Hats off to whoever made this. It sums up the whole real estate ridiculousness of the past few years quite nicely.
A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.
Wednesday, December 26, 2007
Wednesday, December 19, 2007
The Clinton Housing Bubble
December 18, 2007; Page A20
The joint housing and mortgage-market crisis once again reminds us that all financial implosions stem from the same cause: borrowing short and lending long without enough equity to weather periodic storms in the gap between.
But this bubble was different. Besides being fueled by housing purchases and repackaged loans, each with inadequate equity -- doubling down with other people's money -- at the end of the capital-gains rainbow was the right to take up to $500,000 of profit, tax free.
Thank you President Bill Clinton for your 1997 action, applauded by the banks, the realtors and all citizens in search of half-millionaire status from an investment they could understand and self deceptively believe to be low risk; thank you for fueling the mother of all housing bubbles; thank you for enabling so many of us who bought second or third homes, and homes before construction began, which we then sold to someone else who dreamed of riches from owning homes long enough to sell to another fool.
Once again, try as we might and in spite of our political rhetoric, we have failed to help the poor in applauding government action intended to help ourselves.
The consumption binge is now over, and there is more than enough blame and souring loans to spread around. Congress, if its members can stop squabbling, wants desperately to sanctify it all with actions sure to launch at some future date the grandmother of all housing and mortgage-market bubbles. This august body has long forgotten that it set the stage for housing bubbles by creating those implicitly taxpayer-backed agencies, Fannie Mae and Freddie Mac, as housing lenders of last resort.
Financial market innovators who invented securitization as a mechanism for creating a liquid national market for mortgages are now criticized for having caused an "agency problem." This is jargon for management not having good incentives to provide investors with "truth in packaging" of the underlying economic risk. But what does truth matter at the height of a bubble? These critics would solve the agency problem with more government regulation. Excuse me, but does not the political process have the biggest agency problem of all?
The Federal Reserve, with a default-risk tiger by the tail, feels handcuffed by its accountability and responsibility for avoiding a cascade of defaults in the highest quality obligations, as well as the bad investments seeking an asymmetric tax-free profit. Shades of Long Term Capital, the Savings and Loan crisis, and heyday of the myth of Portfolio Insurance -- historical cases of borrowing short to lend for what may turn out to be longer than expected. They are all conditioned on the existence of liquidity for sellers that can dry up with frightening speed.
Consequently we have the "independent" Fed being driven by market forces to accommodate the long-evident and glaringly least-defensible features of the housing/mortgage markets. Moreover, the moment the Fed abandoned its stance against inflation, the dollar, gold, oil and commodity prices signaled inflation, and now two months later consumer prices have confirmed the signal.
More daring than the action to exempt real estate from the capital gains tax -- and in lasting service to the poor -- would have been actions allowing capital gains on all assets to go tax free, provided that the capital was reinvested -- i.e., not consumed, and yes, good citizens, housing counts as consumption.
Unlike the latest housing bubble, the stock market "excesses" of the 1990s financed thousands of new ventures, some of which found innovative ways to manage the proliferation of new technologies. The result: astonishing, long-term increases in productivity still evident in the most recent quarter.
Adam Smith in his "The Theory of Moral Sentiments" (1759) saw the subtle truth that consumption by the rich has little effect on the welfare of the poor. That's because the income of the rich is largely invested in the tools and knowledge of production, which provide future long-term value for everyone: "The rich only select from the heap what is most precious and agreeable . . . though they mean only their own conveniency . . . [and] . . . the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements."
Expenditures on housing construction are not "improvements" yielding increased productivity and future new wealth to be divided with the poor. They are more akin to satisfying government-subsidized vanity.
Mr. Smith, a professor of law and economics at George Mason University, is the 2002 Nobel Laureate in economics.
Tuesday, December 18, 2007
Way to continue to damage whatever is left of your legacy, Mr. Greenspan...
I'm not sure I need to say any more about the following.
Alan Greenspan appeared on ABC’s This Week and discussed the odds of recession, as well as the merits of helping out stressed homeowners. Here is an excerpted transcript from his appearance:
HOST GEORGE STEPHANOPOULOS: Several … say that there is a 50 percent chance of a recession now. Are they right?
