Zero Down Is a Foreclosure Factor (Duh)
There is a kind of weird OpEd in today’s WSJ by Stan Liebowitz. The professor makes the incredible discovery that zero down payments, 100% LTV financings tend to slide in great numbers into foreclosure:
“What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house — that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected.”
This is analysis by gross over-simplification. Not quite reductio ad absurdum, but close. Unfortunately, it leads to conclusions that are at best only partially correct.
And that conclusion? The problem has been Prime, not sub-prime loans:
But the focus on subprimes ignores the widely available industry facts (reported by the Mortgage Bankers Association) that 51% of all foreclosed homes had prime loans, not subprime, and that the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures. (These percentages are based on the period since the steep ascent in foreclosures began — the third quarter of 2006 — during which more than 4.3 million homes went into foreclosure.)
Here is where things get weird: I can’t verify many of these data points. They don’t square with the data I review via RealtyTrac or Mortgage Bankers Association or Bloomberg. (I assume the professor meant we had 4.3m foreclosures since Q3 2006, not during).
As to prime versus sub-prime, it appears the Mortgage Bankers Association, data dispute the professor’s. Jay Brinkmann, chief economist for the MBA, noted in May 2009 that in 2008, prime, fixed-rate loans were only 19% of foreclosure starts nationwide, while Subprime adjustable-rate mortgages were 39%. More recently, the two levels have come together: prime loans are up to 29% of foreclosure starts while subprime adjustables came down to 27%.
But reporting only in percentages can be misleading. As Floyd Norris noted in , “There are far more prime mortgages than subprime, of course, and subprime loans are much more likely to get into trouble. But this does show how the foreclosure problem is spreading.”
Agreed.
But the claim that during this crisis it has been Prime and not Subprime is simply unsubstantiated by the timeline or data. Subprime went bad first, then Alt-A, and then prime followed it later. Sub-prime and Alt-A went bad due to poor lending standards; Prime went bad in part due to job losses and as the economy got worse.
If anything, there is a stronger argument to make that the problem is worse from 30 year fixed versus ARMs. Here is the MBA data from September 2008:
For prime loans, foreclosure starts on fixed rate loans were 0.34 percent, an increase of five basis points, while prime ARM foreclosure starts were 1.82 percent, a 26 basis point increase. For subprime loans, fixed rate foreclosure starts increased 27 basis points to 2.07 percent and subprime ARM foreclosure starts increased 31 basis points to 6.63 percent
Sub-prime worse than Prime, ARMs much worse than fixed.
Of course, it is true that 100% LTV mortgages are a problem. But you need some context to understand how they came about. And while the professor does correctly identify underwater mortgages as a major factor — he seems to place the blame squarely on 100% LTV. Perhaps another question worth exploring is the boom/bust issue: How did those home prices run up so much, only to reverse back towards normal, historical pricing metrics? For that, you need to look at many factors.
A more comprehensive 40,000 foot view would note that 100% LTV is a symptom of the larger problem of a) abdication of lending standards, caused by b) enormous demand for securitized loans, enabled by c) rating junk as AAA, in order to satisfy the demand for higher-yielding, non-junk paper, all of which traces its roots to d) Greenspan’s ultra low interest rates.
Yes, bad lending standards, no money down, lack of income verification or debt servicing ability were key culprits. But to claim that it was more Prime than sub-prime is belied by the history of foreclosures. And, it ignores all the other moving parts to the equation.
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Source:
New Evidence on the Foreclosure Crisis
Zero money down, not subprime loans, led to the mortgage meltdown.
STAN LIEBOWITZ
WSJ, JULY 3, 2009
http://online.wsj.com/article/SB124657539489189043.html
July 3rd, 2009 at 9:34 am
Barry,
I too was puzzled by this “gee whiz, look what I discovered” piece and by its conclusion, that a big part of the “solution” is to make it harder for (underwater) mortgagees to walk away. As if that often gut-wrenching decision was not the last recourse available to people in crisis. What would that leave them, professor: the shotgun in the corner? Brilliant.
