Monday, October 13, 2008

CRASH TALK


Robert J. Samuelson, Washington Post
- Alone, American subprime mortgages should not have triggered a global crisis. Losses are smaller than they seem. Mark Zandi of Moody's Economy.com estimates that all U.S. mortgage losses will ultimately reach $650 billion. But that hefty amount pales against the value of all financial assets -- stocks, bonds, bank loans. For the United States, these totaled almost $60 trillion at the end of 2007; for the world, the comparable figure exceeded $250 trillion.

Such a vast financial system should have absorbed the subprime losses without calamity. By way of contrast, the stock market's drop since its peak in October 2007 to Friday was $8.4 trillion, or 42 percent, reports Wilshire Associates. The official response to the subprime losses also seems larger than the problem. The government has taken over mortgage giants Fannie Mae and Freddie Mac; the Federal Reserve is pumping out short-term loans of $1 trillion or more; and Congress's $700 billion rescue allows the Treasury Department to buy subprime securities and to make direct investments in banks. . .

What we've discovered is that the real problem is bigger. Large parts of the financial system are too thinly capitalized and too dependent on unreliable short-term debt. Leverage ratios often reached 30 to 1 for investment banks and hedge funds (that is, $30 of debt for every $1 of capital). The presumption was that the MBA types had learned how to "manage risk." That false conceit backfired. Low capital didn't adequately protect against losses. Confidence and trust evaporated, because no one knew which institutions held suspect securities, how much the losses were and who was ultimately safe. . .

Consider stocks. Their plunge has been driven in part by hedge fund selling. Hedge funds often buy stocks by borrowing from their "prime dealers" -- firms such as Goldman Sachs and Morgan Stanley, which in turn borrow from commercial banks. If banks "deleverage" by reducing loans to prime dealers, then prime dealers tighten up on hedge funds, which react by selling stocks. "It's a big piece of why the stock market is down," says Michael Decker, former chief economist for the Securities Industry and Financial Markets Association and now co-head of the Regional Bond Dealers Association. . .

The present challenge is far more complicated than merely quarantining dubious mortgage-related securities. What's involved is a fundamental remaking of the global financial system, from one that was inherently fragile to one that rests on firmer foundations. But if the change proceeds too quickly and haphazardly, it risks a hugely destructive credit implosion. All the policies undertaken so far will ultimately be judged by whether they succeed in managing the transition and restoring confidence in financial markets that self-correct naturally -- as opposed to submitting to the continuing mayhem of uncontrolled deleveraging.

Matt Smith, San Francisco Weekly
- In the new book Chasing the American Dream: New Perspectives on Affordable Homeownership, Lawrence Vale, head of MIT's planning department, describes how this conventional wisdom and the generations of public policy based on it were the fruits of an aggressive campaign led by President Herbert Hoover to turn individual homeownership into a national moral imperative. "The high rate of homeownership in the United States has been neither an accident nor an inevitable outcome of land availability and widespread prosperity," Vale writes. "Rather, it has been nurtured by generations of public policy, which were in turn preceded by concerted efforts to instill an ideological belief in the moral value of the owned home."

By 1931, Hoover's pro-homeownership campaigns had distributed millions of flyers, set up more than 7,000 local committees, and even impugned the moral and sexual adequacy of renters. Ownership of detached houses protected families from "the unwholesome and not infrequently contaminating ideas of the floating classes that predominate in the close-in rental districts," one pamphlet claimed, making an opaque, typical reference to immigrants, minorities, and Communists. . .

Dean Baker, Prospect - Well, if the Republicans blamed the financial crisis on Elvis Presley USA Today would probably just write it up politely and then note that the Democrats disagree. That is exactly what the paper did today in an article discussing how both parties contributed to the crisis.

The article notes that Phil Gramm, a former senator and adviser to John McCain, pushed through a law that prevented the Commodity Futures Trading Commission from regulating derivatives. It then presents Gramm's claim that the real problem was the Community Reinvestment Act, but notes that Democrats and "many experts dispute that."

It would have been worth noting that Gramm's claim makes no sense. The CRA did not even apply to the biggest actors in the subprime market. How could the CRA be responsible for forcing financial institutions to make subprime loans when they were not even covered by the CRA. It makes as much sense to blame Elvis.

In discussing the role of Fannie Mae and Freddie Mac in the crisis, it would have been useful to point out that they lost market share during the peak years of the housing bubble. Their share of the mortgage market fell from 50.1 percent in 2002 to 34.8 percent in 2006. While they did get heavily involved in junk mortgages, they lagged the private sector. They did not create the problem.

It would have been useful to mention the bubble itself. Neither party thought it was appropriate to force the Fed to take steps to burst the bubble before it reached such dangerous proportions. This was their bigggest failing.

NNPA - As the black unemployment rate leaped another eight percentage points last month - from 10.6 percent to 11.4 percent, the white unemployment rate actually remained the same - at 5.4 percent, less than half the rate for blacks. . .

John Petro, DMI
- We should look at the idea of the ownership society as it relates to urban housing. In most big cities a majority of households rent their homes. Future housing policies should reflect this reality. Many urban households choose to rent because it is less expensive than owning, but it is far from cheap to rent. The number of renter households that have a severe cost burden (yearly rent exceeds 50 percent of annual income) rose 20 percent between 2001 and 2006. Severe rental burden is not just a low-income household problem either. In the same period, the number of upper-middle income households that experienced a severe rental housing burden rose by 66 percent while severely rent-burdened lower-middle income households rose by 70 percent.