GREENSPAN: Well, that the probabilities of a recession have moved up to close to 50 percent — whether it’s above or below is really extraordinarily difficult to tell. I think that’s correct. You know what the real story is, with this extraordinary credit problems we’re confronting, why the probabilities are not 60% or 70%?
STEPHANOPOULOS: Why aren’t they?
GREENSPAN: The reason, which is fascinating, if you look at the data, is that because of the decline in long-term rates, interest rates for a protracted period of time, American business was able to fund … [a] significant part of its short-term liabilities, and take out low-cost, long-term debt. So the debt credit needs as such have not all been all that large, and so with credit tightening, ordinarily historically that would have been a very major problem for the American economy. It is clearly less so today, because consumption expenditures, even though they’re being pressed by rising energy prices, are actually moving at a reasonably good clip, and the economy, even though it is slowing down — and the way I put it going to stall speed. I mean, the rate of growth is getting to levels which are such that like a human — like a human system when you get vulnerable, you essentially are open to shocks of one form or another. In other words, when our immune systems go down, we get all sorts of diseases. The economy is similar to that.
STEPHANOPOULOS: One of the shocks we saw back in 1970 I think for the first time was what became known as stagflation…How worried are you about it right now, and what should policymakers do?
GREENSPAN: Well, I’m most concerned about it, as I point out in my book, in the sense that the period that — the last 20 years or so has been a remarkable period in which — without going into any of the details — because of the tremendous geopolitical shifts that occurred at the end of the Cold War, we’ve had a period of remarkable disinflation. That period is now coming to an end, and the evidence is clearly there in rising export prices coming out of China. It’s coming out — it’s showing up in a slowed rate of productivity growth in the United States and elsewhere, and we are beginning to get not stagflation, but the early symptoms of it.
STEPHANOPOULOS: And what do we do about it?
GREENSPAN: Well, the one thing we can do is to recognize that one of the lessons of the last 20 years especially is that low inflation is the major contributor to economic growth overall, and that fundamentally, inflation must be suppressed. And it’s ultimately the Federal Reserve in this country which is the key architect of doing that, and it’s critically important that the Federal Reserve is allowed politically to do what it has to do to
suppress the inflation rates that I see emerging, not immediately, but clearly over the intermediate and longer term period.
STEPHANOPOULOS: Some have pointed out … now the historic ratio of price of homes to income and rents is about 30 percent higher than it is historically. Does that mean we have that far to fall in the housing market?
GREENSPAN: There’s a big dispute as to what the basic level will turn out to be. In my judgment, the prices will stabilize when the rate of liquidation of this very large overhang of newly built single-family homes is at a maximum. Not when we completely get rid of the excess, but when we are well under way. Then the market will begin to stabilize. And at this stage, there is some evidence that sales of homes, new homes, are beginning to flatten out. … And if we can get a further drop in housing starts and housing construction, we can begin to really liquidate that excess of inventories. When we’ve got that well in hand, then, I think, prices stabilize. And I think the ratios of income to rent to all various
other financial aspects is important but not determinate. There are going to be significant losses [on Subprime and Alt-A mortgages]. And there are loss ranges, now — the minimum, now, is $200 billion. But it’s easy, by some calculations, to get to $400 billion.
STEPHANOPOULOS: That’s enormous.
GREENSPAN: It is enormous — except, we have to remember that, as a result of globalization and this extraordinary growth over the last couple of decades, aggregate amount of what we call arbitragable long-term assets, which is all sorts of financial instruments, are close to $100 trillion. And while $400 billion is a very large number, we have to put it in the context of how much damage it can do in this very huge system.
STEPHANOPOULOS: The political world is now looking at the immediate pain. And Senator Clinton looks — has called for a freeze on foreclosures. Senator Edwards called for a rescue fund to be set up by the government for people who are facing these kind of foreclosures. What do you think about those ideas?
GREENSPAN: It’s important to help those people … without affecting the mortgage rates and without affecting the structure of markets. Cash [from the government] is available and we should use that in larger amounts. … It’s far less damaging to the economy to create a short term fiscal problem, which we would, than to try to fix the prices of homes or interest rates. If you do that, it’ll drag this process out indefinitely.
STEPHANOPOULOS: But by infusing cash, it sounds like you agree, then, with former Treasury secretary Larry Summers, who says that, right now, given this crisis, there has to be a bias toward activism.
