Let us layout something from the beginning. Bailouts are already occurring. The mainstream media for the most part still seems to be echoing a sentiment that bailouts haven’t occured. The bailouts have already occurred in the past tense. Bear Stearns being injected and propped up via a proxy JP Morgan/Chase was a […]
Related Posts:
■There will be Housing: How we’ve Returned to Selective Market Ignorance.
■Business Devours its Young: Lessons from the Great Depression: Part V: Destroying the Working Class.
■The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part IV: Where do we go After the Housing Crash?
■Crash! The Housing Market Free Fall and Client #10 Contagion. Lessons From the Great Depression: Part VI.
■Lessons From the Great Depression: A Letter from a former Banking President Discussing the Bubble.
Let us layout something from the beginning. Bailouts are already occurring. The mainstream media for the most part still seems to be echoing a sentiment that bailouts haven’t occured. The bailouts have already occurred in the past tense. Bear Stearns being injected and propped up via a proxy JP Morgan/Chase was a bailout. Of course, the public was told and fed a line that if Bear wasn’t propped up the entire edifice of Western Civilization would come careening into the sea. The fact that the Fed is now exchanging Treasurys for zombified mortgage backed securities is an absolute bailout. Have we already forgotten the Hope Now Alliance or the FHA Secure programs?
Keep in mind the current administration has perfected the ministry of truth language. In August of 2007, President Bush had this to say about bailing out homeowners:
“Obviously anybody who loses their home is somebody with whom we must show an enormous empathy,” Bush said. Asked whether he would champion a government bailout, Bush responded: “If you mean direct grants to homeowners, the answer would be `No, I don’t support that.’”
Today we get the following:
“WASHINGTON (AP) — The Bush administration announced new steps Wednesday to help more homeowners head off foreclosure, clashing with lawmakers in both parties who want the government to step in with a broader housing rescue.
Scrambling to counter Democratic calls for a large federal housing aid package, the administration said it would use an existing Federal Housing Administration program to enable more low- and moderate-income homeowners to refinance into government-insured mortgages with monthly payments they can afford.”
Former Goldman Sachs CEO and current US Treasury Secretary Henry Paulson who has been jawboning lassiez faire government, was in secret talks to prop up and bailout Bear Stearns and their whacked out Monte Carlo casino portfolio of counterparty derivatives on the back of the Federal Reserve which has become the de facto loan shark of all investment banks on Wall Street. A sort of flea market and money laundering scheme where you bring in crappy loans and walk out with cash. You would think that the Fed has mastered the Midas touch and is able to turn raw mortgage sewage into pristine bars of gold.
We are dealing with the ministry of truth here and somehow some of the media is buying it. The narrative is now beginning to take shape. That is, Democrats are looking to bailout the mom and pop homeowners while Republicans are taking a hands off approach letting the free market do its thing. This isn’t true. Take a look at everything that has occurred and look at who is running the country. They may be saying no bailout but the actions are showing that they are more than willing to bailout investment banks and Wall Street while letting the American public swallow the bill and in the process, get nothing in return. If anything, it seems that the Democrats are catching onto this and the line in the sand is being drawn. After all, the current administration is more than keen to veto anything coming from the Democrats.
The Democratic side of the argument is pushing for a $300 to $400 billion package to shore up the FHA to buy more toxic waste. It seems that the Republicans have the Federal Reserve and the Democrats are looking to have the FHA:
“Democrats are pushing a plan that would offer government insurance for between $300 billion and $400 billion in refinanced mortgages, potentially allowing more than one million homeowners to move into less costly loans. So far, their proposal hasn’t secured any high-level Republican support.
In a scaled-back version of the Democrats’ plan, Federal Housing Administration commissioner Brian Montgomery said Wednesday that his agency would start providing government insurance for some U.S. homeowners who owe more on their mortgages than their homes are worth. The plan would allow borrowers to qualify for government-insured loans if lenders agreed to write down part of the principal, giving borrowers some equity in the homes.”