This analysis identifies, but not distinguish in a meaningful way between the two distinct groups at the heart of the foreclosure crisis: those with no skin in the game from the start (subprime borrowers, liar’s loan types) and those who HAD skin but have LOST it (prime borrowers). Team Obama does not distinguish between the two groups and frankly neither do most of the bloggers who have dissected this crisis much better than the MSM. How is this possible?
Has anyone seen “Eight Men Out”? In that great movie John Cusick’s character tries vainly to stay out of the Black Sox scandal but ends up losing everything along with the guys actually took the money and threw the game. That’s how a lot of homeowners feel right now. We put down our money and played fair and now we’re treated no better (in the case of jumbo borrowers, much WORSE) than the crooks who crashed the system.
The sense of betrayal by prime borrowers like us is palpable and will need to be addressed if we are to pull out of this tailspin. If I get the sense that my house will not regain its value for 20 years–20 years of large payments, high taxes and high maintenance costs–then I will walk and so will millions of other middle and upper middle class folk. That is the real crisis here. We have not even really looked the problem in the eye yet.
July 3rd, 2009 at 9:41 am
This analysis is akin to one of those studies to see if men want sex …or another one from “The Onion:”
http://www.theonion.com/content/opinion/people_like_food
July 3rd, 2009 at 9:49 am
The economics of the housing boom/bust from the point of view of the mortgagor were very simple: Place a highly-leveraged bet (even 20% down is highly leveraged) that your real estate stock would increase, or at least not lose value. When it does in fact lose value, bail as quickly as possible, preserving capital and leaving your partner in the bet (the mortgagee) holding the bag. It is perfectly rational to walk away, particularly in non-recourse states like California.
I think, besides the inherent credit issues faced by the average sub-prime borrower (which may have been the preeminent cause of the levels of default), that sub-prime borrowers knew full well that their houses were never worth what the sleazy appraisers for the sleazy mortgage brokers claimed. Since the credit profile of sub-prime borrowers effectively makes all their loans “non-recourse”, they bailed out early and often.
In a way the whole thing could be described as the sheeple that were herded into these pastures tore down the fences and bolted for freedom, leaving the shepherds with a worthless piece of pasture land and nothing else, and the sheeple left to discover freedom just means you’ve got nothing left to lose.
July 3rd, 2009 at 10:12 am
The good professor has just figured out that zero down is a risk factor? I presented that at a conference over 3 years ago – http://papers.ssrn.com/sol3/papers.cfm?abstract_id=895231
and got it published in a peer reviewed journal last year -
“Skin in the Game: Zero Down Payment Mortgage Default”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1330132
hardly news at this late date
July 3rd, 2009 at 10:18 am
A couple things.
First, his chart appears to define “subprime” as FICO under 620. This isn’t how the NY Fed defined subprime in its recent analysis of the subprime market:
http://newyorkfed.org/research/epr/forthcoming/0906haug.pdf
In fact, mean FICO scores among subprime borrowers have been above 620 since 2002. It was above 650 in 2006 and 2007.
Second, by his own admission, he had trouble distinguishing second mortgages from first mortgages when analyzing the data. He claims to have adjusted “conservatively” but doesn’t explain how. I’m wondering about refi mortgages also. If somebody pulled all their equity out for repairs, additions, granite countertops, etc. in 2006, then they’re now underwater. It isn’t clear to me from the article how he treated this situation.
July 3rd, 2009 at 10:19 am
Obviously, the Zero Down Phenomenon is a major factor… it doesnt take a very long period of falling home prices to drag you underwater.
The bigger problem, though, is that falling prices are a reality… and one that will likely continue for some time… its not just going to go away for those folks who are underwater.
Other realities we cant avoid that are more systemic factors:
With the jobs situation, again, its obviously going to get worse.
With the credit deflation situation, again, its obviously going to get worse.
We have a dearth of supply, and nowhere near enough demand. Just casually observing… I’d say its going to take MUCH lower prices to spark demand… and I make this assumption based off of the ratio of home price to income.
