around the edges. Big Healthcare is Yugoslavia. Everyone knows it's going to be completely nationalized; the only question is whether it'll be on a fascist model or a socialist one. In both systems, the government exercises managerial control, either de facto or de jure, as the Latin buffs would put it.
In a socialist system, the formal ownership of an enterprise, hence disposition of output and dividends, including reinvestment, is directly a government decision. In a fascist system, the structure of private ownership is left in place, but government socializes risks and has a great deal to say about management. The private "ownership" might be nominal, as with Germany's Krupp steel works by 1944, or not, as with Archer Daniels Midland, the agribusiness giant that, along with Monsanto and Cargill, pretty much dictates American agricultural policy.
In the Fannie and Freddy bailouts, these organizations will be placed in government "receivership." The details are yet to be sketched in, but I expect a period of close government control, followed by a loosening. Once the organizations return to profitability, the government will let them loose on us once again. Fascist, if you ask me. If it were a socialist model, the government would claw back the big bonuses from yesteryear under threat of prosecution, take permanent ownership, and defend the resulting monopoly with a return to interest rate controls and all the rest.
It would be like, say, the city streets, the Hoover Dam, or Seattle City Light, our municipally-owned power distributor. I lean to the Left, so if we're going to have government control of the mortgage business I want it to be socialistic rather than fascistic. But I'm also a free-market Democrat, so I do want to ask whether it's appropriate to nationalize that business to begin with.
Is Mortgage Finance A Utility?
In my view, the only assets that should be on the list for government control are those that economists would call "natural monopolies," meaning facilities whose duplication would cause more harm than good.
Streets are a prime example. This or that gated community aside, do you really want a private company having control of the streets to the point of physical ownership? Notwithstanding this or that private tollroad in Texas or California -- projects that I am deeply skeptical of, by the way -- I think streets belong in government hands. They are a public utility, and you can only have one network of streets.
Electric distribution grids are another. You only get one of those in an area. One way or the other, these grids are under socialist management, as in Seattle, or fascist management -- in private hands, closely regulated by government -- as in most other places. Frankly, after seeing what happened with Enron, I'd lean toward more socialism in that realm.
And then there is the telecommunications grid. Anyone who's ever gotten up close and personal with the companies that own and operate our telephone, cable, and wireless access facilites, and their feeder and transport links, knows that it's often hard to tell where the companies end and where various government entities begin.
I have no wish to bore you with 100 pages on this subject, so let's call telecom another Yugoslavia: Mostly fascist with a pinch of freedom around the edges, owing to most of the system being comprised of natural monopolies or dupolies. The only reason it works better than health care is that the telecom grid is essentially one big computer, and the economies of silicon chips and fiber transmission cover a multitude of management sins. Let the growth of traffic slow down or stop, or technology improvement hit a wall, and we'll all find out just how brilliant these people are not.
But what about mortgage finance? Is there really only one way to skin that cat?
Here's A Thought: Maybe Debt Finance Has Been A Fascist System For A Long Time!
In my other essay on this topic, "We Are All Fascists Now," I greeted the government bailout of Fannie Mae and Freddy Mac as the rise of financial fascism. However, if you examine the background of these entities, there has always been an implicit government guarantee for their bonds. Could it be that this was never anything more than an example of badly managed fascism, now gone awry?
As I mentioned in that essay, you could argue that the U.S. financial system instituted a major fascist element, called the Federal Reserve, nearly a century ago, and that the searing experience of the Great Depression of the 1930s, and the desire not to repeat it, ensured financial fascism's continuation.
To the average citizen, the wild gyrations of the stock market seem about as free as markets get. Notwithstanding the mechanisms of regulation around the edges, there's a lot of truth in that impression. However, equity finance has always been the tail of the dog. When it comes to the world of debt and lending, government has always been a huge, and some would say dominant, player.
Heads You Win, Tails We Lose
I'm not going to launch into an Internet history of the financial system in great detail, but suffice to say that the supply of credit has been government controlled since the Fed was formed in 1913. Most U.S. interest rates were directly set by the government for roughly 35 years between World War II and the late 1970s. There was a lot of socialism involved; in many and sundry ways, government prevented wild risk taking, and attenuated the rewards available to those who worked in finance.
For reasons I explained in an essay here last fall, the floating of interest rates since the late 1970s led to the formation of a hybrid system. Private entities were given ever-greater freedom to make big gambles, while taxpayers continued to assume the risk if those gambles failed. Socialism gave way to fascism; if the cost of socialism is inefficiency and stagnation, the cost of fascism is moral hazard and insider trading.
So, here we are, soon to be left with the detrius of a fascist meltdown. The government will now impose discipline, but perhaps it's all for show. Once the "receivers" (of risk) go away, we'll be right back where we started, with private entities free to take enormous gambles with our money -- claims on our labor -- secure in the knowledge that they will reap the rewards and we will rescue them from their failure, because we have no choice.
Saturday, November 10, 2007
Bailout V: The Fix Is In
My many fans might recall my posting of Sept. 9, Crisis Basics: What Else Can The Fed Do? So, you don't remember it? Let me refresh your memory with the money quote:
Want to get freaky? Well, one thing the Fed could do, at least in theory, is become a mortgage lender in its own right, most likely by refinancing existing mortgages at lower rates. A more plausible "radical idea" would be for Congress and/or the federal regulators to raise the limits on the mortgages that can be held by Freddie Mac and Fannie Mae, and encourage them to buy busted mortgages. (If that works like, say, Medicare Part D, the prescription drug benefit, they'd even forbid Freddie and Fannie from buying bad loans at a discount!) Then, as those loans go bad, the Fed would bail out Freddie and Fannie.
Look at what Bernanke just proposed. And note the reaction of Sen. Chuck Schumer, who in addition to supporting torture is a shill for the banks. Hey, what's a senator from New York for? The money quote:
In response to a question from Committee Chairman Sen. Charles Schumer, D-N.Y., Bernanke suggested that mortgages eligible for government guarantees be capped at $1 million. "I think that's a very good idea,” Schumer said of the guarantees. “In fact, legislatively, it's something that I would try to introduce and get passed.”