Clearly, lenders do not like this deal since they’ll be forced to write down bad loans and take the losses. Why go for this when we can passively wait while Henry Paulson works out some other bazooka ideas with the Fed and investment banks can simply unload their horrific mortgages with the Fed in the great mortgage swap meet? After all, why go for 85 percent or less of the face value of the note when the Fed is willing to give you 100 percent par value for the wink-wink “AAA” rated mortgages, investment firms can shore up a bit more capital, and grease the wheels once again? At this point in the game we are going to get some form of major bailout. We already have. The issue we can focus on now is how do we structure policy to punish those that gambled and inflamed the fires of mortgage and credit (aka debt) fraud and set in place regulation and enforcement that will prevent this from happening again in the future. And for those of you that say, “personal responsibility falls on the borrowers” you should read this article by Gretchen Morgenson over at the New York Times. She has done, in my opinion an excellent job in covering the credit and mortgage debacle. I know some industry insiders have knocked her for some of the nuisances of mortgage finance but overall she’s worth a read:
“WE’VE all heard a great deal in recent months about the greedy borrowers who caused the subprime mortgage calamity. Hordes of them duped unsuspecting lenders, don’t you know, by falsifying their incomes on loan documents. Now those loans are in default and the rapacious borrowers have moved on with their riches.
People who make these claims, with a straight face no less, overlook a crucial fact. Almost all mortgage applicants had to sign a document allowing lenders to verify their incomes with the Internal Revenue Service. At least 90 percent of borrowers had to sign, seal and deliver this form, known as a 4506T, industry experts say. This includes the so-called stated income mortgages, affectionately known as “liar loans.”
So while borrowers may have misrepresented their incomes, either on their own or at the urging of their mortgage brokers, lenders had the tools to identify these fibs before making the loans. All they had to do was ask the I.R.S. The fact that in most cases they apparently didn’t do so puts the lie to the idea that cagey borrowers duped unsuspecting lenders to secure on loans that are now - surprise! - failing.”
And how many people actually spent the ridiculously expensive amount of $20 to verify tax income? How about low single digits:
“My estimate was between 3 and 5 percent of all the loans that were funded in 2006 were executed with a 4506,” Mr. Summers said. “They just turned a blind eye, saying, ‘Everything is going to be fine.”
I mean why wait one day for income verification? Heck, most lenders knew from day one that buyers didn’t have the income yet continued funding the loan since it wasn’t their money, it was other people’s money (OPM). The lender passed the loan to Wall Street, who cut it up and passed it to foreign investors, who naively thought that AAA rated did not mean loading up your portfolio with Real Homes of Genius. It wasn’t like foreign investors were going to take a trip on the 105 and hit North Long Beach to take a look at what they just bought. Would you be angry at a bank if someone walked in and said, “I’m Prince Albert in a Can and you should give me $200,000 on my word and I am going to use this money to purchase an English muffin cart” and the bank proceeded to write a loan in exchange for this promise? Of course you’d be furious and the blame would be largely on the bank since it is their institutional role to manage their own risk. And if it was their own money, they wouldn’t let this happen. The problem occurred because lenders and brokers rarely had their skin in the game.
If lenders are so hungry to lend here is a great idea that puts their money where their mouth is. Start a pool of all like minded folks that think there is really no problem (there is a lot in this group), place your own cash in this fund to dish out mortgages, and start making some loans. If you really believe what you are saying, then you should have no problem handing out your own money to those buyers. Why does my gut tell me that in this case, you’ll be running a 4506 at a larger rate than 3 to 5 percent.
The Great Unfolding Happening Once Again
In our Lessons from the Great Depression series, we try to take an educative look at what occurred in the past and try to avoid similar pitfalls. Clearly, we are not learning anything since we are essentially repeating many things from a bygone era. This is part seven in the series:
Lessons from the Great Depression Series:
1. Personal Story by a Lawyer from a Previous Asset Bubble. Can we Learn from the Past and How will the Housing Decline Impact You?