I’m sure the Fed and Treas are going to do everything they can to reinflate, we know this. But any seeds of a genuine housing stabilization, let alone recovery, will have to come on the back of old fashioned hard work, saving, and paying cash or a significant down payment to own a piece of property. It wont come sustainably through easy money and lax lending, we know this too. But if you dont have a job… all bets are off.
Also, I think what we need for all those underwater borrowers to walk away. I truly believe, though dark it may sound, that we need to go through that kind of pain collectively as a society to reacquaint ourselves with risk across the board… this applies to equities, commodities, and fixed income as well. Prices have to come down… way down. For every asset class.
People need to give up before they can move forward. Easier said than done I’m sure. Its a little hard for me to internalize what that kind of pain may feel like. Sure, I took some nasty hits to my trading account last year which have definitely shaken my net worth… but I’m still in the game and committed to doing it better and better everyday.
As for RE…We bought are first house almost a year ago, with a 10% down payment on a 30 year fixed at 6%… is our house worth less than we paid? Almost certainly. But in a way, I feel it doesnt matter because I dont plan on selling anytime soon. That down payment has definitely bought us some security. But it all hinges on my job, and thats what scares me more than anything… should for most people. I think the next round is going to come from people like me, who tried to do the right thing, and prudently waited for prices to come down… then found themselves unemployed, and forced to sell. Thats the kicker. Didnt wait long enough perhaps.
Oh well… just some thoughts.
July 3rd, 2009 at 10:33 am
@I-man, pain would seem the necessary prescription, but it won’t come so long as the Fed thinks it capable of folding all the bad debts of inept risk managers onto the public’s balance sheet.
Guess which gse has grown in prominence since this crisis? Ginnie Mae, the home of the no-money down mortgage guaranteed by the US taxpayer (okay, technically there is a tiny percent of the purchase price required as a down-payment, but with sham programs like “down payment assistance it is hardly a hurdle).
Yes, they are doing everything they can to reflate, lately including forcing Fannie and Freddie to do “125’s”, i.e., to let borrowers refinance even when they are underwater by up to 25% of the property value.
Like all market interventions by the government, these programs will serve to accomplish the exact opposite of their intent, i.e., they will serve to destroy the housing market completely (along w/ the government’s balance sheet) while the intent is to save it.
July 3rd, 2009 at 10:36 am
Yeah… I know. Everything they touch turns to shit.
Flipside:
We could all get a piece of the next bull market in jobs I guess:
Collections.
Coming to a craigslist jobs board near you.
July 3rd, 2009 at 11:03 am
Buying a home zero down is like buying a low beta stock on 100% margin – once you have large numbers of people doing that it it’s no longer low beta. And with large numbers of people doing that in the sand states those states became the RE Nasdaq, so now the crash is feeding on itself.
The US will go on the hook for these people who are -125% on a nothing down mortgage? Boy the “moral hazard” concept had a nano type half life!0
It will be very interesting to learn how the appraisals are done for these -125% homes, will the appraisers ignore the 50% off foreclosures that are half the transactions or will they ignore foreclosures and short sales to give these people a shot at the -25% cutoff
Will the -25% cutoff be regionalized like the jumbo mortgages so that people in the sand states can mortgage 150% -200% of MV? Someone whose home lost 50% of it’s value needs a 200% mortgage.America been berry berry good to me?0
Mr Mort/Mark Hanson/Field Check Group CA RE update 7/1. Very informative site.
http://www.fieldcheckgroup.com/2009/07/03/6-19-may-ca-housing-update-mid-to-high-end-capitulate/
July 3rd, 2009 at 11:34 am
i suspect the root cause of the entire credit mess is the lack of jobs. and that also caused a collapsing wage. had neither of those happened we wouldn’t be in this mess today.
i suspect the FED and T are only trying to cushion the collapse (probably to protect the banksters! and their buddies the mortgageters). otherwise the unwinding tries to happen at once. with predictable results. so far we have had 50+ bank failures, we might have had 500 in just one month alone without some body doing some thing (which precludes wall street who is broke. and the bankerters are the same along with accomplices).
had the worse happened it would be unlikely that capitalism would ever be the same ever again.
as it is, i suspect that the majority of us have learned old lessons from the GD. don’t trust banks, wall street. and don’t buy more than you need.
which means we need to figure out to create jobs ASAP or there will be unrest as we don’t have jobs for those who need them
July 3rd, 2009 at 12:03 pm
I cringe everytime I see or hear the phrase “create jobs”. Jobs are not created. They arise as a result of demand for labor, which in turn arises as a result of demand for whatever good or service the labor provides. You can no more “create jobs” that are real than you can make a horse drink. Demand drives jobs. If demand aint thirsty, labor won’t be drunk.
