TCS Daily


Two Economic Birds, One Government Stone

By Rex DuPont and Andrew Hamilton - January 25, 2008 12:00 AM

There is a large and potentially risky disconnection between the causes of the current financial crisis and the various macroeconomic stimulus packages proposed by the Fed, the president and others. We propose a precisely targeted stimulus that would seek directly to reduce the underlying uncertainty that is driving markets down.

The current economic and market downturn, which could get worse if not checked, is a reaction to perceived large losses in the real estate sector, amplified by uncertainty about the size of potential losses. Securities backed by American mortgages are held by financial institutions around the world. These securities were packaged in such a way that it is very difficult to identify how much default risk each contains. While efforts to deconstruct them are underway, results are not likely to occur soon enough to reassure markets and lenders, who are adopting an ultra-cautious posture that reduces market capital and could induce a recession.

The problem is further complicated in some areas because the mortgages in question may be clumped into groups that could cause a serious decline in local housing prices. Then the owners who can meet the existing payments in those areas may come to doubt the benefits of meeting the payments on a mortgage that is now larger than the current market value of their homes.

The response by President Bush, Fed Chairman Ben Bernanke and others to this market failure is to put together some combination of economy-wide monetary and fiscal stimulus measures designed to ease access to capital and forestall recession. The potential risks include a further flight from the dollar, yet higher oil prices, and a tilt toward inflation, if not stagflation.

We would prefer to attack the problem from the other end, by directly intervening in the housing market to purchase and eventually resell mortgages in default. We note that the Resolution Trust Corporation (RTC) undertook a similar role and in effect created a market for properties where there had been none, with economy-wide, macroecoomic benefits.

Our approach would be for the federal government to finance the acquisition of defaulted mortgages. The properties so acquired could be used to provide affordable housing where needed, or resold, with proceeds to be used for low and moderate income housing programs. The federal government could create a Fund for Affordable Real Estate through an entity analogous to the RTC. It would make funds available to those regions most affected by non-performing mortgages and foreclosures. These funds would be used by the states involved, or by the appropriate non-profit entities, to purchase distressed properties with a view towards recycling them as "affordable" housing, which is in short supply in many of the same regions.

A simple example of the need for affordable housing is a town that has applied its resources to provide a superior public educational system. Affluent parents will bid up the real estate in that town to gain access to the schools system. However, this will price the teachers in those schools out of the local market, forcing them to live away from their work. A solution used in Massachusetts, for instance, has a goal of 10% of the housing units in a community as affordable. The qualifying applicants must have incomes below a fixed percentage of the area median income, and the cost of the housing provided is set at a level not to exceed about 30% of the applicant's income. There are usually more applicants than spaces, and the successful applicant is chosen by lot. One source of such housing is a requirement that a developer supply some percentage of a new project as affordable housing. Some housing is made available by civic minded owners. The main bottleneck in the process is finding a supply of available land or structures.

The current oversupply of housing on the market provides a unique opportunity to expand the supply of affordable houses nationwide.

These purchases would have the triple effect of cycling new funds into the economy, shoring up the distressed markets, and providing a publicly desirable service. Probably the most important economic effect would be the reduction in uncertainty in the housing markets, allowing them to stabilize at a more realistic level in a shorter time than the current free-form process will take, and will fewer gyrations in price. At the same time the program would rapidly increase the supply of a known desirable public good in the form of increased affordable housing.

Rex DuPont holds a finance doctorate and taught at Boston University. He is currently an officer of DuPont Aerospace, an experimental aircraft company near San Diego. Andrew Hamilton is an editorial writer for the Charleston, S.C. Post and Courier with prior experience at the Congressional Budget Office and the Senate Budget Committee.



47 Comments

Relax
British bankers usually take care of each other...

They don't charge each other much of a premium in interest. For example, in the first half of 2007, the British set the bank-to-bank interest rate at just 0.11 percentage points over the fed-funds rate. It was practically pegged at this level... It hardly fluctuated.

Then August arrived. Fear set in. Things got so bad, bankers wouldn't lend to each other. They didn't trust each other's promises to pay.

Over the summer, the British Bankers Association – the old banking "gentleman's club" – raised the London Interbank Rate (LIBOR) to nearly a full percentage point above the fed-funds rate. It was a sign of distrust and panic. Banks didn't want to lend to each other. And if they did, they only did so at a high interest rate.

Now the fear has completely subsided.

Recently, the LIBOR rate actually fell below the fed-funds rate (which hasn't happened since 2004).

This is a dramatic signal that bankers trust each other again... that they'll lend money to each other again at favorable rates... and most importantly, that the liquidity crisis is over.

I'm not kidding. Today, even with what felt like panic this week, the LIBOR rate is still below the fed-funds rate.

So the liquidity crisis is over.