Want to get freaky? Well, one thing the Fed could do, at least in theory, is become a mortgage lender in its own right, most likely by refinancing existing mortgages at lower rates. A more plausible "radical idea" would be for Congress and/or the federal regulators to raise the limits on the mortgages that can be held by Freddie Mac and Fannie Mae, and encourage them to buy busted mortgages. (If that works like, say, Medicare Part D, the prescription drug benefit, they'd even forbid Freddie and Fannie from buying bad loans at a discount!) Then, as those loans go bad, the Fed would bail out Freddie and Fannie.
Look at what Bernanke just proposed. And note the reaction of Sen. Chuck Schumer, who in addition to supporting torture is a shill for the banks. Hey, what's a senator from New York for? The money quote:
In response to a question from Committee Chairman Sen. Charles Schumer, D-N.Y., Bernanke suggested that mortgages eligible for government guarantees be capped at $1 million. "I think that's a very good idea,” Schumer said of the guarantees. “In fact, legislatively, it's something that I would try to introduce and get passed.”
What can I say? I love being right. Oh, one more thing. Bernanke's proposal is a sign that the banks are scared. The latest mantra is that this will be the size of another S&L bailout. Folks, you heard it here first: It's going to be a lot bigger than that.
A Curmudgeon's 50th Birthday Rant
In early November, a friend asked me for a favor. Or maybe he did me a favor. Or maybe a little of both. He runs a multi-billion dollar investment fund and wanted my opinion about solar power companies.
My friend knows that, on account of multiple sclerosis, I lack stamina and have significant impairments of other skills. But, for some reason, he trusts my powers of general reasoning enough to want my overall impressions of this emerging industry. Both flattered and curious, I agreed to spend a few days listening to alternative energy companies pitch themselves and their technologies at a couple of conferences in the San Francisco Bay Area.
I came away with the following key impressions.
I’m sure it sounds like I’ve drunk the Kool-Aid on solar power, but it’s not so. I'm referring to what's here now and cost reductions that are in the near-term pipeline, not to something I was told at a solar fair where they also sold bongs, rainbow shirts, handmade soap, and bongo drums. The future for solar will be better than I've portrayed it, not worse. Still, power will never be 100% solar. The utility-operated electric power grid will, and for a variety of reasons should, exist for at least the next century. We’ll still use fossil fuel, but much less of it. There’s a massive infrastructure built on oil, and it’s not going to go away overnight.
My point is a different one: As a society, the United States is critically dysfunctional on a scale that threatens our principles, our well-being, and quite possibly our existence. My point is that our problems are not technological. We have the means to solve our most pressing issues, including energy and the wars we (some of us, that is) fight for them, and the emerging threat of global warming.
My point is this: Our failures are generated by a political system that is growing more dysfunctional every year. These failures, and the system that produces them, can no longer be overlooked.
We must ask ourselves: What sort of society devotes almost 20% of a year’s output to an oil war when foreign oil can be, in technological terms, irrelevant? What kind of society allows rampant financial fraud to go unregulated and unpunished – and in fact soon to be rewarded by a bailout of those responsible -- eventually resulting in millions of people being evicted from their homes?
That sort of society is the United States of America, circa 2007. We are a country that is addled by 200 channels with nothing on. We are medicated for depression and for our lack of sexual performance. We can’t spare a half-hour a day to read the newspaper or even listen to the headlines on what passes for television news programs.
Half of us don’t vote, and many of those who do vote make their decisions on the shallowest, least relevant criteria imaginable. Then, when things don’t go well, we look for someone to blame. And it’s always someone else, be it "Islamofascists" or people who smoke a cigarette within 25 feet of a building entrance. Americans are some of the most talented victims this planet has to offer. Let us count the ways.
So, folks, as you max out your credit cards to keep the mortgage payments flowing and to buy another toy made by a Chinese dollar slave, you might want to pause for a second or two and ponder the costs of indifference, complacency, and irresponsibility on a national scale.
This country has tolerated, and even demanded -- from both parties -- a level of waste, corruption, and destruction not seen since the second world war. As we’ve done so, what have we talked about? Viagra, big-screen television sets, the government reading our e-mails, the threat of Mexican gardeners, gay marriage, the missing white girl of the month, and the second coming of someone who died 2,000 years ago for our ever-expanding list of sins. The rest of the world can be forgiven for its growing disgust with us and everything we represent. We take more, and offer less, every year. Courtesy of George W. Bush, we can't even hide behind the "human rights" figleaf anymore.
Chickens do occasionally come home to roost. Why, I think I hear some wings flapping off in the distance. What to do? We can start by waking up and taking a look around, including in the nearest mirror. Mark my words: Paying attention is going to become cool again.
My friend knows that, on account of multiple sclerosis, I lack stamina and have significant impairments of other skills. But, for some reason, he trusts my powers of general reasoning enough to want my overall impressions of this emerging industry. Both flattered and curious, I agreed to spend a few days listening to alternative energy companies pitch themselves and their technologies at a couple of conferences in the San Francisco Bay Area.
I came away with the following key impressions.
- Solar energy is real. Within five years, you’ll see lots of homeowners and businesses installing panels on their roofs.
- Before the middle of the next decade, electricity derived from solar panels will cost the same as power generated by the combination of nuclear, coal, and natural gas that now powers the utility grid.
- Pardon the pun, but here’s a real shocker: Draw a circle 30 miles in diameter and place it in the big desert that runs from southeastern California to western New Mexico. Then fill the circle with currently-available solar panels. The power coming out of that circle would satisfy 100% of this country’s electric power needs.
- For the same amount of money that the U.S. will spend on the Iraq War – about $1.5 trillion -- we could have powered all of the homes in this country.
- If we’d also avoided the $500 billion real estate bubble simply by enforcing current lending regulations, we could have installed enough solar panels to power the rest of the economy, too.
- None of the numbers I’ve quoted include indirect costs. The $1.5 trillion cost of the Iraq War is conservative, once you consider the precedent it sets for American intervention in oil-producing regions. When I compare the cost of solar power to nuclear, oil, and natural gas, I’m not accounting for the "externalities" such as waste disposal, carbon emissions, or wars of conquest.
- The $500 billion cost of the real estate bubble doesn’t include the losses in value to be suffered by homeowners who aren’t having trouble with their mortgages. Nor does it include the spinoff effects of job losses in the financial, retail, and municipal government sectors that are already feeling the impact of the bubble’s deflation. If the Federal Reserve goes ahead with its plan to bail out the banks by inflating the money supply, the resulting costs of a weak dollar, inflation, and economic stagnation aren’t in my numbers, either.