July 3rd, 2009 at 12:15 pm
sorry you example sounds more like job creation based on demand. but that all semantics any way
July 3rd, 2009 at 12:24 pm
on a previous thread there was an ongoing discussion about the law profession and the dire straights the graduates are in coming out of law school w/ substantial debt and having to take temp work- TZ, M in Nola, and okielawyer all had some great comments-
which gets me wondering- after I-Man observation above that jobs are tenuously held- if we are in for a re-alignment of sorts- with jobs and pay- where white collar work pay going down and skilled labor going up- supply and demand issue-
for instance- I read that welders are in short supply and make top $ and that few kids train in skilled labor anymore- which often requires years of on the job training-
observations?
July 3rd, 2009 at 12:46 pm
What would one expect from a Rupert Murdoch-owned rag’s OpEd section than a thinly-veiled excuse for ignoring causation and jumping to correlation-based-conclusions in an effort to justify a return to the glorious days of supply-slide , Greenspanian, Fox-News-approved Reaganomics?
These conclusions are nothing more than a gigantic Paulsonian-like “it is contained” attempt to defraud truth.
July 3rd, 2009 at 12:56 pm
@munn: agree
@ahab: Interesting point. Brings to mind the German model where many fewer go to our version of college, and many more go to a “tech” school where they polish their industrial schools.
We used to have those many years ago. They were called vocational schools.
What happened to us? The American dream became a white collar criminal hawking mortgages.
July 3rd, 2009 at 1:00 pm
Like I said earlier, it looks like he culled more than half of subprime by defining “subprime” as FICO < 620.
July 3rd, 2009 at 1:15 pm
The issue with 100% financing on homes isn’t so much the instant negative equity. With FHA 3.5% down you are instantly negative equity when accounting for selling costs (though FHA default rates are high so maybe I should be quiet).
The really issue is that you make it where people can “impulse buy” a home, when combined with very loose underwriting standards you have a recipe for disaster. Buying a home is a very emotional decision and people can get worked up into a frenzy easily. Either the agent pushing emotional buttons, or nesting instinct kicking in, provider instinct kicking in, or simply greed if people believe the market is going up. (Sorry for the caps but I’d like to make this point clear) SINCE LENDERS ARE NO LONGER THE CHECK AND BALANCE THEY ONCE WERE SOME “PAIN” MUST BE INVOLVED IN BUYING A HOME. The downpayment is that pain. Writing that check for all that hard earned money is a dose of reality for a lot of people. The other factor is there are many who can’t save that money and are ill suited for homeownership and the downpayment requirement filters them out.
People want to yell and scream at how tight underwriting is but it is still historically extremely loose. If we ever went back to a system where the banks actually cared about the money they lent and the financial strength of the borrower the market would be much lower than it is today. Only massive government support through FHA and forcing Fannie & Freddie to keep underwriting guidelines as loose as possible (did you see the hissy fit Barney Frank is throwing because the GSEs tried to change the condo vacancy factor? Why is even involved in such technical details of underwriting?) is keeping the market in this state.
100% financing is bad for other reasons as well. It allows for much easier flipping due to appraisal fraud (or simply incompetence). One can price the asset very high, the borrower is stupid and doesn’t know valuation and just looks at the monthly payment, the lenders are still very aggressive, and as long as the appraisal comes in the seller gets a windfall. People like to treat appraisals like they are this laser accurate measure of value but it is much more an art than science. Even with HVCC as a roadblock you really have to ask yourself why an appraiser gets to know the purchase price on the contract before doing the appraisal… this anchors their expectation and gives them a number to hit. On refinancing.. they dont get the number… Why is that? If you have 100% financing your underwriting should be extremely tight, low DTI’s, high FICO requirement and a very conservative appraisal process. But that clearly was the opposite of what is happening during the boom or even today.
