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December 7th, 2007

Oh Stuff A Sock In It

From Slog this morning, reviewing the morning news

Anger: Among financially prudent Americans who are pissed at the government bail-out other Americans are getting for accepting mortgages they couldn’t afford.

Well I’m not angry, and I think I qualify as prudent.  I bought my little Baltimore rowhouse in 2001 and it was way less house then I could "theoretically" afford, but I wanted something I could pay the monthly mortgage on with a week’s take-home pay.  It was my first house ever, and I didn’t want to be saddled with a lot of debt over it.  Debt makes me nervous.  And I wanted to have plenty of financial breathing room to afford the maintenance costs I knew would be coming with home ownership.  Like the seven grand worth of new furnace I had to put in a couple winters ago.  The purchase price on my house was just under ninety grand, and since then, its "theoretically" gone up in value to just around two-hundred and fifty grand.  So my house could loose over half of its "theoretical" value and it would still be worth more then what I have left to pay on the mortgage.  

So I think I qualify as prudent.  But I was also lucky in some ways.  I bought before the price of housing began to skyrocket here in Baltimore…when for a while there was affordable housing near the place where I work.  If that hadn’t been the case I’d have had to either keep on renting, for every increasing rents as the price of housing around here went up, or I’d have had to find a place to live further out of the city and commute.  And the prices in the outer suburbs were starting to go up, even back then.  Before I got work at Space Telescope, I rented a one bedroom apartment in the suburbs and I watched my rent rise from just under four-hundred a month back in 1993, to close to a thousand a month before I bought my house in 2001.  What do you do when the price of housing just keeps going up and up and up, even in the outer suburbs?  What do you do if you have a family and kids?  I was, and am, a single gay guy.  It’s not terribly hard for me to get a decent place to live at the low end of the cost scale.  If I needed space for a family, I’d have been constantly worried to death about the rising prices.

So if someone came along and said they could get me into a house, even at today’s prices, with some of that new high-tech free-market creative financing stuff…my second thoughts might get snuffed out in the gnawing fear that if I didn’t jump on it now, right now, I might get left behind while home prices soar into outer space, so far beyond my reach I might as well resign myself and my family to living in slums and still not having enough to pay the rent.  Especially when they sit me down and wave a bunch of numbers in my face telling me that even though it looks like I can’t afford this house, I really can because the trend is that in a few years the house’s value will have doubled and I’ll be able to refinance easily then, before the balloon payment comes due.  Pay no attention to that crushing monthly payment behind the curtain…

If you want to point your finger at anyone in all this, point it at the jackasses who, for purely ideological reasons having little to do with the reality of how human beings behave, worked diligently to construct what is essentially a shadow banking system that could exist with nearly no governmental oversight, figured it would self regulate because free markets naturally self regulate to the best possible outcome, and then watched mutely as it evolved into a system of borrowing, wherein the people selling the loans, didn’t have to bear the burden of financing them.  Oh who could have predicted that a bunch of people lending other people’s money for a tidy profit of their own, regardless of whether or not the loans went bad, would make so many bad loans?  Oh who could have predicted that injecting so much easy credit into a market with so much demand for so limited goods would drive the price of those goods into outer space?  Oh who could have predicted that the people making all those bad loans would view those rising prices as a way to make even more money making even more bad loans?

And once again, an unregulated market drives itself off a cliff, taking with it hundreds of thousands of hard working families.  This is the Savings and Loan collapse of 1988 writ large.  And…surprise, surprise…the current little unpleasantness is brought to us by the same people who gave us that other little unpleasantness.  I guess the 1988 Savings and Loan fiasco was just practice, because I don’t think that one sacred Wall Street like this one is scaring Wall Street.

2 Responses to “Oh Stuff A Sock In It”

  1. Jon Says:

    > … because I don’t think that one scared Wall Street like this one is scaring Wall Street.
        Nah.  Wall Street is not scared.  Not even slightly.  They’re sitting fat and happy in their private jets winging to Dubai or the Bahamas for the Holidays, certain that once again Uncle Sugar (read Mr. and Mrs. Average American) will bail them out.  And you can bet that Dubya and his cabal are planning exactly that.  Oh, and how do they feel about talking those "losers" into betting the house on their futures?  Fuck ’em.

