Is the Mortgage Crisis Over?

Photo by: respres

The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco.  While many other factors contributed, this was one of the most visible and visceral to most people.  Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis.  Demand for securitized debt led to tremendous demand for mortgages.   This demand led to lowered lending standards, which led to tremendous demand for housing.   The demand for housing led to soaring housing prices.   When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down.  Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same.  Many people equate the end of the subprime problems with the end of our troubles in general.  This leads us to wonder if the subprime crisis is truly over.  Signs suggest that this is the case.1 After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over.  Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board.  Although many people who bought houses during the boom bought them with subprime loans, many more did not. (more…)

1. Deutsche Bank – Subprime Chart [↩]

Debt and Moral Hazard

Photo by: Vinay Deep

For decades now the American approach to debt has been to worry about it later.  We’ve essentially kicked the problem down the road.  While some points in our history may have suggested somewhat higher debt levels, we’ve done nothing to reduce them in more booming times.  Ultimately we’ve just turned a blind eye to a growing problem and it may be too late. 

Many people are talking about moral hazard these days, but strangely they all seem to think it’s something that applies to someone else.  Bailouts of millionaire bankers strike us as outrageous, while we personally hold an absurd amount of debt.  Somehow the country got all screwed up without any of us being at fault. 

Our politicians seem to suggest that their opponents are the ones rewarding negative behavior and that they themselves would never commit such an act.  This doesn’t hold up to much scrutiny however.  Throughout the booms of the previous decades, neither Democrat nor Republican has ever used fiscal policy to “cool down” a boom.  Nor have they used any of the booms to reduce our debt to increase our capacity to deal with the next bust.

Clinton was just beginning to talk about reducing the debt when the Internet bubble burst.  Bush managed to go through a massive housing bubble while growing the national debt by over 4 trillion dollars.1  Government has simply never shown any discipline in managing its budgets.  Unfortunately, this is not only true of the government.

Short Term Myopia

Americans and people in general have a tendency to look at a very short sample space and assume that the results they’re seeing are meaningful.  Ten years is a long period of time in a human life, so if something has held true for the last decade, it must be true, the thinking goes.   Unfortunately those ten years are actually quite a short time in the life of an economy.

So many times in history we’ve been told that “things have changed.”  Something has fundamentally shifted and the old rules don’t apply anymore.  For the last decade, people watched their 401(k) accounts grow by double digit figures each year and they just came to assume that this was a sustainable result.  Similarly they’ve leveraged themselves to the hilt and assumed that since they’ve been able to sustain themselves with this massive debt they’d be able to do so in the future.  Sadly, this is an untenable ponzi scheme. (more…)

1. CBS News – Bush Administration Adds $4 Trillion To National Debt [↩]

Is the Financial Sector a Utility?

Photo by:  futureatlas.com

I am a fervent believer in free markets.  More specifically I believe that they, much like Democracy, are flawed but vastly superior to any alternative.  As various elements in the world decry the current financial crisis as an indictment of the flaws of capitalism, I wait patiently for them to suggest the proven alternative.  Despite this, I am left wondering if the financial sector is an exception to the wisdom of free markets.

Does Regulation Even Work?

If I’m defending free financial markets, my first piece of evidence is the Office of Federal Housing Enterprise Oversight.   This organization was 225 people as of 2006, tasked solely with regulating and overseeing Freddie Mac and Fannie Mae.1 With both of those organizations now being operated by the government after becoming tremendously over-leveraged, the efficacy of regulation is certainly in doubt.  If an organization of 225 people cannot regulate a large financial entity, what good does adding more regulation to the system do? (more…)

1. OFHEO 2006 Performance and Accountability Report [↩]

AIG and Populist Rage

Photo by: Gene Hunt

Populist rage is all the…well…rage.  Everyone right now is outraged over how much people get paid to do their job poorly, or how much more some people have than everyone else.  Now of course you can make arguments that the income distribution of modern society is counter-productive, but one key question is:

Why Do We Care RIGHT NOW?

As of now Congress is considering passing a tax to basically recoup 100% of any bonuses paid to AIG employees.1  Everyone is incensed that people get paid these bonuses despite their companies doing poorly.  It seems that the public will not be satisfied until they get their pound of flesh.  This leads one to question why we stop at bonuses?  If the American government is willing to institute taxes to recoup money from the employees of this company, why not garnish their wages too?  

They did a bad job, so lets punish them, regardless of whether they were instructed to do what they did, and more importantly:  They have contracts stating they get this pay.2 These employees signed contracts indicating that if certain events happened they would get these bonuses.  We now want to invalidate them, simply because we don’t like what they are getting paid.  Imagine if you were guaranteed a signing bonus after one year of employment and then because the company did poorly, they decided to simply not honor that obligation.

“Yes But They’re Taking Our Bailout”

The justification for this 100% tax is that AIG took our bailout money so all their obligations are moot.  They want our money, they have to do whatever we say.  In theory that sounds fine, but then you have to question why we bailed out AIG in the first place.  The reason we bailed out AIG was so that the people to whom they had obligations would not be wiped out.  AIG had obligations to foreign banks and other institutions and investors that we didn’t want to see destroyed, so we bailed out AIG so they could meet those obligations.  Now we want to essentially pick and choose which obligations we’re willing to meet.

What’s interestingly lost in all of this is the release of AIG counterparties and where all your tax payer money has been going.  Among the recipients of these funds are foreign banks.3  In that same populist vein, had the bonus story not overshadowed this story, would the same people be advocating that we not pay back European banks?  Or other Wall Street firms?  Ultimately all of this bailout money is going to people who helped create the crisis, because if it wasn’t there wouldn’t be a crisis.  It is interesting that in all of this mess, alleged “populists” are getting outraged by individuals having their obligations met, but not institutions.

None Of This Is Fair

One thing you have to remember in all of this is that none of this is fair.  It’s not fair that poorly mismanaged companies get bailed out at all, while people who made much less egregious mistakes go without aid.  However the sum of these bonuses, $170 million dollars in a bailout in the trillions of dollars, seems like too little of a price to compromise the law.  Ultimately when it comes to the law we all like to have a certainty that if we have a contract to receive something, we will receive it.  I personally don’t think it’s wise to discard the law simply because of one of the smaller injustices in a story rife with injustice.  I’d rather not set the precident that in times of crisis, the law goes out the window.  My sharpest criticisms of the Bush administration were that when our principles were challenged we threw them all out the window in the pursuit of revenge, I have no desire to see us repeat that mistake.

1. AIG Bonus Checks May Be Taxed At Up to 100%, Says Sen. Chuck Schumer – U.S. News and World Report [↩]
2. The Case for Payout Out Bonuses at AIG – New York Times [↩]
3. AIG Outs Counterparties – Forbes.com [↩]