100% financing is toxic to long term housing market and financial market health (overleveraged borrowers applied to leveraged institutions). But over the short term (5-10 years) it provides a large boost to the market.
July 3rd, 2009 at 1:19 pm
I ran across this excellent post via Naked Cap and Edward Harrison’s guest post.
http://www.creditwritedowns.com/2008/08/cautionary-tale-story-from-1994-japan.html
It’s a cautionary tale for those who are anxious to get a “great deal” out there in RE land (i.e. knife catchers). These folks are just going to add to the mess down the road as they default on their “great deals.”
This 125% refi thing is atrocious, and will only get the more uninformed home owners out there in more trouble than they’re in right now. It’s being appropriately characterized as debtor’s prison and predatory lending by many out there in the blogosphere.
Here’s a couple of good posts on NC:
http://www.nakedcapitalism.com/2009/07/freddie-fannie-to-provide-125-ltv.html
http://www.nakedcapitalism.com/2009/07/is-new-affordable-fhfa-loan-program.html
July 3rd, 2009 at 1:30 pm
There are some better stats out there but for some reason my google abilities are failing me today but as a reality check between zero down and 3.5% down default rates check out this graphic for FHA:
http://www.npr.org/templates/common/image_enlargement.php?imageResId=92166688&imageStoryId=92152401
From this article: http://www.npr.org/templates/story/story.php?storyId=92152401
So exact same underwriting but zero down.
Fraud is much higher in such programs, fraud of all kinds, fraud for money (seller, buyer too if they are getting kickbacks) or housing (buyer). The underwriting just isn’t geared to be conservative enough for all the issues that crop up when 100% financing is available.
July 3rd, 2009 at 1:31 pm
Only 7 banks closed yesterday, I was expecting double digits although some banks are open today, maybe we’ll get a few more to rech double digits
July 3rd, 2009 at 3:19 pm
If “Greenspan’s ultra low interest rates” are the cause of eveyrthing, how do you explain Japan’s experience? The Nikkei ran from 10K to 40K from 1984 to 1989. I don’t have the hard data, but I’m sure you will stipulate that Japanese commerical property prices also went into a bubble during that time.
The BOJ kept the discount rate between 2.5% and 4.25% during the entire “bubble” period of 1984-1989. Then the equity and property bubbles burst.
Since 1995, the highest the discount rate has been is 0.5%, and has been as low as 0.10%.
Why did interest rates of 2.5% to 4.25% induce bubbles in asset prices in Japan, but an interest rate of no more than 0.5% for almost 15 years has not?
July 3rd, 2009 at 3:20 pm
Here are a couple of Loan To Value charts, one from 2006, one from 2009:
http://effectivedemand.blogspot.com/2009/07/orange-county-loan-to-value-comparison.html
Orange County is much more “prime” territory, there are some lower income areas but in general its a pretty rich place. If you enlarge both graphics in two browser windows and tab back and forth you get a real sense of the depreciation and deleveraging going on in the market.
July 3rd, 2009 at 4:04 pm
I’m realizing that, depending on the source, “subprime” either includes alt-A or subprime is FICO <620 (in general) and is a subspecies of “nonprime” — with alt-A as another major subset of “nonprime.”
The NY Fed report treated “nonprime,” so the avg FICO scores skewed higher since alt-A borrowers tend to have higher FICO scores than other “nonprime” borrowers.
So I shouldn’t have dismissed Liebowitz’s classification so quickly.
Per the NY Fed report:
There is no one definition of a subprime mortgage. The classification “subprime” generally is a lender-given designation for loans extended to borrowers with some sort of credit impairment, say, due to missing installment payments on debt or the lack of a credit history.
and in a footnote:
Based on First American LoanPerformance (FALP) data for September 2007, FICO scores averaged 705 for alt-A borrowers and 617 for subprime borrowers for the U.S. [emphasis mine]
So I’ll stick by my assertion that cutting off FICO at 620 doesn’t accurately reflect the true range of “subprime” mortgages. Clearly, if the average is around 620, you really need to look at the data set used to determine what % was above and below that cutoff.