- My numbers don’t include any economic benefits from switching away from oil. Once you’ve installed solar panels, the resulting power is free. That eventually lets money be directed elsewhere. And there are the jobs created when a new industry is born, not to mention spinoff industries like electric cars and improved batteries.
I’m sure it sounds like I’ve drunk the Kool-Aid on solar power, but it’s not so. I'm referring to what's here now and cost reductions that are in the near-term pipeline, not to something I was told at a solar fair where they also sold bongs, rainbow shirts, handmade soap, and bongo drums. The future for solar will be better than I've portrayed it, not worse. Still, power will never be 100% solar. The utility-operated electric power grid will, and for a variety of reasons should, exist for at least the next century. We’ll still use fossil fuel, but much less of it. There’s a massive infrastructure built on oil, and it’s not going to go away overnight.
My point is a different one: As a society, the United States is critically dysfunctional on a scale that threatens our principles, our well-being, and quite possibly our existence. My point is that our problems are not technological. We have the means to solve our most pressing issues, including energy and the wars we (some of us, that is) fight for them, and the emerging threat of global warming.
My point is this: Our failures are generated by a political system that is growing more dysfunctional every year. These failures, and the system that produces them, can no longer be overlooked.
We must ask ourselves: What sort of society devotes almost 20% of a year’s output to an oil war when foreign oil can be, in technological terms, irrelevant? What kind of society allows rampant financial fraud to go unregulated and unpunished – and in fact soon to be rewarded by a bailout of those responsible -- eventually resulting in millions of people being evicted from their homes?
That sort of society is the United States of America, circa 2007. We are a country that is addled by 200 channels with nothing on. We are medicated for depression and for our lack of sexual performance. We can’t spare a half-hour a day to read the newspaper or even listen to the headlines on what passes for television news programs.
Half of us don’t vote, and many of those who do vote make their decisions on the shallowest, least relevant criteria imaginable. Then, when things don’t go well, we look for someone to blame. And it’s always someone else, be it "Islamofascists" or people who smoke a cigarette within 25 feet of a building entrance. Americans are some of the most talented victims this planet has to offer. Let us count the ways.
So, folks, as you max out your credit cards to keep the mortgage payments flowing and to buy another toy made by a Chinese dollar slave, you might want to pause for a second or two and ponder the costs of indifference, complacency, and irresponsibility on a national scale.
This country has tolerated, and even demanded -- from both parties -- a level of waste, corruption, and destruction not seen since the second world war. As we’ve done so, what have we talked about? Viagra, big-screen television sets, the government reading our e-mails, the threat of Mexican gardeners, gay marriage, the missing white girl of the month, and the second coming of someone who died 2,000 years ago for our ever-expanding list of sins. The rest of the world can be forgiven for its growing disgust with us and everything we represent. We take more, and offer less, every year. Courtesy of George W. Bush, we can't even hide behind the "human rights" figleaf anymore.
Chickens do occasionally come home to roost. Why, I think I hear some wings flapping off in the distance. What to do? We can start by waking up and taking a look around, including in the nearest mirror. Mark my words: Paying attention is going to become cool again.
Tuesday, October 16, 2007
Bailout IV: "Washington Worries"
It's official: The New York Times informs us that Washington is worried about the mortgage crisis.
Gee, do ya think so? At the epicenter of the crisis, (you guessed it) Southern California, home sales have declined by 48% and the state is in recession. Median house prices, which in today's two-tier America understate the problem, are falling. The Los Angeles Times, which like newspapers all over the country is ever willing to serve its real estate advertisers, blames this on "motivated sellers." Builder confidence is at a record low, even lower than during the 1991 recession. Oil is trading above $86.
A key index of sub-prime mortgage sentiment is falling through the floorboards. And that's not the half of it. Check out this truly astonishing article, which is appropriately titled, "The Eve of Destruction." Don't let its appearance on a California real estate blog fool you: What they're talking about is a nationwide tidal wave that will make the current troubles look easy by comparison. Unless the federal government bails out the banks in the next three or four months, that tsunami is going to hit nationwide, starting next spring and continuing for at least a year. Welcome to the White House, Mrs. Clinton!
The money quote:
The foreclosures and REOs* we are seeing today were caused by people who started defaulting in 2006. Now that prices are clearly off the peak, most of the people needing to refinance will not be able to get it. In short, many of the homeowners represented on this chart are going to default and become REOs.
Vicious cycle, anyone? As I noted in Bailout II and Bailout III, the question of the hour is not, not, NOT whether the federal government is going to try to rescue the banks and insurance companies. A bailout is baked in the cake. As if we needed any more confirmation, there was this from the Idiot-in-Chief's addled corporate waterboy, also known as his Treasury Secretary:
I have no interest in bailing out lenders or property speculators, Mr. Paulson said today [Oct. 16]. Still, we must recognize the very real harm to families affected by the housing downturn.
Nope, he's got no interest in bailing out lenders or speculators. But he'll try anyway. The question is whether it will succeed. Here's a hint:
The fourth issue that has garnered attention is whether greater liability should be imposed on securitizers and investors. In my view, this is not the answer to the problem. Imposing broad liability provisions on investors and securitizers would very likely generate significant unintended consequences. It would potentially paralyze securitization, a process that has been extremely valuable in extending the availability of credit to millions of homeowners nationwide and lowering the cost of financing. Again, balance is critically important. Congress should proceed with extreme caution so as to avoid cutting off investment inflows to the housing market.
Now tell me, does a confident government urge that reckless criminals be set free on the grounds that we need their money?
By the way, Democrats, where have you been hiding? Right now: Get out of your offices and go stand in the sun. See that shadow? It isn't going to bite you. Especially you, Hillary. If you wait until you get into office before you speak up, you're going to look like just another buck-passer. Your biggest risk is that the current administration will do just enough to make themselves look like they're trying, as they wait to drop this 3 million-degree potato in your lap, right there next to the defeat in Iraq and soon in Afghanistan.
---------------
* REO = Real Estate Owned by a lender after foreclosure.
