The Credit Crunch, the Mortgage Mess and the Threat to Economic Growth
Rep. Miller and the folks at TPM cafe asked me to join in a conversation about Rep. Miller's housing bill, the housing market in general and the credit crunch. So... here goes.
Here's a brief overview (read very brief) of the current problem.
To get the US out of the last recession the Federal Reserve lowered interest rates to inter-generational lows. There are two other developments that added fuel to the fire.
The first is the deterioration of loan underwriting standards. I often joke that instead of looking at someone's credit report, mortgage bankers instead asked if a person had a pulse. If the answer was yes, they got a loan.
The second issue is that of "securitization". This is the finance geek way of saying the following. Mortgage loans were combined into large pools of mortgages and then cut into different cash flows. For example, an investment bank would buy 100 $100,000 mortgages (for a total of $10,000,000) and then create a group of bonds from that pool. The bonds would have different payment characteristics for different types of investors.
The process of securitization has been around for about 25 years and in general has worked very well. Until now. The central problem was the collateral that backed the loans. Because the collateral was weak -- meaning a lot of people started to default on their loans -- the bonds that were carved from the pool of loans started to drop in value -- big time. This has led to all of the writedowns in the financial sector you've been hearing about.
Compounding this problem is the ratings agencies which gave these bonds stellar ratings. This means that instead of only speculative buyers purchasing bonds backed by sub-prime collateral (think junk bond funds and the like) everybody purchased these bonds. As a result, everybody and their dog are taking nasty hits to their capital.
So we arrive at the position where we are today, which is a terrible place. Financial companies are writing down the value of their holdings, which hinders their ability to do what they're supposed to do, namely, lend money. In addition, financial companies are also loathe to lend money to each other because of "counter-party risk", which simply means lenders don't know if a borrower will be around in 90 days to pay back loaned funds. This is what is being called the "credit crunch". The Federal Reserve is trying to alleviate the problem by slashing rates, but this doesn't alleviate the lack of confidence in the financial markets.
All of the mortgage defaults that have caused the bond prices to drop have also led to serious problems in the housing market -- namely, a huge super-glut of inventory with more on the way.
And all of this is is seriously dampening consumer sentiment, which couldn't come at a worse time for retailers.
So, in sum, the economy is facing a very difficult time right now.
The fundamental problem seems to me to be that over the last 20 years we have transformed our diverse economy to one almost wholly based on building ever-larger new houses on ever-more-remote cornfields (then borrowing money from China to fill these houses up with electronic gadgets we don't make). It simply wasn't and isn't possible for this trend to continue forever; many people predicted its end over the last 2 years and - surprise - the end has arrived.
So I am not sure how any amount of jiggering with the financial paper system will change anything significant. There is no there there to improve.
sPh
December 19, 2007 8:51 AM | Reply | Permalink
no only that, but the sprawl that has to be supported is getting out of hand.
To boldly go...
December 19, 2007 3:14 PM | Reply | Permalink
Morgan Stanley wrote down $9.7 BN in the fourth quarter, out of a total position of $10.3 BN. This is bad news for the folks at Morgan Stanley as they saw their bonus pool evaporate (I can just hear the violins you're playing for them). It's goods news for the overall market, as such omnibus writedowns accelerate the return of market confidence.
John Mack, MS CEO, took responsibility (foregoing his $16M bonus) and assured investors with a $5 BN cash infusion from a Chinese sovereign fund. The hope is that the mortgage-backed bond fiasco is finished at Morgan. It didn't hurt that every other business unit at Morgan had an otherwise stellar year. The market response has benn to push MS stock up--so it's working for now.
If other large firms did the same the markets will recover by summer. It's painful, like lopping off a limb, but not as painful than if they parse out the writedowns in smaller chunks (death by a thousand papercuts) thereby feeding the lack of confidence in the markets.
/c
In the blogosphere every one is an expert, so no one is an expert.
December 19, 2007 1:42 PM | Reply | Permalink
"recover" to what? There isn't going to be a market for millions of additional cornfield mansions again for at least five years and probably ever (given the trend in oil prices). If the mortgage-backed securities and their high-yield "strips" don't exist any more, where will the next year's profits come from?
sPh
December 19, 2007 2:17 PM | Reply | Permalink
Newsflash: this is a nation of 300 million people, and that number is growing due to immigration. Housing is not an optional expense. People will still be buying and, yes, building houses for the foreseeable. Yes, there's going to be a slow year or two until the current mess is purged from the system, but it will happen.
December 20, 2007 3:29 AM | Reply | Permalink
Next year's profits will not come from mortgage backs; that's for sure. Capital will be deployed other sectors. Some niche players will stay in the game, but then they're either better at it, or feel they've learned enough from the meltdown to avoid another.
Those left holding the McMansion bag are a minority with little impact on the capital economy. Once the big players get out (via massive mea culpa writedowns),the capital economy will recover and move onto the next big thing. It's about time to start breaking up all those private equity consolidations.
/c
In the blogosphere every one is an expert, so no one is an expert.
December 21, 2007 11:18 AM | Reply | Permalink
Hello Hal! You can tell Rep Miller that buying a house is like tying a rock around your neck and jumping in a lake! I'm going to stay in my comfy apartment for the foreseeable future! There's no reason to take on the burden of someone elses debt!
To boldly go...
December 19, 2007 3:16 PM | Reply | Permalink
Amen, brother! It's all about net cash flow after overhead. Nothing else matters. The more people jump into housing for little more than a chance to commute and work away their two-income lives, the cheaper my rent gets (and the shorter my commute). Here's to a quick recovery! Enjoy the "American dream."