July 3rd, 2009 at 5:56 pm
[...] Zero Down Is a Foreclosure Factor: There is a kind of weird OpEd in today’s WSJ by Stan Liebowitz. The professor makes the incredible discovery that zero down payments, 100% LTV financings tend to slide in great numbers into foreclosure…. This is analysis by gross over-simplification. Not quite reductio ad absurdum, but close. Unfortunately, it leads to conclusions that are at best only partially correct. And that conclusion? The problem has been Prime, not sub-prime loans…. [...]
July 3rd, 2009 at 8:52 pm
I’ll apologize right now if I step on anyone’s feet and because I’m not going to provide any examples to back up my perception of the WSJ. I stopped reading the WSJ years ago. I find their articles not to be, insightful, collaborated, comprehensive or conclusive. To me, they are to the newspaper world what CNBC is to the TV world, Wall Street cheerleaders.
July 3rd, 2009 at 9:36 pm
If “Greenspan’s ultra low interest rates” are the cause of eveyrthing, how do you explain Japan’s experience?
@ Groty
Not speaking for Barry, but I believe there is some misunderstanding about Greenspan’s role – it was far deeper and more insidious than simply lowering interest rates. In the U.S. case it was the culmination of Greenspan’s beliefs in A) deregulation, B) corporate profits at the expense of the working class, and C) the lowering of interest rates that perpetuated the demise.
By defending and promoting Reagan-era supply-side economic ideology, Greenspan became a key player in the destruction of the U.S. working class by promoting productivity gains be held primarily by the wealthy and the corporate entities, ensuring a redistribution of wealth and in effect creating a productivity gap for the American worker – which was filled for a time by new and heavy borrowing.
The Greenspan rates allowed this excessive borrowing that filled the void left by productivity gains of which the American worker did not share. Because they did not share the productivity gains, the U.S. worker could not afford to service the incurred debt.
That is the real story of Greenspan’s rates. If rates had been kept high, not only would the housing and credit bubble have been impossible to form, but Americans would have discovered long ago that the lifestyles they had long been accustomed to were no longer sustainable – their efforts and labor having been sacrificed to Ayn Rand’s false god of noble greed, whose high priests thrived on Wall Street, subverted the U.S. Congress, and came close to destroying a nation.
July 3rd, 2009 at 11:18 pm
In the early days of the bad loan crisis, Fannie Mae began a program called HomeSaver Advance in which they offered a loan for a maximum of $15,000 to homeowners who were behind. Proceeds went only toward wiping out delinquency. I was puzzled – who wants to loan money to a deadbeat? But then I realized the answer was: someone who wants to avoid having a bad loan on their books (and Fannie got another “good” $15,000 asset in the bargain). The majority of these loans went into foreclosure eventually. These 125% LTV loans seem to have that same element of postponing the bad news as the central motivation. Oh well, it’s harmonious with other policy responses.
~~~
BR: Fannie has been a poorly managed disaster for a long time. They were not the cause of the boom and bust or the credit crisis, but a wholly separate nightmare of accounting fraud and shareholder theft, run by poitical hacks and weasels.
July 4th, 2009 at 9:25 am
«a) abdication of lending standards, caused by b) enormous demand for securitized loans, enabled by c) rating junk as AAA, in order to satisfy the demand for higher-yielding, non-junk paper, all of which traces its roots to d) Greenspan’s ultra low interest rates.»
In the rush, BarryR forgets about the even bigger role of Japanese zero interest rates, and the resulting yen carry trade, and the effective abolition of bank capital requirements for many types of assets in the USA.
Overall the picture he paints is correct: there was a gigantic surge of credit starting 1995-1996 (very clearly visible also in the graph of stock held on margin that he once published) and for most of the 15 years since then interest rates in the USA have been zero or negative in real terms, and Japanese rates zero in nominal terms, fueling a whole sequence of gigantic asset price bubbles in the USA (and job and investment bubbles in Asian and China).