Gee, do ya think so? At the epicenter of the crisis, (you guessed it) Southern California, home sales have declined by 48% and the state is in recession. Median house prices, which in today's two-tier America understate the problem, are falling. The Los Angeles Times, which like newspapers all over the country is ever willing to serve its real estate advertisers, blames this on "motivated sellers." Builder confidence is at a record low, even lower than during the 1991 recession. Oil is trading above $86.
A key index of sub-prime mortgage sentiment is falling through the floorboards. And that's not the half of it. Check out this truly astonishing article, which is appropriately titled, "The Eve of Destruction." Don't let its appearance on a California real estate blog fool you: What they're talking about is a nationwide tidal wave that will make the current troubles look easy by comparison. Unless the federal government bails out the banks in the next three or four months, that tsunami is going to hit nationwide, starting next spring and continuing for at least a year. Welcome to the White House, Mrs. Clinton!
The money quote:
The foreclosures and REOs* we are seeing today were caused by people who started defaulting in 2006. Now that prices are clearly off the peak, most of the people needing to refinance will not be able to get it. In short, many of the homeowners represented on this chart are going to default and become REOs.
Vicious cycle, anyone? As I noted in Bailout II and Bailout III, the question of the hour is not, not, NOT whether the federal government is going to try to rescue the banks and insurance companies. A bailout is baked in the cake. As if we needed any more confirmation, there was this from the Idiot-in-Chief's addled corporate waterboy, also known as his Treasury Secretary:
I have no interest in bailing out lenders or property speculators, Mr. Paulson said today [Oct. 16]. Still, we must recognize the very real harm to families affected by the housing downturn.
Nope, he's got no interest in bailing out lenders or speculators. But he'll try anyway. The question is whether it will succeed. Here's a hint:
The fourth issue that has garnered attention is whether greater liability should be imposed on securitizers and investors. In my view, this is not the answer to the problem. Imposing broad liability provisions on investors and securitizers would very likely generate significant unintended consequences. It would potentially paralyze securitization, a process that has been extremely valuable in extending the availability of credit to millions of homeowners nationwide and lowering the cost of financing. Again, balance is critically important. Congress should proceed with extreme caution so as to avoid cutting off investment inflows to the housing market.
Now tell me, does a confident government urge that reckless criminals be set free on the grounds that we need their money?
By the way, Democrats, where have you been hiding? Right now: Get out of your offices and go stand in the sun. See that shadow? It isn't going to bite you. Especially you, Hillary. If you wait until you get into office before you speak up, you're going to look like just another buck-passer. Your biggest risk is that the current administration will do just enough to make themselves look like they're trying, as they wait to drop this 3 million-degree potato in your lap, right there next to the defeat in Iraq and soon in Afghanistan.
---------------
* REO = Real Estate Owned by a lender after foreclosure.
Saturday, October 13, 2007
Bailout III: O! The Complexity!
You just knew the fix was in when the Idiot-in-Chief and his banker made the following statements on August 31:
A federal bailout of lenders would only encourage a recurrence of the problem. It's not the government's job to bail out speculators, or those who made the decision to buy a home they knew they could never afford. - Bush
It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. - Bernanke
Now the shoes are dropping. The biggest bank, Citigroup, is conniving with other banks and the U.S. Treasury to invent a $75 billion bailout. I especially like the $75 billion part, because if you read through the "Bailout II" essay on this blog, you'll see that before this thing was announced I had guesstimated the banks' immediate exposure to bad mortgages at $75 billion.
There's no word yet on how much the federal government will kick in, but you can bet it will be involved. How? We don't really know yet, but watch your wallet. And don't even bother objecting. The choice is between a bailout and a full-scale depression. Even if a bailout won't work, they're going to try. They don't have any other choice.
More moving parts than a reticulated python
The federal government has done plenty of financial bailouts. There was the so-called "Plunge Protection Team" that, on Tuesday, Oct. 20, 1987, intervened in the Major Market Index in Chicago. That bailout was led by Alan Greenspan, who used the Federal Reserve to buy stock index futures. It stopped the stock crash dead cold. Greenspan was proclaimed the new Wizard of Oz. The munchkins agreed not to look behind the curtain.
Shortly thereafter, Congress and the Fed bailed out banks, thrifts, and insurance companies to cover up their losses in Latin America and the U.S. commercial real estate market. Iraq was successfully invaded and oil prices fell below $20 a barrel, which helped quite a bit. Later in the '90s, the Fed bailed out the stock market by rescuing a big hedge fund, the hilariously misnamed Long-Term Capital Management. After 9/11, it propped up the U.S. economy with a big influx of new money.
Moral hazard abounded in those bailouts, yet they were relatively simple compared to what's ahead. Although the numbers on this one are just starting to take shape in the mist, I think the earlier rescues will wind up being smaller than what we're facing now. The necessary recipients of bailout money were easier to identify than they will be this time. All of us, including me, are going to be learning some lessons, and paying some prices.
Who holds $9 trillion in mortgages? We do!
Recall some basics from "Bailout II":
Why not just let the banks and bondholders eat the losses? After all, they're the ones who made the stupid loans, right? My inner populist wants to do exactly that, but my outer realist knows it won't happen. Why? Because banks and bondholders aren't aliens from outer space. There are us, whether we know it or not. In a future essay, I'll be hanging more specific numbers out there, but I can say this much: Most bonds, mortgage or otherwise, are owned by pension funds, mutual funds, insurance companies, and banks. And that's where our money is.
If those bonds go bad in a massive way, you'll see retirement funds go bust. You'll see insurance companies unable to pay claims, and raising rates in a major way. You'll see banks failing, which will mean that Federal Deposit Insurance Corp. -- guaranteed by the government -- will have to step in to pay off their depositors.
And that's only the beginning. When banks fail, businesses fail. When insurance companies close, people's hospital bills don't get paid and the hospitals close. Colleges pay a lot of their expenses from endowment funds that -- you guessed it -- hold mortgage bonds. It goes on and on and on. I really wish it was just a bunch of rich people in New York, Boston, Dallas, L.A., and San Francisco who were at risk. Unfortunately, the truth is very different.
Pretty much anyone or anything that has any money at all has mortgage investments, whether they know it or not. Mostly not, for now. Let them fail in a major way, and a whole lot of ordinary people are going to find out just how exposed they are and just how bad things can look. If the federal government can't contain this situation, "I love a surprise" will become an entire country's famous last words.