Let me be careful with my words here... The subprime mess isn't over. And the housing crisis isn't over. More finance and housing companies with too much debt to survive will go under.

But please understand, the super-dangerous crisis – the liquidity crisis – is over. A liquidity crisis is what we saw in the Great Depression... and it's what Japan saw in the 1990s. When banks won't lend, the wheels of commerce stop.

Now banks are willing to lend again. That's a good sign.
~ Dr. Steve Sjuggerud

Gate, Soros and Buffet could put their money where their mouths are.
If they want moral capitalism, why don't they invest their billions into such a venture?

What the heck is this?
So were proposing;

1) Thwarting a needed market correction.
2) Expending more Federal Funds to bail out banks who made dumb loans.
3) Experiment in more public housing which has been a abysmal failure. Public housing residents have no stake in the condition of the property, why should they care?

Further, affordable housing? So in other words were going to subsidize house purchases?

No, they want US to finance such ventures
Do as I say not as I do?

An easier plan
"The federal government could finance the acquisition of defaulted mortgages. The properties so acquired could be used to provide affordable housing where needed, or resold, with proceeds to be used for low and moderate income housing programs."

More economical would be to just lower the prime rate. That way existing loans could reset to the lower rate, and a fresh wave of foreclosures be averted.

People could then be able to afford to stay in their homes. Thus there would be fewer foreclosures and empty houses glutting the market. And fewer homeless families finding it difficult to contribute to the economy.

Plus, the government could save a lot of money. But what am I saying? This is an election year. Everyone loves to think it's patriotic to get money back from the candidates they're being asked to re-elect. By spending it, they're doing their part to get us out of the Re-cession. Just like after 9-11 they could go shopping and spend money to help lick the terrorists.

Besides, what's the federal gubmint going to do with a million empty houses? Back when they had all those HUD houses they were just good for giving crack heads a roof over their heads.

Consequences
Lowering the prime rate has other consequences, which may turn out to be quite costly down the road.

I fear that making expensive houses cheap so that teacher, police officers and career firefighters can afford them will not in fact make them affordable. The local property taxes are often far more than these people can afford.

Easier solution
Have the state and local governments buy the houses and then provide them to the state and local employees as part of their employment package.


Give the people a choose of renting them or buying them as part of their employment, just like the military does with on base housing.

If renting they would be responsible for upkeep of the property just like military personal on base are.

If buying the house would be theirs as long as they remained employed with the option of selling it back for the equity or refinancing the remaining balcance at the end of employment.

what a load of steaming krap
This sums it up: "The current oversupply of housing on the market provides a unique opportunity to expand the supply of affordable houses nationwide."

The US government is no constitutional business making housing "affordable" for anyone. People are paid commensurate with the value of their labor and the cost of the housing they inhabit is commensurate with their ability to pay for it. To in any way reward people for their poor, no scratch that, _stupid_ decisions just reinforces the view of entitlement shared by the "I deserve - you deserve" crowd.

As more and more of the US population come to believe that they deserve a home beyond their ability to pay for it, there will be an unstoppable John Edwards-type of call for increasing the tax rates back to pre-Reagan levels (70%) or even to pre-Kennedy levels (91%) with the resulting deteriorating living standards as seen in parts of Old Europe.

The whole idea of saving the stupid from their own stupidity stinks like a big pile of sun-cooked krap.

TS

Here that Roy? the problem is NOT bank liquidity
As is quite clearly stated best:


The current economic and market downturn, which could get worse if not checked, is a reaction to perceived large losses in the real estate sector, amplified by uncertainty about the size of potential losses. Securities backed by American mortgages are held by financial institutions around the world. These securities were packaged in such a way that it is very difficult to identify how much default risk each contains. While efforts to deconstruct them are underway, results are not likely to occur soon enough to reassure markets and lenders, who are adopting an ultra-cautious posture that reduces market capital and could induce a recession.

The problem is further complicated in some areas because the mortgages in question may be clumped into groups that could cause a serious decline in local housing prices. Then the owners who can meet the existing payments in those areas may come to doubt the benefits of meeting the payments on a mortgage that is now larger than the current market value of their homes.


Now, for another shock for Roy. There IS one of the FEW successful FDR New Deal programs that can be revived that I would support. That was the Home Owner's Loan Corporation.

It worked in that it prevented a million homes from being foreclosed and even turned an operating profit. But any revived version I would not like the 'bail out the banks' provisions. It should only be used to buy breathing room to the market and get houses selling again, that's all.

http://en.wikipedia.org/wiki/Home_Owners%27_Loan_Corporation

Agreed...but it IS going to happen
just like how the feds will never stop being in the insurance business that allows all those homes in hurricane coast country from being rebuilt over and over again.

Welcome to Atlas Shrugged.