2. Lessons From the Great Depression: A Letter from a former Banking President Discussing the Bubble.
3. Florida Housing 1920s Redux: History repeating in Florida and Lessons from the Roaring 20s.
4. The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part IV: Where do we go After the Housing Crash?
5. Business Devours its Young: Lessons from the Great Depression: Part V: Destroying the Working Class.
6. Crash! The Housing Market Free Fall and Client #10 Contagion.
This is going to be a rather long post but I think it warrants a full reading. These excerpts were written in 1935 during the Great Depression. They give us a look at an overall perspective of what happened both politically and economically to exasperate the current situation. The parallels are uncanny and of course, we are in different times, yet it doesn’t mean that many rules do not apply in the current environment. The text is from Lords of Creation (a 450 page tome but worth every page) by Frederick Lewis Allen. I know many of you may have a hard time finding this rare old gem of a book. It is worth transcribing parts from this book in their entirety because they offer an excellent case study of how the crisis unfolded and I’m not sure if many of you will have a chance to read this superb book:
The Vicious Spiral
“Let us try to analyze what was happening in those dolorous years of 1930 and 1931 and 1932.
The analysis cannot be simple, clear cut, dogmatic; for the sequence of cause and effect in our world of endlessly involved mutual relationships is exceedingly complex.
We must remember, in the first place, the continued existence of various distortions in the American economy which had made the recovery and prosperity of the country during the nineteen-twenties an astonishing achievement against odds. We must remember how curiously our foreign trade was balanced - that the only way in which we had been able to permit Europe to buy our goods was by lending her huge amounts of capital, and that obviously this could not keep up indefinitely. We must remember that the farmers who grew our staple crops had never fully recovered from the distress into which the collapse of their overseas markets had plunged them shortly after the war; and that as soon as industry languished, the country as a whole was likely to feel the dragging weight of a comparatively impoverished farming population”
I think it is worth mentioning that at this time, we were a creditor nation. War torn Europe rebuilding after the first World War had caused great amounts of debt which was owed to the United States. We are no longer a creditor nation so this parallel is different and clearly not a better position to be in. Let us continue:
“Nor must we overlook the fact that the economic breakdown of the early nineteen-thirties was not simply an American phenomenon, but was world-wide. Europe in particular, staggering under a terrific burden of debts incurred during the war, and hampered by trade barriers built up by bitter national rivalries, had never enjoyed any such boom in the nineteen-twenties as had the United States, and was now drifting into a fresh economic crisis. This was bound to prolong and intensify the American crisis.
But it is doubtful if an of these factors - or all of them together - quite explain a breakdown as cumulative and appalling as that which actually took place. Let us look for other clues.
One of these clues is the increase in efficency which was being brought about by improved methods of manufacture and of business, and especially by the machine - above all by the power-driven machine. As we have already noted (in Chapter VIII) machines were constantly replacing men. A given number of people were becoming able to produce and distribute more and more goods. There is no need to present specific illustrations of this fact; the Technocrats of 1932 deluged the country with them. But it may not be amiss to remark that the tendency toward technological unemployment about which the Technocrats talked so furiously was not confined to industry; consider, for example how the output of American farms had been increased by the use of huge reapers and combines and also by the spread of knowledge about better farming methods; or consider how machinery and improved organization had likewise speeded up work in business offices. That the machine was an instrument for the production of plenty is undeniable - but that its increasing use was attended by economic strain is also undeniable. During the seven fat years the men whom it had thrown out of work had lost his job in the textile mill became an apartment-house janitor, the man who had been fired from the automobile factory ran a filling station, and so on. But the strain was there - and it was just barely met.”
It is worth noting that the weak recession of 2001 from the technology bubble bursting was propped up by a subsequent bubble in housing. Many that lost jobs in the field were able to retool and jump into the real estate industry either as brokers, agents, financiers, or ancillary support to a booming market. The barrier to entry was non-existent and the pay nearly matched up if not superseded the pay from the high-tech jobs. Those that lost jobs in manufacturing were able to jump into the construction field to boost up the home builders and the insatiable demand for housing. We had our own 7 fat years.
“To meet it, the American economy had to expand. There had to be constant growth - new factories, new construction, new industries, new occupations, new expenditures. The moment this expansion stopped for any reason, the American economy would begin, so to speak, to die at the roots - to suffer from and increasing technological unemployment. Prosperity had to go ahead very fast to stay in the same place.