How do you bail out a whole country?
With great difficulty. If the federal government and the big banks can limit the losses to a few hundred billion dollars, I think they'll be able to pull it off. However, if the hatches aren't as watertight as we've been told, it's another story. It's a bit like the Titanic: As long as the gash wasn't too big, it really was unsinkable. And there was the matter of the watertight compartments, whose barriers stopped well below the deck.
When it comes to the mortgage crisis, the barriers are those loan classifications: prime, alt-a, and sub-prime. For now, we are told that they are entirely separate categories. But are they? As I noted in Bailout II, if things get dicey enough, some of those prime borrowers might start acting like alt-a and sub-prime borrowers. If enough of them do so, the game's over.
Even if a bailout works -- and I certainly have my doubts about that -- there is still the injustice of it all. Yes, we are all the holders of mortgages, but very few of us made the big bucks from writing fraudulent loans and using them to sell phony bonds. Even in an "optimistic disaster scenario" in which the bailout keeps the economy from falling off a cliff, millions of people will lose their houses and millions more will have paid too much to get in and will lose money getting out.
Jobs will be lost, services will be cut, dreams (and more than a few people) will die, lives will be changed for the worse. Even in an optimistic scenario, there's going to be plenty of pain. I think it ought to be spread around, especially to those at the top who concocted and profited from the fraud and irresponsibility that caused it. I'll be writing more about that in the months and years to come.
A federal bailout of lenders would only encourage a recurrence of the problem. It's not the government's job to bail out speculators, or those who made the decision to buy a home they knew they could never afford. - Bush
It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. - Bernanke
Now the shoes are dropping. The biggest bank, Citigroup, is conniving with other banks and the U.S. Treasury to invent a $75 billion bailout. I especially like the $75 billion part, because if you read through the "Bailout II" essay on this blog, you'll see that before this thing was announced I had guesstimated the banks' immediate exposure to bad mortgages at $75 billion.
There's no word yet on how much the federal government will kick in, but you can bet it will be involved. How? We don't really know yet, but watch your wallet. And don't even bother objecting. The choice is between a bailout and a full-scale depression. Even if a bailout won't work, they're going to try. They don't have any other choice.
More moving parts than a reticulated python
The federal government has done plenty of financial bailouts. There was the so-called "Plunge Protection Team" that, on Tuesday, Oct. 20, 1987, intervened in the Major Market Index in Chicago. That bailout was led by Alan Greenspan, who used the Federal Reserve to buy stock index futures. It stopped the stock crash dead cold. Greenspan was proclaimed the new Wizard of Oz. The munchkins agreed not to look behind the curtain.
Shortly thereafter, Congress and the Fed bailed out banks, thrifts, and insurance companies to cover up their losses in Latin America and the U.S. commercial real estate market. Iraq was successfully invaded and oil prices fell below $20 a barrel, which helped quite a bit. Later in the '90s, the Fed bailed out the stock market by rescuing a big hedge fund, the hilariously misnamed Long-Term Capital Management. After 9/11, it propped up the U.S. economy with a big influx of new money.
Moral hazard abounded in those bailouts, yet they were relatively simple compared to what's ahead. Although the numbers on this one are just starting to take shape in the mist, I think the earlier rescues will wind up being smaller than what we're facing now. The necessary recipients of bailout money were easier to identify than they will be this time. All of us, including me, are going to be learning some lessons, and paying some prices.
Who holds $9 trillion in mortgages? We do!
Recall some basics from "Bailout II":
- $6 trillion in residential mortgage bonds outstanding, and another $3 trillion in bank-held residential mortgages, secured by about 60 million mortgaged dwelling units that house 150 million or so people.
- One-quarter of the mortgages -- 15 million units with about 40 million people -- are "non-prime," meaning that the loans were made to borrowers who didn't prove their income or who had bad credit.
- In an "optimistic disaster scenario," 20% of the non-prime loans go bad, forcing 3 million foreclosures that displace about 7.5 million people. Mortgage bondholders lose $150 billion, and banks will lose $75 billion. Homeowners lose a few trillion. There's an inflationary recession, and state and local governments have a new round of hard choices to make.
Why not just let the banks and bondholders eat the losses? After all, they're the ones who made the stupid loans, right? My inner populist wants to do exactly that, but my outer realist knows it won't happen. Why? Because banks and bondholders aren't aliens from outer space. There are us, whether we know it or not. In a future essay, I'll be hanging more specific numbers out there, but I can say this much: Most bonds, mortgage or otherwise, are owned by pension funds, mutual funds, insurance companies, and banks. And that's where our money is.
If those bonds go bad in a massive way, you'll see retirement funds go bust. You'll see insurance companies unable to pay claims, and raising rates in a major way. You'll see banks failing, which will mean that Federal Deposit Insurance Corp. -- guaranteed by the government -- will have to step in to pay off their depositors.
And that's only the beginning. When banks fail, businesses fail. When insurance companies close, people's hospital bills don't get paid and the hospitals close. Colleges pay a lot of their expenses from endowment funds that -- you guessed it -- hold mortgage bonds. It goes on and on and on. I really wish it was just a bunch of rich people in New York, Boston, Dallas, L.A., and San Francisco who were at risk. Unfortunately, the truth is very different.
Pretty much anyone or anything that has any money at all has mortgage investments, whether they know it or not. Mostly not, for now. Let them fail in a major way, and a whole lot of ordinary people are going to find out just how exposed they are and just how bad things can look. If the federal government can't contain this situation, "I love a surprise" will become an entire country's famous last words.
How do you bail out a whole country?
With great difficulty. If the federal government and the big banks can limit the losses to a few hundred billion dollars, I think they'll be able to pull it off. However, if the hatches aren't as watertight as we've been told, it's another story. It's a bit like the Titanic: As long as the gash wasn't too big, it really was unsinkable. And there was the matter of the watertight compartments, whose barriers stopped well below the deck.
When it comes to the mortgage crisis, the barriers are those loan classifications: prime, alt-a, and sub-prime. For now, we are told that they are entirely separate categories. But are they? As I noted in Bailout II, if things get dicey enough, some of those prime borrowers might start acting like alt-a and sub-prime borrowers. If enough of them do so, the game's over.