Why bother? Housing is already pretty affordable...
The current housing "crisis" is that banks over-valued risky mortgages and now they've realized how risky they were and are writing them off. The only losers in this game were the banks. The public didn't lose because a lot of undeserving people who didn't own houses got to buy houses and a lot of homeowners were able to get cushy home equity lines of credit they didn't deserve. Homeowners got free money, and they (we, actually) went out and spent it on new cars, new toys, and fancy degrees. Who cares that my property value has dropped 20% in the past year? I wasn't planning to sell, I've already secured my line of credit, and really, it hasn't "dropped" at all, it's just corrected itself. We all knew those super high real estate prices were artificial, that banks were being stupid with their valuations. When I was getting my home equity line, I was getting valuations anywhere between 700k and 970k. Of course, I went with the bank that valued it at 970k. Millions of Americans got affordable housing at the expense of dumb banks all over the world. Now the banks are finally realizing their losses, and we American homeowners are realizing how fortunate we are to have dumb banks. So a few hundred thousand of us will lose our houses--so what, rents are super cheap right now. Millions more will get to keep their houses.

One more thing....
Did I mention that the millions of us Americans who *sold* homes in the past few years are the actual beneficiaries of all these dumb banks? The $100 billion that has been wiped off of banks' balance sheets in the last couple months was not money that just disappeared into thin air. It went into our wallets -- some of it into my wallet, in fact, when I sold two homes to people who nowadays would have a much harder time getting loans. So those two parties got nice homes and I got wallet full of money. Now if either of those two people default on their loans, poor bank. But I still got my money and those two parties got to live in nice places for a couple years.

That wasn't my comment
My comment went to the observation that the worst of the foreclosures still lies ahead of us. And the approach with the greatest impact would not be one that addresses how to clean up after the fires, but how to prevent the fires from breaking out. Therefore I would lower the prime, so interest rates on these VRMs would reset at a lower, more affordable rate.

Brand new neighborhoods would then not die, with blighted, boarded up, unsalable homes on every block. And there would be hundreds of thousands fewer families going through bankruptcy. Are you seeing the picture yet? We're trying to avoid a recession.

But let's address the liquidity issue you raise.

All of our largest banks are getting kicked in the teeth now by their own greed and haste. In hindsight they should never have considered those bundled mortgage backed securities. It was pie in the sky, with an exploding balloon for a tag line. The recipe EVERY pundit has recommended involves flushing a lot of cheap, instant cash through the system.

Whereas the gold-centric view is that gold is appreciating against the dollar and we are in the beginning stages of a bout of serious inflation. So the approach we should take must be to tighten up the money supply, raising interest rates and cooling things down.

What I'm asking you, as our resident expert on gold, is to square the circle. Which view is the correct one? Tighter? Or looser?

Or should we split the difference... and do nothing.

What planet are you on, Roy? (really)

"All of our largest banks are getting kicked in the teeth now by their own greed and haste. In hindsight they should never have considered those bundled mortgage backed securities. It was pie in the sky, with an exploding balloon for a tag line. The recipe EVERY pundit has recommended involves flushing a lot of cheap, instant cash through the system."

None of those statements have anything to do with bank liquidity. It has nothing to do with whether the currency is fiat or fixed, either. Do you even KNOW what that term (liquidity) with regards to banking even means? Do you know the difference between banking 'liquidity' and 'insolvency' is?

'Liquidity' with regards to banking operations merely refers to the bank's ability to make its credit obligations to its depositors at any given time, with the help by the lender of last resort specifically assigned and chartered with doing so -- the Federal Reserve. The Fed will provide as much liquidity as necessary to a bank in order to prevent or stop a bank run, period. It doesn't matter if the bank's CEO ran off with the money to Aruba with his girlfriend or burned the money at Burning Man while chanting naked around it, the Fed steps in pretty much regardless. It also doesn't matter if the currency is pegged to Gold, Roy's underwear collection or just to an interest rate target (which is to say, really nothing at all like our current policy is).

That's it, Roy. Yet you misunderstand that basic concept and push that misunderstanding into a further quest to compare apples with oranges that aren't even in the same grove.

'Insolvency' is when a bank is kaput, period. It is going under no matter what the Fed does in the short term to help out with liquidity problems. That is when the FDIC has to step in to cover depositors and the banking regulators arrange for a buy out or merger with another bank. The Fed is involved with those activities also. This is far less common than liquidity situations are.

So, your questions are not relevant as they are grounded in illogical concepts that just don't exist. Its as if you hear/read these terms being bandied about but don't bother to really understand what they mean, yet try to say something you 'think' is intelligent. Therefore, I simply can not answer your questions anymore than I can answer someone's basic physics questions by a person who doesn't understand what gravity is.

Have you ever noticed
That for roy, every problem in the world boils down to the greed of capitalists?

More socialism form TCS
Right you are ...

“Our approach would be for the federal government to finance the acquisition of defaulted mortgages.”

