Monday, September 22, 2008

The way I see it.

The hardest thing so far is to put thing succintly without yielding to my base and loathsome impulse to editorialize and otherwise hurl (richly deserved, in my opinion) invective. Still, I have disabled comments on this entry, as during a politically charged time, there is the risk of things overheating.

Here's how we got into this mess. The Community Development Initiative was put in place to combat something called redlining, generally defined as banks not willing to issue mortgages in certain areas; literally drawing red lines on maps of places where they would not lend. However, the effort to combat this actually compelled banks to issue loans to people who otherwise would not qualify for them. The spectre of government action against those banks who did not participate seemed to have been adequate incentive. (As usual, things swung from nonexistent to overkill.)

Now, banks are not charities and if they are going to lend money to people who ordinarily would not qualify for mortgages, they would have to structure these loans so that they made some semblance of business sense. In many cases these were the infamous "subprime" mortgages, but also prominent were mortgages with adjustable rates.

What really happened is actually related to oil. After Sept . 11, 2001, the Federal Reserve (correctly) dropped the interest rates to prevent an economic crisis. This led to a housing boom. People could now afford "more house" than they used to, and they availed themselves of the opportunity to trade up. Those people who couldn't previously afford a home could do so now, barely, with the help of ultra-low adjustable rate mortgages or subprime loans. Banks issued tons of these loans.

Here is where the wheels fall off the wagon. Speculators in oil drive up the price, which the Fed considers inflationary; food (especially corn, which is in EVERYTHING) starts being diverted to biofuel which drives up food costs, and the Fed (thinking this is even more inflationary) starts jacking up rates.

Only all those people who could BARELY afford their mortgage as it was start seeing their monthly payments -- they had adjustables, 'member? -- spike upwards. They default. The banks foreclose. The insurance companies who covered these risky loans have to start shooting off checks to cover the defaults. These assets have to be declared as WORTHLESS (instead of at a reduced value, as would be the normal case before the accounting rules changes mandated by the Sarbanes-Oxley Act) because the new accounting rules -- which ought be eliminated, IMCO -- called "mark to market" (a phrase of which you will all grow sick within the month) say you have to declare your assets at market price.

Problem is, when there is no organized market (and there isn't one, in the case in mortgages) the declared value of these is zero. So these institutions have their ratings downgraded, the brokers who invested in shares of the banks have THEIR ratings downgraded and eventually some companies, perfectly healthy ones, go under. Not because they are broke, but because they couldn't get access to cash.

The toxicity aspect is that each bank, broker, etc. that is affected, in turn affects others who have their shares in their portfolio. The issue here is not solvency, but it is liquidity. That is, certain institutions rely on the give and take of gazillions of dollars every day. This is like the leave-a-penny-take-a-penny tray at a checkout. When these institutions cannot get the cash they need, at a rate that is viable, they lock up and have to declare bankruptcy. Regardless how many squajillion dollars they have in assets.

The current proposal is for the Treasury to semi-revive the Resolution Trust Corporation (it'll get a different name, prob'ly), only instead of buying out whole companies, it'd only buy those bad loans. The number thrown around in $700B over time (my estimate is 12 years) With these bad loans off their books, banks would have the proper ratios to start lending money for mortgages again, which would firm up the housing market, which would bring back the economy. The money would not "go to Wall Street" and given that because of the "mark to market" accounting rule -- meaning bad loans would be bought at absurd discounts, and eventually resold back to the private sector at slightly less absurd* discounts-- the gummint would almost certainly likely make money in the long haul. At +/- $1500 per year per person it's not cheap, but the alternative, in my opinion, is unthinkable: A second Great Depression. That $1500 is chump change in comparison to the alternative.

The risk right now is not inflation (correctly identified as the growth in the gap between the velocity of money, and GDP; i.e., more and more money chasing relatively fewer goods and services, which manifests itself as, but is NOT defined as being, rising prices) but DEflation. Ignore the price spikes in oil. These are (and have been) purely speculator-driven, and are unsustainable. My guess is that oil will settle around $80-$85 a barrel by the time all this is done. Especially if people would just listen to me and adopt my "mean and green" approach to energy independence. But I digress.

Right now, as financial institutions engage in the unwinding of debt and the selling of stuff to get the cash to make up for that debt drives prices down. Since this includes houses, this also affects the number of industries that depend on housing. They have to lower their costs in order to sell something.

A tax increase -- essentially a massive withdrawal of liquidity -- at this point would be an epic catastrophe, and certainly ensures a Depression, just as the Smoot-Hawley Act did in 1930. I'm not against a board to oversee the entity in charge of the bailout, but I'm not adamantly for it either. That whole limit on CEO compensation sounds nice, but it's locking the barn after the horse is gone. The idiots who looted Fannie Mae and Freddie Mac for tens and hundreds of millions and then bailed out (in varying degrees of disgrace) are already gone. The people needed to clean up the mess simply won't come cheap.

The idea of protecting some people under the threat of foreclosure is also something I am not against, especially if these are people who had been making good faith efforts to meet their debt obligations. Not that they should be given any freebies, but there should be some flexibility in restructuring their mortgages commensurate to their ability to pay.

Also, I'm pretty Goldilocks on the issue of regulation. Part of the problem (esp. on the whole "credit swaps" morass) is that some things are utterly unregulated to the extent nobody has any idea how much money is tied up in them, and the other part is that "regular" securities are subject to useless and counterproductive (and contradicting!) regulation. When regulation becomes a barrier to business, people have an incentive to invent new things, seek out loopholes and otherwise escape ANY regulatory oversight. Our regulations need to be fewer and smarter and more evenly distributed. If everything had a few commonsensical regulations, instead of a) none whatsoever, or b) 1283 pages of bureaucratic pig Latin, much of this could have been avoided.

Finally, stocks-wise, I think we're not at rock-bottom. We're probably over the steep part of the down curve, though...but there is still some down to go. At least until the bailout starts bailing out.


* The general figures thrown around are that the gummint will buy these at +/-30 cents on the dollar, and they will likely be eventually resold at +/- 50 cents on the dollar.

Posted by Joke at 10:12 PM

« Home