If the ultimate goal is indeed ownership, we still need to address the strain that rental prices are making on middle-income households. The cost of renting is making it more difficult for households to get ahead and to save, seriously hurting the chance that such a household will be able to get together the money needed for a down-payment on a mortgage. But we will also need to challenge the central tenet of the ownership society and see if it truly holds water, the assertion that for every household in America it is better to own than to rent.

HOW THE MELTDOWN WORKED

9 Comments:

At October 14, 2008 11:11 AM, Anonymous wellbasically said...

McCain proposed $300B to buy up the bad mortgages... so what was that $700B for again? Not for mortgages.

The problem is that the economy is bad, not that the mortgages were bad. People defaulted on their mortgages because they lost their jobs; they lost their jobs because the economy went bad. That's the problem.

 
At October 14, 2008 11:46 AM, Anonymous Anonymous said...

No, the economy wasn't bad until all the scammers who lied to buy houses they knew they weren't going to pay for started defaulting. Every statement by the Bush administration for years has told us how great the economy was doing. An economy as strong as they claimed couldn't possibly have had people getting laid off. An economy as strong as they claimed couldn't possibly have melted down so quickly. Hmmmm...

 
At October 14, 2008 12:05 PM, Anonymous Anonymous said...

11:46

I think you have part of that backward. It's not the
"all the scammers who lied to buy houses they knew they weren't going to pay for started defaulting."

It's the predatory lenders who pushed people to take subprime loans instead of normal 30 year fixed rate loans. They offered these loans to anyone who thought they could afford them, without all the finance checking that normal 30 year loans required. They even forced people who could borrow for a normal 30 year fixed rate loan to take adjustable rate loans.

For example a friend of mine bought his house 2 years ago. He asked for, qualified for, and signed up for a 30 year fixed loan, he even had a 5% down payment. The morgage company gave him an adjustablerate loan anyway, and he had to sign it or go back though the whole finance process again and possibly lose the house.

The morgage company took a good risk borrower and forced him into a subprime loan, whose fault is it when lenders act like predators.

My friends was unhappy with the loan and got a 30 year fixed morgage last winter, thank goodness.

 
At October 14, 2008 12:05 PM, Anonymous Anonymous said...

11:46

I think you have part of that backward. It's not the
"all the scammers who lied to buy houses they knew they weren't going to pay for started defaulting."

It's the predatory lenders who pushed people to take subprime loans instead of normal 30 year fixed rate loans. They offered these loans to anyone who thought they could afford them, without all the finance checking that normal 30 year loans required. They even forced people who could borrow for a normal 30 year fixed rate loan to take adjustable rate loans.

For example a friend of mine bought his house 2 years ago. He asked for, qualified for, and signed up for a 30 year fixed loan, he even had a 5% down payment. The morgage company gave him an adjustablerate loan anyway, and he had to sign it or go back though the whole finance process again and possibly lose the house.

The morgage company took a good risk borrower and forced him into a subprime loan, whose fault is it when lenders act like predators.

My friends was unhappy with the loan and got a 30 year fixed morgage last winter, thank goodness.

 
At October 14, 2008 12:05 PM, Anonymous Anonymous said...

11:46

I think you have part of that backward. It's not the
"all the scammers who lied to buy houses they knew they weren't going to pay for started defaulting."

It's the predatory lenders who pushed people to take subprime loans instead of normal 30 year fixed rate loans. They offered these loans to anyone who thought they could afford them, without all the finance checking that normal 30 year loans required. They even forced people who could borrow for a normal 30 year fixed rate loan to take adjustable rate loans.

For example a friend of mine bought his house 2 years ago. He asked for, qualified for, and signed up for a 30 year fixed loan, he even had a 5% down payment. The morgage company gave him an adjustablerate loan anyway, and he had to sign it or go back though the whole finance process again and possibly lose the house.

The morgage company took a good risk borrower and forced him into a subprime loan, whose fault is it when lenders act like predators.

My friends was unhappy with the loan and got a 30 year fixed morgage last winter, thank goodness.

 
At October 14, 2008 4:46 PM, Anonymous Anonymous said...

12:05,

One post is sufficient.

Also, your sarcasm detector doesn't seem to be working.

I know all too well that the only scammers involved in the mortgage mess were the rich investors who were betting that prices could go up forever. The worst defaulting has been on the part of such people who could easily afford to keep paying off the loans that are now bigger than the value of their investment properties, but choose to default anyway because it will allow them to lose less.

11:46

 
At October 14, 2008 5:21 PM, Anonymous Anonymous said...

So you guys are saying we should outlaw borrowing and lending?

wellbasically

 
At October 15, 2008 9:35 AM, Anonymous Anonymous said...

No.

 
At October 15, 2008 12:14 PM, Anonymous Anonymous said...

12:05 here, Sorry about the multiple posts, my computer went crazy or something. I only wanted one post myself.

11:46, First there are enough people here who post things that should be sarcasm, but are written in all seriousness, that I have taken to first thinking posts are meant seriously, unless the sarcasm is very very obvious. You were subtle enough to sound like you might have meant it.

5:21,

No, I don't want borrowing and lending outlawed, but I would like to see it regulated to remove unessisary risks, to end predatory lending and usury.

 

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