It was government financing and government induced financing that led to the mal-investment.

“The properties so acquired could be used to provide affordable housing where needed …”

Propping up prices isn’t a way to achieve affordable housing.

“The current oversupply of housing on the market provides a unique opportunity to expand the supply of affordable houses nationwide.”

There is no oversupply. There is a miss-priced supply. That requires allowing prices to fall as will happen when the foreclosures come on the market next year. Allow the liquidation of mal-investment.

Agreed but TCS is lead the charge
Talk about sanction of the victim! I thought TCS would be outraged at government engineering of the economy. I misjudged this venue.

noticed about Roy
We notice that he keeps trying to push more marxist economics and crappy Keynsianism on us. Us guys have all read that discredited stuff, but I don't think he has read anything else like say, Austrian School economics, or even Adam Smith.

You're still just pretending
This is you at your most obnoxious. In your haste to contrive a case against me, you have now attempted twice to turn the conversation to bank liquidity, so you can make it appear as though I'm wrong.

Yet if you look closely at both my comments-- An easier plan and That wasn't my comment, you'll see that I haven't mentioned liquidity, or anything remotely like it.

Why do you do this? Do you imagine you're impressing me with your... your what? It's just stupid. It's a serious defect.

If you want to comment or critique anything I'm actually saying, I invite you to do so. Don't just invent something and blather on as though it relates to something I've said. Address my points. I invite actual, non-moronic criticism.

Here is one, and you may restrict yourself to responding to this and nothing else: what would you do today to bring the price of gold back into line?

The solution proposed works against the writer's stated objective
The writer argues that people like teachers in rich school districts need affordable housing in the nearby towns. And to solve this supposed problem he creates a solution which props up the prices of homes.

Here are a couple of better solutions. Let the rich school districts pay sufficient wages to attract teachers given the local cost of housing (which they already do or they wouldn't have teachers - QED). And let the market drive down the prices of houses to their real values by avoiding a government program which will only prop up the prices of homes while rewarding those who foolishly speculated.

In line with what?
What is the 'line' price of gold?

"But let's address the liquidity issue you raise."
"But let's address the liquidity issue you raise."

Ok, let's have a vote: Who how has read these posts did see at LEAST that statement by Roy?

Yes originally, I took Roy to task because in the forums of a similar topic "A Very Stimulating Crisis" Roy started harking about bank liquidity then. I quoted directly from this article that clearly reinforced my case that the problem isn't bank liquidity. I didn't want him to skate off that original conversation. For those who want to brush up on that, here's the link:
http://tcsdaily.com/discussionForum.aspx?fldIdTopic=9549&fldIdMsg=89173

Now back to this thread, in response Roy says, "That isn't my comment...BUT let's talk about it [liquidity]". So, he does...rather badly for all the reasons I then mention. In fact, he doesn't talk about liquidity at all!

He ignores all of those reasons I mention in response and instead decides to cry like Hillary in New Hampshire. He claims I am 'inventing' his own words as he posted them. He even claims that he didn't mention liquidity!

"But let's address the liquidity issue you raise."

"But let's address the liquidity issue you raise."
"But let's address the liquidity issue you raise."

How much do I have to clip and paste this Roy for you to finally fess up, eh?

Oh, and to answer your final straw-man question (and to prove that I do try to stay on topic I volunteer to): The price of gold is not the problem, the price of dollars in relation to gold is, so your question is not germane. I've only been re-explaining the aforementioned difference for months now yet you still don't get it.

Hey Roy, I just re-read your original post that started all of this particular thread and found another quote of your's I'd like to ask you about. You say this:

"More economical would be to just lower the prime rate. That way existing loans could reset to the lower rate, and a fresh wave of foreclosures be averted."

So...uh, how would the existing loans 'reset'? By magic? Or, did you have some particular means in mind for those resets to happen? Just wondering.

We are just a bunch of King Cnutes trying to hold back the sea.
What TCS Daily is posting is just part of the overall trend. Just as in Europe, rational economic thought is a dying animal in our culture, I am afraid.

Besides, what would we have to b!tch about then? :)

An expounding on a point nwcnwc makes...
...which is:

"The $100 billion that has been wiped off of banks' balance sheets in the last couple months was not money that just disappeared into thin air. It went into our wallets..."

Provides more proof to what I've repeatedly posted for months about banking and money creation. That is, "Banks do not create MONEY, they create CREDIT." There's a difference between the two and nwcnwc clearly spells it out.

Therefore, the statement "There is a systemic credit contraction, not a liquidity crisis" is the correct one when it comes to describing (in a nutshell) the current mortgage lending industry problem. When it comes to economics, 90% of copy written in financial columns are by English/Liberal Arts* majors who don't know what the hell they are writing about. They treat terms like 'liquidity' as a buzzword to just bandy about, that's it. You can't rely on them. You have to educate yourself.