Even if a bailout works -- and I certainly have my doubts about that -- there is still the injustice of it all. Yes, we are all the holders of mortgages, but very few of us made the big bucks from writing fraudulent loans and using them to sell phony bonds. Even in an "optimistic disaster scenario" in which the bailout keeps the economy from falling off a cliff, millions of people will lose their houses and millions more will have paid too much to get in and will lose money getting out.
Jobs will be lost, services will be cut, dreams (and more than a few people) will die, lives will be changed for the worse. Even in an optimistic scenario, there's going to be plenty of pain. I think it ought to be spread around, especially to those at the top who concocted and profited from the fraud and irresponsibility that caused it. I'll be writing more about that in the months and years to come.
Thursday, October 11, 2007
Bailout II: How Big A Problem?
I think the federal government will try to bail out the mortgage lenders. Notice that I wrote try. Here's the question of the hour: Could the problem be too big for even the feds to sweep under the rug?
The spreadsheets in this posting come from Calculated Risk, a superb website that does an outstanding job of collecting and analyzing the details. In short, they establish the following facts:
Historically speaking, home mortgages are some of the most secure loans around. Not only do people bend over backwards to pay their mortgages, but houses are usually pretty good collateral. Consequently, mortgage default rates have run well under 0.5% of the total. Investors have been willing to pay high prices for mortgage bonds, resulting in interest rates close to those of U.S. Treasury securities.
It helps that two "agencies" -- Fannie Mae and Freddie Mac -- are federally chartered corporations that issue a huge amount of debt and, as a result, enjoy a status among investors as quasi-government entities. The feds don't actually promise to repay Freddie and Fannie investors if the bonds go bad and the companies can't come up with the cash, but investors think that, if push came to shove, the feds would step in.
This is called the "implicit guarantee" behind Freddie and Fannie bonds, and most studies say it reduces mortgage rates by at least a half-point below what they'd otherwise be. (Note: Ginnie Mae is different. Ginnies are backed by FHA and VA mortgages and formally guaranteed by the U.S. government. They comprise less than 10% of the "agency" total.)
What are "trillions?"
There are nearly $6 trillion of mortgage bonds outstanding, and banks hold another $3 trillion or so worth of mortgages. In 2007, the federal government collected $2.5 trillion in taxes, and the U.S. economy will produce about $13.5 trillion worth of goods and services. Mortgage bonds outstanding are 2.5 times annual federal tax collections, and about 43% of the U.S. economy's output. If we add bank-held mortgages to the mix, housing loans outstanding are 3.6 times annual tax collections, and 67% of a year's output.
Let's look at it from a different angle. There are 120 million dwelling units in the U.S., two-thirds of which are owner-occupied. Of the 90 million owner-occupied units, one-third are actually owned: there isn't a mortgage. Of the 60 million owner-occupied, mortgaged dwellings, about 15 million are financed by risky "alt-a" and "sub-prime" loans, while the other 45 million are financed by "prime" loans.
U.S.D.A. Prime, Choice & Standard Loans?
Not quite. Let's look a bit deeper. There are three levels of mortgage debt, judged by riskiness: prime, alt-a, and sub-prime. "Agency" debt is considered prime, on account of lending standards that (we hope) are imposed by Freddie and Fannie as a condition of buying debt. The same goes for so-called "jumbo" loans, which exceed Freddie and Fannie's size limits but (supposedly) go to only creditworthy borrowers.
The spreadsheets in this posting come from Calculated Risk, a superb website that does an outstanding job of collecting and analyzing the details. In short, they establish the following facts:
- There are $5.8 trillion worth of dollar-denominated mortgage bonds outstanding
- $1.4 trillion worth of mortgage bonds are less than prime grade: about half of them are "sub-prime" and about half are "alt-A," which are supposedly between prime and sub-prime in terms of their default risk
- $3.9 trillion worth of mortgage bonds are "agency" bonds, 90% of which are issued by Fannie Mae or Freddie Mac, with the other 10% issued by Ginnie Mae.
Historically speaking, home mortgages are some of the most secure loans around. Not only do people bend over backwards to pay their mortgages, but houses are usually pretty good collateral. Consequently, mortgage default rates have run well under 0.5% of the total. Investors have been willing to pay high prices for mortgage bonds, resulting in interest rates close to those of U.S. Treasury securities.
It helps that two "agencies" -- Fannie Mae and Freddie Mac -- are federally chartered corporations that issue a huge amount of debt and, as a result, enjoy a status among investors as quasi-government entities. The feds don't actually promise to repay Freddie and Fannie investors if the bonds go bad and the companies can't come up with the cash, but investors think that, if push came to shove, the feds would step in.
This is called the "implicit guarantee" behind Freddie and Fannie bonds, and most studies say it reduces mortgage rates by at least a half-point below what they'd otherwise be. (Note: Ginnie Mae is different. Ginnies are backed by FHA and VA mortgages and formally guaranteed by the U.S. government. They comprise less than 10% of the "agency" total.)
What are "trillions?"
There are nearly $6 trillion of mortgage bonds outstanding, and banks hold another $3 trillion or so worth of mortgages. In 2007, the federal government collected $2.5 trillion in taxes, and the U.S. economy will produce about $13.5 trillion worth of goods and services. Mortgage bonds outstanding are 2.5 times annual federal tax collections, and about 43% of the U.S. economy's output. If we add bank-held mortgages to the mix, housing loans outstanding are 3.6 times annual tax collections, and 67% of a year's output.
Let's look at it from a different angle. There are 120 million dwelling units in the U.S., two-thirds of which are owner-occupied. Of the 90 million owner-occupied units, one-third are actually owned: there isn't a mortgage. Of the 60 million owner-occupied, mortgaged dwellings, about 15 million are financed by risky "alt-a" and "sub-prime" loans, while the other 45 million are financed by "prime" loans.
U.S.D.A. Prime, Choice & Standard Loans?
Not quite. Let's look a bit deeper. There are three levels of mortgage debt, judged by riskiness: prime, alt-a, and sub-prime. "Agency" debt is considered prime, on account of lending standards that (we hope) are imposed by Freddie and Fannie as a condition of buying debt. The same goes for so-called "jumbo" loans, which exceed Freddie and Fannie's size limits but (supposedly) go to only creditworthy borrowers.