«Why did interest rates of 2.5% to 4.25% induce bubbles in asset prices in Japan, but an interest rate of no more than 0.5% for almost 15 years has not?»
Many USA people forget that capital is global. The goal of the ZIRP in Japan was not to fuel a second asset price bubble, as the balance sheets of Japanese banks had been brutalized by the previous bubble’s debt deflation. Also, who get credit for what reason at what price is driven by politics in Japan, not just in the USA, and the policy goal of the Japanese ZIRP was to drive exchange rates to support exports, not to enrich asset speculators again. “Administrative guidance” works in Japan, just as it works in the USA.
Conversely, the policy goal of the Greenspan/Gingrich/Rubin/Gramm credit explosion in the USA was exactly the opposite: to drive up USA imports, as a way to destroy unions by exporting union jobs from the USA to non-union countries (and to a very modest extent to non-union areas in the USA itself), and to boost asset prices to create huge financial sector profits and to create capital gains to support baby boomer retirements. Thus in the USA “administrative guidance” has ensured that most of the credit bubble has gone to USA banks and the shadow banking system (can *you* borrow at 0% from Fed or use TALF to get rid of your bad assets?).
July 4th, 2009 at 10:56 am
«Many USA people forget that capital is global. »
As to this, there have been enormous bubbles, especially housing bubbles, in several other countries, principally UK, Australia, Spain, Ireland.
The gigantic credit explosion was not so much fueled by low interest rates, but by the *availability* of credit. Even if RETAIL nominal interest rates in the USA had been 3-5% (as they were in UK, Australia, Spain, Ireland) there would have been credit driven bubbles, in part because even nominal rates of 3-5% were near zero or negative in real terms.
To some extent, as far as speculation goes, demand for credit is constrained more by the availability of supply than by its cost, and some things conspired to ensure a gigantic supply, whether or not nominal rates were near zero (USA) or not (UK, …):
* Supply is often risk-constrained. The USA and many other countries largely removed this constraint in various ways. Those governments did not remove the risk, they just removed the constraint.
* Supply was being provided in essentially unlimited quantities (and not just at a very low nominal price) the Japan. Sure, with a huge currency risk attached, but see the previous point.
* Supply was also being provided in essentially unlimited quantities (and not always at a low nominal price) in the USA too, as authorities sought to fund the rise of the FIRE sector as the new “locomotive” for the USA economy, and to export USA union jobs by providing a lot of (cheap) capital for export to India and China. Also for ideological reasons: providing endless credit is how the Republican party and a large number of Democrats earn their support from their sponsors.
July 4th, 2009 at 11:05 am
«Even if RETAIL nominal interest rates in the USA had been 3-5% (as they were in UK, Australia, Spain, Ireland) there would have been credit driven bubbles, in part because even nominal rates of 3-5% were near zero or negative in real terms.»
The point I am making here by capitalizing “RETAIL” is that a large supply was the big deal, but also the WHOLESALE price of near zero in nominal terms (thanks to Japan for example, or the very generous purchase of Treasuries at very high prices by China, Arabia and Japan).
If you tell bonused/optioned bank executives that they can can borrow at 0-1% in one place unlimited amounts and lend at 3-5% somewhere else, they will see it as a giant cash-in opportunity for themselves, and will load their employers with “whatever it takes” toxic stuff at 3-5% as they can, because as long as they do that they are minting money for themselves at essentially zero risk to themselves.
A lot of the supposed “financial innovation” of the past 20 years was just opaque ways to arbitrage an unlimited supply of yen (and later dollars) into high-interest consumer credit, and damn the consequences.
The result has been an enormous contribution of productivity and creativity by heroes of capitalism like Mozilo, Fuld, Cayne, Skilling, Prince, Thain.
July 4th, 2009 at 11:14 am
«The result has been an enormous contribution of productivity and creativity by heroes of capitalism like Mozilo, Fuld, Cayne, Skilling, Prince, Thain.»