* Apologies to all those English/LA majors out there who do believe that they are well grounded in economics. BTW, what is the name of the economic law the following statement describes? "If given the choice of what money to accept, people will transact with money they believe to be of highest long-term value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else."

The line price of gold...
...you take enough powdered gold to pour in a straight line on a horizontal mirror, and then snort it up your nose with a straw. The dollar price of the amount of powdered gold snorted is thus The Line Price of Gold.

Oh, and since that amount of gold is no longer available on the world market -- unless the mortician finds it in your body during the autopsy he/she will be performing on you in the next day or so AND finds a way of extracting it out of your body -- then the world's gold supply technically contracts and Roy's Gloom & Doom scenarios of gold standard caused economic depressions will be proven beyond a doubt. Zyndryl will be declared an Idiot and all will be well again in Liberal Land.

At least, that's my best shot at defining The Line Price of Gold. I don't know what the hell it really is either. So, you'll have to wait on Roy to answer that one.

Hey Roy! You brought up this topic, remember? It's germane! We aren't inventing words for you! Trust us, okay? :)

gold out of line
Gold is not out of line, or out of whack, but it's just that it takes so many more dollars to buy some gold because the dollar has been inflated so much, jeez.

Playing the clown
You'll do anything to avoid addressing the issue. You know perfectly well what I mean.

The greater context is your feeling that the price of gold should remain fixed and stable, as a discipline against the issuance of easy money. And within that context I have asked "what would you do today to bring the price of gold back into line?" Meaning, of course, stabilizing gold around a fixed value in dollars. Possibly its value on January 1, 2008.

Certainly you are aware that gold and the dollar are currently going in two separate directions. Please don't continue playing the buffoon. If you don't want to answer, just say "I don't have any good answer".

My gloom and doom scenario
Picking through your word pile I came across this:

"...Roy's Gloom & Doom scenarios of gold standard caused economic depressions will be proven beyond a doubt."

It doesn't strike a bell. If I've ever said anything that led you to believe I thought the gold standard caused economic depressions, please point it out.

Otherwise, let it stand as a perfectly fraudulent statement. You used to be much better than this. What happened?

The banking mortgage liquidity crisis
You're very good at bobbing, weaving, misdirecting and evading. But that makes no points in a serious discussion, which is what I'm trying to have with you.

I claim no special expertise in the field of economics. I only know what I read. And since you claim familiarity with the subject, I've been asking you to make sense of the many articles we read now that go like this:

"The Federal Reserve and the 2007 Banking Liquidity Crisis

"The 2007 banking liquidity crisis was caused by the lenders who approved mortgages to subprime borrowers, and the hedge funds and other investors who bought the mortgage-backed securities. When borrowers began defaulting, banks stopped lending, signaling a liquidity crisis.

"This primer details how the Federal Reserve is intervening in the financial markets. It also explains the subprime mortgage mess, the role of hedge funds, the 1998 LTCM hedge fund crisis, and some commonly used terms."

etc.

http://useconomy.about.com/od/monetarypolicy/tp/2007-Banking-Crisis-Primer.htm

Or this, from Freddie Mac:

"Over time the GSE market has evolved to serve household needs, and there is no better example than the high share of low-cost fixed-rate mortgages made possible by GSE mortgage purchases and investments. In contrast, the subprime market, as we know it today, is largely investor-centric. Investor demand tends to drive what gets originated. Further, when yields dry up, investors will look for better opportunities elsewhere. This is not the case in the GSE market, where we ensure a continuous presence. This responsibility to serve markets in good times and bad is a responsibility not shared by private equity funds, hedge funds, non-bank financial institutions or even depositories. These institutions have the freedom, and indeed an obligation to their owners, to deploy their assets as they wish.

"In summary, the GSEs statutory requirement to provide liquidity to the nation's mortgage markets remains a highly important aspect of their congressional charter. Mortgages financed by the GSEs are lower cost, highly available, and permit consumers to shift interest rate risk – at will – to financial institutions that are highly qualified to manage it."

http://www.freddiemac.com/corporate/about/policy/reg_reform/mission_liquidity.html

People writing articles such as these seem to believe that the tanking market in subprimes equates to some kind of crisis in liquidity. And I was asking you to shed some light on it.

You haven't. Instead you prefer behaving like a five year old. Please grow up. Answer or don't answer, as you please. But if you do answer, try being civil and helpful.

Thank you in advance.

Not knowing what you mean
No, I don't. Not in this case. And, I come out and outright say so.

And, I think that the price of gold in dollars should remain fixed and stable. As to what that is, at this point it would probably have to be set between $500-$800.