For years past, this expansion had been achieved with the aid of a huge inflation of credit, and in particular with the aid of the speculative boom in real estate and then of the boom in the stock market. It was as if a huge bellows were blowing upon the industrial system of the country, making the fires burn brightly. Meanwhile, however, this expansion had had other effects - and they, too, are clues to what happened when the bellows ceased to blow.
For one thing, it had helped to bring about an immense increase in the internal debt of the country. One needs only to glance at the tabulations in Evans Clark’s study of The Internal Debts of the United States to realize what a change had been brought about by the “investment consciousness” of the American people, plus the urgent salesmanship of the dispensers of securities and of life-insurance policies, plus the new financial gadgets of the time, plus the reckless optimism of the boom years. During these years, to quote Mr. Clark’s book, we had “piled up our debts almost three times as fast as our wealth and income increased.” While our wealth was growing only by an estimated 20 per cent, and our income by an estimated 29 per cent, the total amount of our long-term debt had been growing by an estimated 68 per cent - from 76 billion dollars to 126 billion dollars. A large increase? Yes, and it and come on top of another large increase during the war years. If we compare the long-term debt of the United States in 1929 with that in 1913-14, we find the increase in fifteen or sixteen years to have been no less than 232 per cent!”
People forget that a large part of the speculative boom of the 1920s was tied to real estate. It is ingrained in the cultural psyche that the stock market and Wall Street set off the Great Depression decade but the 7 fat years were built on a very weak house of cards. During this time we also saw that while income was rising, the amount of debt was growing even quicker. Does this sound familiar?
“Part of this huge accretion was due to the same factor which had placed such a heavy burden on indebtedness upon Europe - the war. The Federal Government’s debt was 1154 per cent larger in 1929 than in 1913-14. But the states and the smaller governmental untis had also increased their obligations - by 248 per cent. And business, too, had succeeded in cumbering itself with fixed claims of unprecedented magnitude. The debt of the railroads had not increased by very much, if only because they had been notoriously over-bonded in 1913-13; here the gain amounted to a mere 26 per cent. But meanwhile the total debt of pulbic utilities had grown by 181 per cent; the debt of financial concerns (including especially investment trusts and insurance companies) by 389 per cent; and a series of real-estate booms had lifted the total amount of urban mortgages by no less than 436 per cent.
Now it is obvious that no man can say with certainty how large a burden of debt an economic system can carry. No man can say with assurance that this vastly enlarged debt was enough to break the American system. For one thing, one man’s debt is another man’s wealth. Yet here was at least a potential source of strain: a rigid structure of claims - many of them imprudent - in an otherwise highly flexible economy.”
Again we realize that during this time, the pushers here weren’t brokers with mortgage products although this was high as well during this time, but pushers of stock and insurance policies. Debt was simply growing in so many areas that the amount was back breaking to the public.
“But it did not go on. President Hoover prevented it from going on by calling for the formation of the Reconstruction Finance Corporation to bring first aid to harassed banks and corporations and to stop the epidemic of bankruptcies. Thus another traditional cure for a business depression was withheld. Rightly or wrongly, the property interests of the country felt that the financial system could not stand such strong medicine. The debt structure - now supported by government intervention - remained almost intact. Many long-term debts - especially mortgages - were in default, but new ones had taken their place. The cold figures show what was happening: according to the computations of Dr. Simon Kuznets for the National Bureau of Economic Research, the amount of money paid out in interest in the year 1932 was only 3.3 per cent less than in 1929 - though meanwhile salaries had dropped 40 per cent, dividends had dropped 56.6 per cent, and wages had dropped 60 per cent.”
Interesting to note that WaMu cut its dividend from 15 cents to 1 cent, a drop of 93 percent. Also, the idea of the government buying up mortgages to prevent collapse did not keep the Great Depression from coming. Why go down this road again? We already know how it ended back then.