December 20, 2007 1:34 PM | Reply | Permalink
If you want to get to the root of this problem, you need to look at how to close our central banking system, and put our money back on the Gold standard. This will introduce fiscal discipline that is needed to have a stable economy. Currently the problem is undisciplined lending, and allowing our banks to print money out of nothing, causing an acceleratede rate of inflation. The root of this problem was planted in 1913 with the founding of the Federal Reserve Bank. Repeal the Federal Reserve Act of 1913.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 19, 2007 9:05 PM | Reply | Permalink
There is no logical reason whatsoever why the wealth of the world shoudl depend on how nuch of a pretty but rather useless metal we can grub out of the Earth in Siberia and South Africa. None. Nada. Zip. And the gold standard was no panacea in its day. Quite the contrary as roaring inflation and brutal depressions were routine. By contrast the current monetary regime, though far from perfect, has been fairly successful.
December 20, 2007 3:31 AM | Reply | Permalink
After years of reading and researching, trying to figure out what the root of the problem really is, I can come to no other conclusion. It doesn't matter how "useless" a metal is, it is a standard that introduces discipline to economic monetary management. You say it wasn't a panacea, well nothing is. However, the gold standard was not the cause of inflation. Quite the contrary. Since the U.S. has gone off the gold standard, inflation has skyrocketed, and if history repeats itself for every other fiat currency, it will eventually deteriorate into hyperinflation if something isn't done to stop the endless printing of money from nothing.
The current monetary system isn't working as well as you think. The only real claim to success we have with it is that we have sandbagged inflation better than anyone in history and have lasted longer. We are overdue for the inflationary consequences that we haven't seen yet that will cause our currency to fail.
I have read volumes of books on money, and monetary history in the past 6 years, with all kinds of economic theories and monetary philosophies. I also majored in finance in business school, where I learned the politically correct version of economics, and failed me in managing my own business. Now I understand more clearly what is going on, and unfortunately it isn't a generally understood. That is the reason we will suffer the consequences, unless we can begin to accept reality and stop walking around with our brainwashed, politically correct, version of economics fed to us by our government.
The government's solution to the symptoms of this problem is bank bailouts. That is the historical response throughout the world with central banks using a fiat currency and fail (which has always happened in about 200 years from inception). We will surely end up doing the same, and lose our national sovereignty in the process. Someone once said, "He who has the money makes the rules." That idea seems to have held true throughout history.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 20, 2007 8:57 PM | Reply | Permalink
I like your point about "gold as a measure." We measure the speed of light, the duration of a second, the length of a meter, the amount of mass, the force of gravity, etc... and yet people are afraid to standardize the measure of wealth.
And, in general, I think people have to have "aha moments" to actually understand what you're saying.
i.e. Money is nearly a perfect piece of propaganda, in the "Mein Kampf sense."
To boldly go...
December 21, 2007 12:30 PM | Reply | Permalink
Re: After years of reading and researching, trying to figure out what the root of the problem really is, I can come to no other conclusion.
To be a bit blunt your conclusion is similar to someone deciding that if we all went back to using outhouses we would not have to worry about sewage in our lakes and rivers. Well, yes, true enough but the consequences of that (especially with today’s population density) would be far worse than the consequences of our current sewage treatment process. So it is with the old gold standard. Once upon a time it was a necessary evil. Back when wealth was primarily based in land, you needed a reasonably stable means of exchange (since the supply of land is limited and generally fairly stable, at least in normal time frames). Gold fit the bill because it was of limited supply and almost indestructible. When however land ceased to be the major form of economic value, or whenever the real wealth of society exceeded its gold supply, or if there occured a sudden increase in the gold supply (after the wars of Alexander or after the discovery of the New World) then the gold standard had ruinous consequences: either massive inflation as governments were forced to debase their coinage or else crushing depressions (generally followed by revolutions and wars). Yes, the current economic regime is far from perfect, but it works better than what we had in the past, and given today’s conditions the gold standard would bring the world’s economy to its knees with fearsome consequences of violence on an uminaginable scale. I’d rather put up with a glut of foreclosed properties and $3 or even $5 gas than endure some of the things that could result from global economic collapse.
December 21, 2007 3:01 PM | Reply | Permalink
You are simply terribly misinformed, and do not have a clear understanding of economics. We'll see who understands what is happening better in about 10 or 20 years. Unfortunately, at that point we can't turn back the clock and try again, but hopefully we'll learn from our mistakes. If history is any indicator, we won't learn a thing.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 22, 2007 11:05 AM | Reply | Permalink
My realtor is now a waitress at Jimmy Buffet's Margaritaville. I think her fetching my drinks and hot wings was more service than I got during my home purchase.
So a giant Bronx cheer to Realtors(tm) and mortgage brokers. They are superfluous at best, and their industry spokespeople actively promoted the idea that it's smart to flip your house, move up or take a cash out refinance every 3 years.
It's really not even fun to laugh at most of them. I'm sure they had no idea they were part of the biggest economic disaster in three generations, and their nifty little racket blew up in everyone else's face too. Not just theirs.
Double thumbs down to the "journalists" who interviewed Realtors(tm) and mortgage brokers to write all those columns favorable to -- guess who -- Realtors(tm) and mortgage brokers. Financial journalism is even more stenographic than the political kind.
December 20, 2007 8:11 PM | Reply | Permalink