Setting it too low or too high would cause short-term deflationary/inflationary problems. Or, we could just reissue notes in a remonitization drive by lopping off a zero.

http://en.wikipedia.org/wiki/Remonetisation

A perfect example of a moron writing an economic piece
...or a Liberal Arts major. :)

Just because banks stop lending does not qualify it as a liquidity crisis. It is a liquidity crisis when a bank can not meet its obligations to others, not when it can not generate new business. The terminology is incorrect.

If you and I are at a restaurant and notice I forgot my wallet when the bill comes due, I am technically experiencing a 'liquidity crisis' -- my income-liabilities ratio is just fine, I just temporarily need a loan. So, I borrow $20 from you. But if I was flat broke and you knew it, you might not be inclined to lend me the $20, correct? In this latter case, I would be experiencing an 'insolvency crisis'.

The vast majority of copy out there about finance/economics is written by unqualified people. It is one of the main reasons why people are confused about economics. I expound on this in a thread below: http://tcsdaily.com/discussionForum.aspx?fldIdTopic=9550&fldIdMsg=89337

to Znydral re economic morons
Are you familiar with the site where a guy often gives examples about how clueless most econ. journalists and commentators are? brookesnews.com.
like:
http://brookesnews.com/082801usbooms

I guess the guy is Australian, but often comments on the US.

Liabilities unknown, income unknown
Your response is both civil and informative-- for which I thank you.

But I will humbly proffer that what has been making the current crisis one that hovers between (using your own definitions) insolvency and mere illiquidity is that no one knows whether it will turn out to be one or the other. The definition of our crisis is hovering somewhere on the ragged line.

So, to return to your restaurant scenario-- if I happened to know that you had just lost a big bundle at the race track that day, even though you might be normally flush with cash I might still hesitate to lend you that $20.

It all depends on whether we have our anticipated two million additional foreclosures this year-- sort of. But even then, no one knows exactly how many of these bum mortgages have been slipped into everyone's portfolio.

So we have a market characterised by unease. Or at least so it would seem to me.

BTW I would like to correct a misimpression I may have fostered inadvertently the other day. I suggested that the Fed might want to lower the prime so existing ARMs reset at a lower rate-- thus staving off the Grim Reaper.

Now I find that mortgage rates typically reset to the rate for T-bills-- not the prime. I suppose I've been blissfully unaware of such details because I avoid whenever possible being either a borrower or a lender.

Oh well. Surprised you didn't catch that. :)

Well...no
There is simply no 'ragged line'. Talking about liquidity or even insolvency as a general issue with regards to banks in reference to the 'mortgage crisis' is like comparing sugar to salt, apples to oranges, etc.

No matter how liquid the banks are, they won't refi that house loan for $500k when the property is worth only $400k. They won't loan someone stupid enough to want $500k to buy a house now appraised at $400k just because the seller refuses to sell it for less.

Oh, and given the nature of mortgage lending as it was during the past few years, the ones who are going to get hit with liquidity or even insolvency crises aren't the banks, but the sucker investors who bought their bundles of non-joy from 'em. The Fed doesn't care nor can do much for them. Nor should they. So, the banks won't lend for crap asset values and where they can lend, they won't be able to sell those loans in CDOs as easily because the buyers of those got burned too badly.

Thus, 'injecting' liquidity into the banking system doesn't do a damn thing to bail out the banks for bad lending that's already happened NOR for lending/refinancing for homes owned by people that have lost equity. The banks just can't issue mortgages under certain market conditions, whether they are struggling meet their daily operational credit obligations to depositors or are flush with trillions they need to lend out pronto. Liquidity is a whole different animal and has very little to do with falling asset values after a bubble. The Fed can do what the Bank of Japan did -- set their federal funds borrowing rate to ZERO -- and it won't make a damn bit of difference any more than eating an apple while expecting to get the same vitamin c you would get from eating an orange will. Yet, the bulk of those who write for financial/economic articles DO expect loads of vitamin c from eating apples. Their editors are even MORE deluded, I think.

Don't feel too bad, Roy. I was quite pissed when I discovered that most of what I knew about economics and banking was wrong precisely because my sources of information were so retarded.

Thus, articles with titles like 'The Federal Reserve and the 2007 Banking Liquidity Crisis' are written by subprime writers, not testaments to anything credible. The scary thing is: You'll find that kind of krap published on the Federal Reserve's own web site. Even worse is when actual economists are that sloppy, like Paul Krugman routinely is.

As to your statement about automatically resetting loan terms to the prime...or the T-bill rate, I caught that. Thing is, most ARMs reset to higher rates after a while anyway. That's going to hit a lot more people this year than the subprime mess did. And given how most people won't be able to refinance them, the foreclosure rate will skyrocket! This is going to hit those with good credit (who won't have it for long) who didn't believe that home asset values ever fall and a lot more of them than the subprimers were. Interestingly, a few banks will then experience liquidity problems because of the volume of late payments and defaults hitting their cashflow will be large, but like I said -- the Federal Reserve will step in to keep things running while real problem banks will be consolidated with others. Mostly it will be the CDO holders who will get burned big time. That whole market might just evaporate.