What does "prime" really mean? Recall that I mentioned the historic low default rates for mortgages. There are a bunch of reasons for that, one being that lending standards used to be high. Until very recently, most borrowers needed to come up with a 20% downpayment. If they couldn't do so, they had to show solid income and take out private mortgage insurance -- at considerable expense -- to further collateralize their loan.
There were some exceptions, notably VA and FHA loans. But those are a small share of the total, and they are directly guaranteed by the government. For everyone else, the rule was 20% down, or high income plus "PMI." I bought my first house with a 10% downpayment, and PMI added about $150 a month to the mortgage. Needless to say, I made extra principal payments in short order so I could remove the PMI.
Starting in the mid-1990s, lenders inaugurated two new categories of loan. One was "alt-a," for borrowers who were unable to document their income yet had sufficiently high credit scores to otherwise be considered a "prime" borrower. The other was "sub-prime," for borrowers who had bad credit histories, including prior bankruptcies and repayment problems. Included in the sub-prime category are so-called "interest-only" and "negative amortization" loans.
In 1995, alt-A and sub-prime were only 6% of the total made that year. In 2006, they were 42% of the total. Last summer, The Wall Street Journal reported that 16% of sub-prime loans were in default or approaching default. This compares to historic mortgage default rates of less than 0.5%. In recent days, I've been reading that default rates are rising.
The Optimistic Disaster Scenario
There are $1.5 trillion in outstanding bonds backed by sub-prime and alt-a loans, and another three-quarters of a trillion in such loans that were held by banks and never turned into bonds. They are secured by 15 million houses and condos that house about 40 to 45 million people. If the current late-payment numbers are a sign of things to come, in the next few years we'll see 3 million of those houses foreclosed, and their 7.5 million or so occupants told to find other digs.
The houses will then be sold at auction, fetching maybe half of their prior value on average. Bondholders will lose $150 billion, and banks will lose $75 billion. Oops, scratch that. Uncle Sucker (meaning you and me) will pay out $225 billion to keep bondholders and banks from going under. How can we afford it, you might ask. The answer is that, in the early 1990s, the federal government spent about the same amount (maybe a little more) to bail out the banks from the crappy commercial real estate loans they made in the 1980s.
The public won't stand for it, you might exclaim. Oh, really? This is the same American public that thinks Saddam Hussein planned the 9/11 attacks. We believe in magic. If the feds can keep this problem at roughly the level I've just laid out, we'll coast on through with nary a ripple.
It Might Not Be That Easy
Imagine that you borrowed to buy a brand new $500,000 house a year ago. You wake up one day to find that a place across the street, nearly identical to yours, is on the market for $350,000. Scuttlebutt is that, next month, another half a dozen houses are going on the market at the same price. Word is that, by the time it's all over, people will be getting them for $250,000.
It seems that your neighbors weren't as prudent with their financial lives as you had been been with yours. Like good Americans they believed in magic, and look where it got you. What to do?
If you had only been a reckless fool like everyone else! Had you taken out one of those interest-only, no-downpayment loans because you'd gone bankrupt before, it'd be a no-brainer: You'd call the lender and tell them the keys will be under the front doormat. But you? You're a prime borrower. Do you call your lender and say, "You can keep my 50 grand. Come get the keys"?
I'd say the answer depends on a bunch of factors. First off, were you really a prime borrower or did you and your "mortgage broker" -- you know, that guy who sold cellphones out of his trunk in the 1980s, Internet stocks and Mercedes cars in the 1990s, and maybe some meth on the side -- phony up the loan documents? Is your house one of four that you "bought," hoping to do a quick flip during the real estate bubble?
There are 45 million houses carrying "prime" mortgages. Historically, those loans hardly ever default. But there has been rampant fraud -- oops, "moral hazard" -- in the mortgage business. And if things get weird enough, even honest people will act in ways that wouldn't normally be expected. You, for instance. You've always paid your bills. It's a point of pride. But that mortgage is killing you. The second job is a pain, and you're not sure that the first job is going to last. And you've noticed that the neighborhood is looking pretty scruffy these days, what with all those empty, bank-owned houses sitting there with untended lawns and even a broken window here and there. And here you sit, with a $450,000 loan on a $250,000 house. Hmm.
The Pessimistic Disaster Scenario
This is the nightmare scenario for bondholders and the federal government: That the non-prime mortgage crisis will spread to the so-called prime loans. Dump 3 million foreclosed dwellings on the market, and it just might happen.
And we haven't talked about the spinoff effects. Already, the problems in the non-prime sphere have begun to hurt the economy. Falling real estate values have made it impossible for many borrowers (and not just the irresponsible ones) to tap into their home equity to finance their spending. Retail sales are down, and Christmas is looking bleak. New home construction is falling sharply, and people are canceling new homes in developments all around the country.
This is causing layoffs and putting even more on downward pressure on retail sales, as do layoffs by the retailers themselves. California is already in recession. Home repair and remodeling is down, and there have been big layoffs and income reductions among real estate agents and bankers. Soon enough, state and local governments are going to feel the pinch. Those responsible prime borrowers are going to look at their falling property values and demand that their assessments be reduced. The next set of headlines is likely to be about falling state and local tax receipts, and the cutbacks they'll force. Which will add further downward pressure on the economy, as public employees are laid off.
Even in normal recessions, default rates rise on prime mortgages. In a real estate-led recession characterized by widespread imprudence among borrowers and lenders, it could be much worse. Sub-prime defaults could easily be catalyst for what eventually turns into a tidal wave of default: 20% default rates turn into 50% in the bad-credit category, and 0.5% default rates rocket past 10% in the prime category. Foreclosed property swamps the market, and property values collapse by 75% or more in some areas. A $225 billion problem becomes a multi-trillion dollar problem, its tentacles extending everywhere you look.
You think I'm crazy, don't you?
Fine, but chew on this: Between 1969 and 1974, the U.S. stock market lost 70% of its value. How did that Internet bubble work for you? Tell the truth! The NASDAQ is currently at half the peak reached in March 2000. As a participant in the financial sector during the period, I saw stocks lose 95% or more of their value in less than two years. But you can't live in your stocks, you answer. Houses are different. They are special.