GREENSPAN: It depends what you mean by activism. If you mean
doing something that works, absolutely. If you mean doing something just for the sake of perceptions, that’s very costly. I don’t know if [infusing cash] would work, but it would certainly help people — it would help their incomes; it would help their personal state, without affecting the structure of the way markets are behaving and the way adjustment process is going on. It’s very critical that this thing reach a selling climax — if I may put it in other words, exhaust itself. It’s only when the markets are perceived to have exhausted themselves on the downside that they turn. Trying to prevent them from going down just merely prolongs the agony.
Monday, December 10, 2007
Monday, December 3, 2007
Sometimes, with Louis Armstrong playing in the background, I think about the wonderful country we live in, where our leaders make good decisions, our citizens are free and brave, markets are free and the most deserving receive the greatest reward. God bless America.
Then I wake up... Ladies and gentlemen, our country is nuts. I didn't need any more evidence after I saw a gaggle of house "owners" outside of a Countrywide office protesting because they didn't want to or can't pay their debts. I am dumbstruck that a person who receives hundreds of thousands of dollars to buy something is painted as a victim when he/she doesn't pay the money back. And the lender is the bad guy because... gasp!... he wants to receive interest in an amount that would cover his expected losses. These people with crappy credit histories should feel fortunate to receive credit in the first place. Instead, they feel entitled to the same rates that us borrowers who actually pay our debts receive. This is absolute lunacy.
Note the sign that says "My life is not adjustable... stop adjustable rates." A few questions here: If that is the case, lady, why did you enter into an adjustable rate contract? Would you be protesting to give back all of the capital gains you got because the big bad lender gave you money if the housing market were still hot? Didn't you know your rate would reset and that could cost you money? How is it possible not to know what you are getting into when you enter into a financial obligation for an amount of money equal to 10 or 20 years your annual pay?
I'm willing to bet that most people knew what they were getting into and accepted the risk. When they found out how boneheaded their decision was, they wanted to back out. We are a nation of children, with a profound sense of entitlement and a complete lack of personal responsibility. Unfortunately, we are led by politicians who shamelessly pander to these children.
Rate Freezes and Moratoriums
When I first began writing this over the weekend, I thought that the government was getting on the boneheaded train with a "Mr. Freeze" plan, where Hank Paulson shoots all of the subprime mortgages in the U.S. with a freeze ray and locks their rates in for five years, which would be a total disaster. It turns out that his "plan" is for loan servicers to try to figure out which borrowers cannot afford higher rates, but can afford to stay in debt slavery by paying normal interest rates, and charge them those normal interest rates. Well, I have news for you... The servicers already do this!
I'm glad that Hammerin' Hank Paulson realizes that an actual blanket rate freeze is a terrible idea (I think we all know how well price controls work). If lowering rates magically turned subprime borrowers into prime borrowers, well, then everyone would be charged the prime rate. It doesn't work that way. Subprime borrowers are charged higher rates because they tend to default more (a lot more) on their payments than prime borrowers. The high rates make sure I can earn a decent return on my investment after accounting for the high loss rates that I'll sustain by giving money to people with shaky credit histories. Freezing subprime rates at low levels virtually guarantees a loss on investment. With legislation pending in congress that makes the investor liable for "predatory" lending practices even though he never saw or met the borrower (he has to take someone else's word for it) and if the interest rates on loans can be reduced whenever politically expedient, who would ever take on such an investment? Any hope for private sector financing of subprime borrowers (what little is left) would be completely gone. As it stands now, subprime financing won't recover for some time.
We all can see what is going on: Most of the subprime "proposals" are desperate, self-serving attempts to put a floor under house prices, all of which are destined to succumb to economic reality. It all boils down to house owners not wanting to admit that their homes are worth less than they thought, and pandering politicians, who know otherwise, but pander to the house owners nonetheless. Now that the Ponzi scheme is over (they always end), house prices will have to re-set to levels that are affordable to the population, regardless of the amount of foreclosures. Forced sales simply expedite the process. Short-sighted policies, like freezing rates, a moratorium on foreclosures, or expanding the FHA to include ever-riskier borrowers (Yeah, were thinking about eliminating the 3% down payment and raising the loan limit to let the government extend no-money down loans to crummy credits in high priced areas - who do you think is going to pay for that one when they all blow up?) only delay the inevitable, and will end up doing much more harm then good.
- ▼ December (6)