Mortgages have turned into auto loans
The value of the asset is less than the payoff.

Cars should depreciate. They can make more.

Somemone said, invest in land. They ain't makin' anymore.

Supply exceeded demand and the price of real estate slowed and will settle out.

Won't see too many 125% home equity loans anytime soon. Should not have seen them a few years ago either.

Won't see too many 125% home equity loans anytime soon..
..Should not have seen them a few years ago either.
Darn right! It was *almost* as insane as the Dutch Tulip Mania:


In 1623, a single bulb of a famous tulip variety could cost as much as a thousand Dutch florins (the average yearly income at the time was 150 florins). Tulips were also exchanged for land, valuable livestock, and houses. Allegedly, a good trader could earn six thousand florins a month.

By 1635, a sale of 40 bulbs for 100,000 florins was recorded. By way of comparison, a ton of butter cost around 100 florins and "eight fat swine" 240 florins. A record was the sale of the most famous bulb, the Semper Augustus, for 6,000 florins in Haarlem.

By 1636, tulips were traded on the stock exchanges of numerous Dutch towns and cities. This encouraged trading in tulips by all members of society, with many people selling or trading their other possessions in order to speculate in the tulip market. Some speculators made large profits as a result. Others lost all or even more than they had.

In February 1637 tulip traders could no longer get inflated prices for their bulbs, and they began to sell. The bubble burst. People began to suspect that the demand for tulips could not last, and as this spread a panic developed. Some were left holding contracts to purchase tulips at prices now ten times greater than those on the open market, while others found themselves in possession of bulbs now worth a fraction of the price they had paid. Allegedly, thousands of Dutch, including businessmen and dignitaries, were financially ruined.

The aftermath of the tulip price deflation led to a widespread economic chill throughout the Netherlands for a number of years afterwards, resulting in what we would describe today as a mild or moderate economic depression.


From: http://en.wikipedia.org/wiki/Tulip_mania#Popular_view

Another way to hurt the economy.
The best thing for the government to do is to STOP PRINTING MONEY!!!! The interest rates will be the "REAL" interest rate that is the optimal relationship between savings and investment. That is the only way for the markets to get any economic value back from risky loans and bad investments.

Next best thing: Do nothing. Keep the interest rates steady and for heavens sake do not provide "stimulus". These activities simply transfer more money from savers (Critical to future investment) and spenders (to helps us get out of a credit mess with more risky credit).

But now even this web site supports violence and destruction. It wants to save lenders from bad loans and give the garbage left over to the citizens who get stuck paying for the mess. How to pay for the mess: Bill future people for the bill, they won't notice it.

Good progress!
Okay. We're halfway there.

You say that the price of gold should remain fixed and stable. And at the moment, gold is going through the roof. This implies that some action should be taken.

What sort of action would that be? Would raising interest rates to dry up the excess money be a good route to take? And would that have any unintended consequence?

Remonetization would seem to be the most disastrous route to take. They'd no longer be dollars. They'd be like Reichsmarks, or the old Argentine peso. And I can't see any positive benefit. Would we try to welsh on our debts? One New Dollar would still be the equivalent of ten real dollars. Only it would no longer be seen as real money.

More questions than answers
I get the feeling that we're still on two different pages. There's no question that by now subprime loan originations have dried up. That's not the issue.

The issue is that lenders originated millions of extremely marginal loans, but didn't have to pay the stupidity penalty because they were able to sell them all to the banking giants, getting their cash back and coming out smelling like a rose. Crime apparently pays.

The big banks bundled them and resold them. And now that so many are already no good it's both the banking majors and their investors who are taking a big hit.

My comments went toward the fact that we don't yet know how big the hit is. Because the actual collapse is only starting. In another year we'll have a much better feel for whether it's survivable-- if we wait another year before acting.

You say no problem, "the Federal Reserve will step in to keep things running while real problem banks will be consolidated with others". But if the banks in question are Bank of America and all the other biggies, who do they consolidate with? It's like saying the five richest guys in town have all lost their shirts in a deal gone bad-- but they can bail out by pooling their resources.

One other aspect seems mysterious to me. If two million loans default this year, that sounds something like a cash loss of a half trillion or maybe 3/4. But so far I understand the markets have collectively lost about seven trillion in value. Is this just because at bottom, it's all a confidence game? What's going on?

I guess I just don't understand these things. Please, 'splain it again for me.

admitting you don't understand
Finally you admit you don't understand, and then some of us keep explaining, year after year, and you still don't accept that your crappy marxism and Keynsianism is wrong. So here's my question; why don't you actually study up on another point of view, like the Austrians who correctly predicted the great depression, and a few others? Once you told you you have read Murray Rothbard, but it doesn't seem like it according to your wacky statements.