“It was a bitter time in which to be President of the United States. No presidential reputation can withstand an economic depression; even those people who are most insistent that the government should keep its hands off business will blame the government when business goes wrong. It was particularly bitter time for a President who had proclaimed in his speech of acceptance that “given a chance to go forward with the policies of the last eight years, we shall soon, with the help of God, be in sight of the day when poverty will be banished from this nation.” Hoover had gone forward with the Coolidge policies; Andrew Mellon, the idol of the conservative business world, was still Secretary of the Treasury; and yet disaster was descending upon the nation with cumulative force.
By the autumn of 1930, the Hoover recovery moves of late 1929 and early 1930 were clearly failing. The cut in the income tax was accentuating a mounting governmental deficit. The public works program had not gone far - the deficit stood in its way. The President’s insistence that wages must not be reduced was being widely disregarded, and even where the wage rate still stood firm, the amount of money paid out in wages was becoming smaller and smaller as factories went on part time or shut down entirely. The Federal Farm Board’s effort to sustain the price of wheat was a dismal failure, involving the government in huge losses. And as for the campaign of synthetic optimism, by the autumn of 1930 it was already becoming a sour jest, and by the end of 1931 a compilation of the cheerful prophecies made by Hoover and his aides and by the leaders of business and finance, published under the scornful tile of Oh Yeah? Was greeted everywhere with derisive laughter.”
If anything, this site and many other sources have chronicled the absolute absurd and unjustified optimism of the current decade. Random quotes. Pollyanna predictions justified on whim. Clearly there is a more modern form of cynicism to the current captains of industry who run firms into the ground much to the chagrin of investors and jump out of their corner office in golden parachutes. We also know from history, that cutting taxes and running massive deficits always ends badly! Yet during this administration we have run incredible deficits while cutting taxes as if economic law has been suspended. Of course these things end badly. We also know that trying to put in any price supports is absolutely insane. That is why the increasing of mortgage caps sets an almost reverse price ceiling which makes no sense since prices are now naturally adjusting to market forces. Price supports are absolute failures. The fact that the Fed stepped in and offered $2 for Bear Stearns was $2 too much. JP Morgan/Chase went up to $10 to placate investor outcries. Either way, if the forces were allowed to take place Bear Stearns would have gone down and exposed cracks that are still in the system. All we’ve done is offered a temporary price support via public intervention and allowed key players to get out with some money instead of none.
“It was during this panic of the autumn of 1931 that Hoover decided that the American debt structure must not be permitted to fall to pieces. He called a group of financiers to Washington to form a pool of credit for the rescue of distressed capital; and presently he asked Congress to take over the task by setting up the Reconstruction Finance Corporation.
The situation which thus arose contained, perhaps, a certain element of ironic humor. Now financial magnates who still cried out for “less government in business” and inveighed against “the dole” could go, hat in hand, to Washington and get the government to put itself into business by giving a dole of credit to their banks or railroads. The apostle of rugged individualism had taken the longest step in American history toward state socialism - though it was state socialism of a very special sort.”
Sort of like the $15 billion home builders are asking for in retroactive tax breaks. Or giving tax incentives for buyers to jump into the shark tank of homes. Again, Wall Street is demonstrating that when times are good, the government should stay as far away as it can but when things get tough, they have no problem running to mommy for an extra $20 to make it through the week. At least that vapid hypocrisy isn’t something new. They were doing it over 75 years ago.
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Related Posts:
■There will be Housing: How we’ve Returned to Selective Market Ignorance.
■Business Devours its Young: Lessons from the Great Depression: Part V: Destroying the Working Class.
■The Menace of Mortgage Debts: Lessons from the Great Depression Series: Part IV: Where do we go After the Housing Crash?
■Crash! The Housing Market Free Fall and Client #10 Contagion. Lessons From the Great Depression: Part VI.
■Lessons From the Great Depression: A Letter from a former Banking President Discussing the Bubble.
Via [DrHousingBubble]
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Yesterday, I met up with a health care venture capitalist. He mentioned that M&A is likely to be a big factor over the next few years. After all, major pharma companies will have a variety of their blockbuster drugs go off-patent.
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