Here I feel compelled to make a very important point about the compensation of these hero producers and creators: they have been massively underpaid and overtaxed, and it is because of this that the financial crisis has happened. If the best and brightest had been given higher incentives and rewards proportional to all they have produced and created they would have done a better job of risk management.
With the underpayment and overtaxation caused by the socialist legacy of the New Deal and extreme leftists such as Clinton, they were not incentivized to aim for high risk adjusted returns, as it was hard work enough to aim for high absolute returns, which they delivered in massive amounts, way beyond their miserly compensation.
Once again this crisis shows that communism as that introduced by FDR never works, and only rewarding the best and brightest (produced income tax credits for incomes over $1m would be right) and discouraging the unproductive and uncreative (raise taxes on lower incomes up to $50k to at least 50-60% to tax poverty out of history) is the way forward.
July 4th, 2009 at 1:07 pm
Blissex:
You sound alot like Stephen Roach, which is a compliment, and I mostly agree. I’m not sure that busting unions and exporting American jobs was the explicit policy goal of American policymakers. Maybe I’m naive, but I’m more inclined to believe that was a consequence of the policies of our trading partners who intentionally devalued their currencies to facilitate exports to the U.S.
Those devaluation policies contributed to the U.S. running massive current account deficiits as Americans rationally preferred spending their money on “artificially” cheap imports rather than more expensive goods produced domestically. Of course, the other factor contributing to the current account deficits is our dependence on foreign energy. Whether we’re exporting dollars for cheap imported manufactured goods or foreign oil, all those newly exported dollars have to be recycled into dollar denominated assets. Treasuries and GSE agency backed MBS were the assets of choice due to their perceived low risk. So while Greenspan was hiking the fed funds rate from 1.0% to 5.25%, long rates and mortgage rates didn’t respond nearly as aggressively, in part because they were being held low by the demand created from the need to recyle those dollars. Thus, the famous Greenspan conundrum.
So, while Greenspan’s “ultra low interest rates” certainly contributed, they weren’t the sole cause. Thanks for the thoughtful and well reasoned response.
July 4th, 2009 at 4:21 pm
«I’m not sure that busting unions and exporting American jobs was the explicit policy goal of American policymakers.»
Well, there are quite a few more, but there are a few striking data points. One is that the destruction of the unions has always been one of the goal of the Republicans. A very recent data point is their very explicit statements by Republican leaders in the past few months that the automaker bankruptcies were a great opportunity to destroy union jobs.
Then there are the statements by UK ministers (of the Labour party nonetheless) that high immigration was designed to drive down wages in unionized sectors like health care.
But for a general statement of intent, Grover Norquist is a very good source:
http://www.enterstageright.com/archive/articles/0903/0903norquistinterview.htm
«The growth of the investor class–those 70 per cent of voters who own stock and are more opposed to taxes and regulations on business as a result — is strengthening the conservative movement. More gun owners, fewer labor union members, more homeschoolers, more property owners and a dwindling number of FDR-era Democrats all strengthen the conservative movement versus the Democrats.»
«Maybe I’m naive, but I’m more inclined to believe that was a consequence of the policies of our trading partners who intentionally devalued their currencies to facilitate exports to the U.S.»
The governments of the trading partners and of the USA had the same goal: more jobs for cheap, nonunionized Asian workers, fewer jobs for expensive, union USA workers. The Saudis, Japanese and Chinese governments have done whatever they could to get Republican (or “triangulating”) administrations elected, because of the similarity of interests.
Another factor in our current economic complications is that from before the collapse of the USSR in effect the cold war was over and the governments of the USA and Europe no longer had to worry about home front morale and expenses like a full employment policy, welfare or pensions.
July 4th, 2009 at 7:59 pm
OK….I see where you’re coming from now. I mistakenly believed you were making a non-ideological general statement about policy because you included Rubin in the list of those who want to export American jobs.
But now that you’ve clarified things, I think you probably included Rubin because he is a proponent of globalization and deregulated markets, two forces that will crush the effective protectionism inherent in unionized labor, so he deserves to be lumped in with the evil Republicans.
I get it. Thanks.
July 5th, 2009 at 10:01 am
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