  2. Bruce Says:

    I’m seeing quite a bit of fear, but maybe I’m not reading from all the right news sources.  Brad DeLong, a professor of economics at Berkeley, and a member of the Clinton administration back when, posted this just this morning

    A Good Take on the CDO Mess from Steven Pearlstein

    An excellent piece from Steven Pearlstein, who is still at the Washington Post:

    It’s Not 1929, but It’s the Biggest Mess Since: It was Charles Mackay, the 19th-century Scottish journalist, who observed that men go mad in herds but only come to their senses one by one. We are only at the beginning of the financial world coming to its senses after the bursting of the biggest credit bubble the world has seen. Everyone seems to acknowledge now that there will be lots of mortgage foreclosures and that house prices will fall nationally for the first time since the Great Depression. Some lenders and hedge funds have failed, while some banks have taken painful write-offs and fired executives. There’s even a growing recognition that a recession is over the horizon. But let me assure you, you ain’t seen nothing, yet.

    What’s important to understand is that, contrary to what you heard from President Bush yesterday, this isn’t just a mortgage or housing crisis. The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts. It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

    At the center of this still-unfolding disaster is the Collateralized Debt Obligation, or CDO. CDOs are not new — they were at the center of a boom and bust in manufacturing housing loans in the early 2000s. But in the past several years, the CDO market has exploded, fueling not only a mortgage boom but expansion of all manner of credit. By one estimate, the face value of outstanding CDOs is nearly $2 trillion. But let’s begin with the mortgage-backed CDO.

    By now, almost everyone knows that most mortgages are no longer held by banks until they are paid off: They are packaged with other mortgages and sold to investors much like a bond. In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next. With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches — those with the lowest credit ratings — were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the "mezzanine" tranches, which offered middling yields for supposedly moderate risks.

    Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same "tranching" process, they could use these mezzanine-rated assets to create a new set of securities — some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired. It was a marvelous piece of financial alchemy, one that made Wall Street banks and the ratings agencies billions of dollars in fees. And because so much borrowed money was used — in buying the original mortgages, buying the tranches for the CDOs and then in buying the tranches of the CDOs — the whole thing was so highly leveraged that the returns, at least on paper, were very attractive. No wonder they were snatched up by British hedge funds, German savings banks, oil-rich Norwegian villages and Florida pension funds.

    What we know now, of course, is that the investment banks and ratings agencies underestimated the risk that mortgage defaults would rise so dramatically that even AAA investments could lose their value. One analysis, by Eidesis Capital, a fund specializing in CDOs, estimates that, of the CDOs issued during the peak years of 2006 and 2007, investors in all but the AAA tranches will lose all their money, and even those will suffer losses of 6 to 31 percent. And looking across the sector, J.P. Morgan’s CDO analysts estimate that there will be at least $300 billion in eventual credit losses, the bulk of which is still hidden from public view. That includes at least $30 billion in additional write-downs at major banks and investment houses, and much more at hedge funds that, for the most part, remain in a state of denial.

    As part of the unwinding process, the rating agencies are in the midst of a massive and embarrassing downgrading process that will force many banks, pension funds and money market funds to sell their CDO holdings into a market so bereft of buyers that, in one recent transaction, a desperate E-Trade was able to get only 27 cents on the dollar for its highly rated portfolio. Meanwhile, banks that are forced to hold on to their CDO assets will be required to set aside much more of their own capital as a financial cushion. That will sharply reduce the money they have available for making new loans. And it doesn’t stop there. CDO losses now threaten the AAA ratings of a number of insurance companies that bought CDO paper or insured against CDO losses. And because some of those insurers also have provided insurance to investors in tax-exempt bonds, states and municipalities have decided to pull back on new bond offerings because investors have become skittish.

    If all this sounds like a financial house of cards, that’s because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole. That’s not just my opinion. It’s why banks are husbanding their cash and why the outstanding stock of bank loans and commercial paper is shrinking dramatically. It is why Treasury officials are working overtime on schemes to stem the tide of mortgage foreclosures and provide a new vehicle to buy up CDO assets. It’s why state and federal budget officials are anticipating sharp decreases in tax revenue next year. And it is why the Federal Reserve is now willing to toss aside concerns about inflation, the dollar and bailing out Wall Street, and move aggressively to cut interest rates and pump additional funds directly into the banking system.

    This may not be 1929. But it’s a good bet that it’s way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.

    I suppose the vastly rich are not concerned about this. but if it’s as bad as this makes it look, then I don’t think a bailout is going to help anyone or anything.  What’s happened here it seems, is that so much bad debt has been hidden along with the good, that nobody knows what’s good paper and what’s bad anymore, and trust is collapsing.  Injecting money into the system isn’t going to help that, and if everyone stops lending money to everyone else, the feds can only prop up the liquidity in the system so much and then everything just grinds to a halt.  That’s the fear.  Mr. and Mrs. Average American can’t bail out anyone if they’re out of work, and the rest of the world won’t bail us out either if the dollar plunges in value.

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