My answer is that, whether you're buying your favorite stock, a tube of toothpaste, or a new house, there are two decisions to make: Know what you like, and know what to pay. Yes, a house is special, but it's not any different. Special can get cheaper. A whole lot cheaper.
There were some exceptions, notably VA and FHA loans. But those are a small share of the total, and they are directly guaranteed by the government. For everyone else, the rule was 20% down, or high income plus "PMI." I bought my first house with a 10% downpayment, and PMI added about $150 a month to the mortgage. Needless to say, I made extra principal payments in short order so I could remove the PMI.
Starting in the mid-1990s, lenders inaugurated two new categories of loan. One was "alt-a," for borrowers who were unable to document their income yet had sufficiently high credit scores to otherwise be considered a "prime" borrower. The other was "sub-prime," for borrowers who had bad credit histories, including prior bankruptcies and repayment problems. Included in the sub-prime category are so-called "interest-only" and "negative amortization" loans.
In 1995, alt-A and sub-prime were only 6% of the total made that year. In 2006, they were 42% of the total. Last summer, The Wall Street Journal reported that 16% of sub-prime loans were in default or approaching default. This compares to historic mortgage default rates of less than 0.5%. In recent days, I've been reading that default rates are rising.
The Optimistic Disaster Scenario
There are $1.5 trillion in outstanding bonds backed by sub-prime and alt-a loans, and another three-quarters of a trillion in such loans that were held by banks and never turned into bonds. They are secured by 15 million houses and condos that house about 40 to 45 million people. If the current late-payment numbers are a sign of things to come, in the next few years we'll see 3 million of those houses foreclosed, and their 7.5 million or so occupants told to find other digs.
The houses will then be sold at auction, fetching maybe half of their prior value on average. Bondholders will lose $150 billion, and banks will lose $75 billion. Oops, scratch that. Uncle Sucker (meaning you and me) will pay out $225 billion to keep bondholders and banks from going under. How can we afford it, you might ask. The answer is that, in the early 1990s, the federal government spent about the same amount (maybe a little more) to bail out the banks from the crappy commercial real estate loans they made in the 1980s.
The public won't stand for it, you might exclaim. Oh, really? This is the same American public that thinks Saddam Hussein planned the 9/11 attacks. We believe in magic. If the feds can keep this problem at roughly the level I've just laid out, we'll coast on through with nary a ripple.
It Might Not Be That Easy
Imagine that you borrowed to buy a brand new $500,000 house a year ago. You wake up one day to find that a place across the street, nearly identical to yours, is on the market for $350,000. Scuttlebutt is that, next month, another half a dozen houses are going on the market at the same price. Word is that, by the time it's all over, people will be getting them for $250,000.
It seems that your neighbors weren't as prudent with their financial lives as you had been been with yours. Like good Americans they believed in magic, and look where it got you. What to do?
If you had only been a reckless fool like everyone else! Had you taken out one of those interest-only, no-downpayment loans because you'd gone bankrupt before, it'd be a no-brainer: You'd call the lender and tell them the keys will be under the front doormat. But you? You're a prime borrower. Do you call your lender and say, "You can keep my 50 grand. Come get the keys"?
I'd say the answer depends on a bunch of factors. First off, were you really a prime borrower or did you and your "mortgage broker" -- you know, that guy who sold cellphones out of his trunk in the 1980s, Internet stocks and Mercedes cars in the 1990s, and maybe some meth on the side -- phony up the loan documents? Is your house one of four that you "bought," hoping to do a quick flip during the real estate bubble?
There are 45 million houses carrying "prime" mortgages. Historically, those loans hardly ever default. But there has been rampant fraud -- oops, "moral hazard" -- in the mortgage business. And if things get weird enough, even honest people will act in ways that wouldn't normally be expected. You, for instance. You've always paid your bills. It's a point of pride. But that mortgage is killing you. The second job is a pain, and you're not sure that the first job is going to last. And you've noticed that the neighborhood is looking pretty scruffy these days, what with all those empty, bank-owned houses sitting there with untended lawns and even a broken window here and there. And here you sit, with a $450,000 loan on a $250,000 house. Hmm.
The Pessimistic Disaster Scenario
This is the nightmare scenario for bondholders and the federal government: That the non-prime mortgage crisis will spread to the so-called prime loans. Dump 3 million foreclosed dwellings on the market, and it just might happen.
And we haven't talked about the spinoff effects. Already, the problems in the non-prime sphere have begun to hurt the economy. Falling real estate values have made it impossible for many borrowers (and not just the irresponsible ones) to tap into their home equity to finance their spending. Retail sales are down, and Christmas is looking bleak. New home construction is falling sharply, and people are canceling new homes in developments all around the country.
This is causing layoffs and putting even more on downward pressure on retail sales, as do layoffs by the retailers themselves. California is already in recession. Home repair and remodeling is down, and there have been big layoffs and income reductions among real estate agents and bankers. Soon enough, state and local governments are going to feel the pinch. Those responsible prime borrowers are going to look at their falling property values and demand that their assessments be reduced. The next set of headlines is likely to be about falling state and local tax receipts, and the cutbacks they'll force. Which will add further downward pressure on the economy, as public employees are laid off.
Even in normal recessions, default rates rise on prime mortgages. In a real estate-led recession characterized by widespread imprudence among borrowers and lenders, it could be much worse. Sub-prime defaults could easily be catalyst for what eventually turns into a tidal wave of default: 20% default rates turn into 50% in the bad-credit category, and 0.5% default rates rocket past 10% in the prime category. Foreclosed property swamps the market, and property values collapse by 75% or more in some areas. A $225 billion problem becomes a multi-trillion dollar problem, its tentacles extending everywhere you look.
You think I'm crazy, don't you?
Fine, but chew on this: Between 1969 and 1974, the U.S. stock market lost 70% of its value. How did that Internet bubble work for you? Tell the truth! The NASDAQ is currently at half the peak reached in March 2000. As a participant in the financial sector during the period, I saw stocks lose 95% or more of their value in less than two years. But you can't live in your stocks, you answer. Houses are different. They are special.
My answer is that, whether you're buying your favorite stock, a tube of toothpaste, or a new house, there are two decisions to make: Know what you like, and know what to pay. Yes, a house is special, but it's not any different. Special can get cheaper. A whole lot cheaper.
Subscribe to:
Posts (Atom)