Pretending a great expertise
I see you're pretending you have a thorough understanding of the question I raised. Excellent! Then you can answer my question for me.

Here it is again:

If two million loans default this year, that sounds something like a cash loss of a half trillion or maybe 3/4. But so far I understand the markets have collectively lost about seven trillion in value. Is this just because at bottom, it's all a confidence game? What's going on?

The view from over here
Allow me to offer a couple of observations-- from a career spent in the housing biz.

First, not much of the gain resulting from pumped up housing prices has come from the resale market. You are correct that proceeds from the sale of an overpriced used home go into someone's pocket. But the majority of sales I see now, especially those at today's pumped up prices, are in new homes. And the proceeds go to builders and developers, small contractors and trades people, sales agents, appraisers, title officers and suppliers. This money keeps a large portion of our economy afloat.

The corollary is that when this industry sinks, it's a lot harder for America to swim. All those newly unemployed are like a cinderblock tied to our feet.

Second, think about how it is that home prices are able to outpace either inflation or incomes, decade after decade. Over time, who can still afford these prices?

The sticker price of a home is dictated by the monthly payment, not by the total cost. So when interest rates are trending upward, sales prices level off, or even go backward. When they go way down, an ordinary household might be able to afford the payments on a $200,000 home instead of a $100,000 home. So the price of a starter home suddenly doubles.

This was a consequence of the lowering of rates back in 2002-2003. Price inflation. Then when the rates started to climb, greedy lenders had thought ahead to offer people ARMs on ridiculous terms, thinking they'd clean up big time when the loans reset.

Only there was a bomb in the goody bag. The loans are resetting to monthly sums that few of those families can aford to pay. So the original money lent, plus the anticipated monthly income, are both wiped off the books. Instead, the current holders of those loans get to own piles of brick, expensive to maintain and constantly losing value. Plus, this plethora of boarded up housing creates instant slums, depressing the resale values of all the neighbors.

So why were the lenders so dumb? Oh man, they weren't dumb at all. The loan officers got paid their commissions, as did the sales brokers. And the actual lenders got their money back by instantly selling the bum loans to outfits like Citibank, who didn't know what they were buying.

The banks paid full price for a bunch of chickens... but the eggs are failing to hatch. So the only losers are the big banks and the investors who bought their mortgage backed securities.

Liquidity isn't the issue
"The issue is that lenders originated millions of extremely marginal loans"

That's one way of looking at it, but it also doesn't have much to do with liquidity.

"If two million loans default this year,that sounds something like a cash loss of a half trillion or maybe 3/4"

It's a value loss perhaps that high. But no cash is destroyed. Cash flow is impacted. But that doesn't impact the banks much since they offloaded these as you and I have both states.

And I agree with you that it is only the beginning. When the normal grade A loans with ARMs reset, those borrowers will be in the same boat as the sub-prime ones are. And there are a LOT more of those. It won't be pretty.

As to the biggest banks getting bailed out, unfortunately that is quite true. In fact, there was just an article on it about how how the Fed *hates* bailing out the big boys -- but have contingency plans to do just that if/when it happens.

I found the article: http://www.businessweek.com/magazine/content/08_05/b4069032985454.htm

Here's a graphic attached to the article on how it might all go down:
http://images.businessweek.com/mz/08/05/pop_0805_32theban.jpg

Good explanation Roy
"So the only losers are the big banks and the investors who bought their mortgage backed securities."

Now tell me, how is adding more 'banking liquidity' going to get the banks-who-now-know-better to lend like they did before? I personally think that the days of the 120% mortgage and no money down mortgages are long gone. Then again, I was one of the few who thought it was crazy in the first place so I could be proven wrong on both predictions.

But if I am correct, then that will lower the bar on housing demand and corresponding prices no matter how good the interest rates are. Injecting more bank liquidity thus won't do a damn thing, except make credit easier to get for non-housing borrowing (which might not be a bad thing).

confidence game
Yes it is rather like that. The government pretends it has money it doesn't, the banks pretend it's real money, the poor people pretend they can afford houses they can't, etc down the line, because it's not a real economy but a semi command economy. Even so, all those trillions you talk about also ain't accurate, the whole thing is still only a small precentage of the whole economy.

Seattle Public Housing is selling off their neighborhood houses.
Some years ago Seattle public housing bought individual houses in the neighborhoods on the theory that poor people would improve their work ethic (?) living next to white people. (?) Like cross town bussing to deseg the schools?

Anway, they are selling the houses stating that it is inefficient to manage them and the taxpayers and the poor get more for their money by building multi familly units.

It's already seen as not real money
..as for what needs to be done to peg the dollar to gold, I have stated so numerous times: Let the interest rates float but create/destroy dollars directly through the purchasing and selling of bonds or other assets.

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