Some people have been asking me of late why it is that such a small portion of the Mortgage market falling into default can bring down the entire economy. I'm not an economics genius but I know a few and am more than willing to henpeck their ideas in order to make my analysis of the situation seem more reasonable than it might have in the first place. I don't have a PHD but I assume that the shameless rape of another person's ideas in order make to make yours seem more plausible, if only by the manipulation of context and syntax, is the highest road to intellectual development. The same is most certainly true of religious zealotry and I can't imagine that higher education and the church differ all that much in their methods.
So I will attempt to make sense of how a relatively small shift in one area of the market can inject the kind of issues we've seen this month. The answer is not drastic shifts in actual money as one might imagine being necessary. The answer is quite reasonably uncertainty. The stock market and most other forms of trade based solely on the movement of money and not real goods, is simply like most markets a place for the exchange of risk from one source to another. Risk is the central theme of it all and is the means by which fortunes are made on Wall Street. For example if I have a company and want to try and make it bigger and better I need to invest money into it, if I invest all my own money I get all the profit but also take all the risk should my endeavor fail. If I offer a percentage of the business up for sale in the form of stock (or any number of other forms) I allow the business to be propped up on another person's money, in exchange for them sharing the risk, they also share in the possible profit. The end result is a positive one for the most part as a well examined risk is one that can be worth taking for the investor and the needed capital can be the thing that makes my business successful for both me and my investors. The problem is that when external factors to that arrangement constrain one or both parties from examining the risk they are buying, then the unknown risks make investment scary and scared investors don't invest.
To bring this into our mortgage 'crisis' scenario think of it this way; Fannie and Freddie by urging and by regulation sent a message to the lending community that they were willing to purchase any debt no matter how high the risk, as long as that debt contained the right quantity of people fitting the right physical description. That of course being an address in the poorest, least fortunate neighborhoods. In order to make the sales of these high risk assets worth while up the food chain, they had to be bundled with large quantities of low risk loans. When bundled together and sold over and over again from one lending institution to another the street level risk gets lost in a pile of numbers that average with other numbers repeatedly. The influx of loose cash on the housing market drove prices up as one would imagine. One of the things about the housing industry is that it has historically been a safe place to invest money for moderate growth over any period of time. In this case a drastic increase in capital without a corresponding increase in wages, meant that people were buying beyond their means. Functionally what we saw was a price increase driven solely by an increase in the number of people participating in the real estate market, not by actual economic growth or prosperity. All of this predicated on 'guarantees' issued by government backed lending institutions to buy all this higher risk debt.
But we know this already because you and I have a television or a radio and haven't heard anything but this for weeks.
But it's not a huge quantity of default. Sure a ton of people have loans that will be larger than the actual value of their homes for a very long time, but most are still making payments on those loans. Why then is the disaster afoot? It's simple really, the bundling of those high risk loans with other loans throughout the market and the sale of those bundled products repeatedly throughout the market have taken away any simple method for assessing the risk in any individual package of debt. With no firm way to assess risk there's no way to set a scale for acceptable loss, there is no way to set a fair price for sale. No one knows which packages of debt have the most high risk debt and which have the least. Nobody buys uncertain risk at a reasonable price. So thousands upon thousands of good loans are on the market for way below market price and people still aren't buying. Banks who responsibly wish to protect the real assets of their depositors are hesitant to lend money to other banks on the basis of the wild level of uncertainty in their real assets.
Bluntly, you can't see from the outside of these packages if there's more anchor than boat and nobody wants to take the risk. When people aren't willing to take risks businesses stop working.
How the government thinks they have any better shot at picking out the bad risk than the financial institutions holding the packages is beyond me.
Or maybe I'm reading everything wrong.
Showing posts with label lending. Show all posts
Showing posts with label lending. Show all posts
Monday, October 06, 2008
Friday, September 26, 2008
To Own a Home in the State of Nature
Why isn't anyone anywhere looking at the fact that housing prices were becoming irrationally, and unreasonably high in the first place?
In 1995 Bill Clinton and the 104th congress pushed through legislation altering the Community Reinvestment Act, in essence to promote more home ownership in what were considered to be overlooked, poorer and often minority neighborhoods. A1992 Federal Reserve Bank study on lending determined that a disproportionately small number of minorities were being approved for loans. The first instinct of Washington politicians was not that we as a country needed to address the potential issue that a disproportionately large number of minorities in America were needlessly poor and had bad credit; no the response was predictably that the banking industries method's for calculating lending risk were hopelessly outdated and wildly racist. The result was well over a decade of public policy aimed at forcing lending institutions to adopt low income and high risk neighborhoods. In order to maintain a favorable ranking with the Federal Government (a CRA ranking as came to be called) lenders had to comply or face fines, loan penalties and major roadblocks in deals like mergers and acquisitions. In order to assuage the risk that banks knew existed while complying with federal regulations and HUD policy, banks did two main things. The first was to offer mortgages at variable interest rates in order to ensure that if the cost of federal loans went up they wouldn't lose money. These adjustable rate mortgages (ARMs) meant that they could offer reasonable rates to attract high risk borrowers, as long as the FED did the same, but then they could raise rates to cover potential losses when FED rates rose. This as a banker seems like a reasonable idea until you factor in massively inflated home prices (due to too much lending) and stagnating wages.
The second thing the banking institutions did was to package extremely risky debt with extremely safe debt and sell it to larger lending institutions under the average overall risk ratings. The problem with this is of course that risk factors on main street are easier to observe in person than they are from thousands of miles away based only on a few numbers. The Federal Government added to this lending trend with the heavy the handed promotion of HUD's government backed lending institutions like Fannie May and Freddie Mac. These government backed lenders worked hard, and were encouraged by the Federal Government to promote and purchase as many of these complicated risk balanced debt packages as they could acquire. In essence the government was creating a giant banking competitor with a virtual guarantee that drove the market to deeply invest in these debt packages with no real understanding of the street level risk. There's no way the market can, by itself, escape a predatory competitor as large and unwieldy as the Federal Government and the government systems within which banks are required to operate. The result when coupled with the low interest rates and loose lending policy in a post 9/11 panic economy, is not simply the collapse of the system we are seeing now, but the precipitation of this collapse by the drastic and unrealistic increase of home prices. Take a look at every aspect of the housing market, from sales to renovation, over the last ten years and you will see the bloody opportunistic profiteering that can only occur in unrealistically sharp market increases. Entire cable TV channels sprung up over night, devoted to flipping houses in what many believed was a magically growing housing market. Prices just couldn't seem to stop multiplying.
The problem is that more and more people, responsible workers, middle class families, and careful investors went looking for that first home and saw a market that had vastly out-priced their stagnating wages, and had inflated beyond the means of their hard earned savings. What had begun as a program to promote increased lending to high risk mortgagees became the only game in town with home prices soaring to astronomical levels.
To put it another way, bad mortgages and bad mortgagees are and have been preventing responsible savers and wage earners from paying the right price for a home. When too many people move into a market with money no one should have lent them, and when at the urging of the government they overextend their reach, they compete with people who live responsibly and who do not overextend their reach. Hard working middle class Americans have been bamboozled by the entire length of this process, not just this end of it. And when we use tax dollars that come from the middle (and yes the wealthy) classes to 'bail out' these institutions, we are in actuality punishing the same people who are already being punished by higher home prices. Whats more the punishment comes in the interest of saving a system that will continue to lend irresponsibly to the segment of the population who, for better or worse, doesn't pay much if any income taxes and who will continue to buy beyond their means.
It's time for the banking industry to take it's own knocks, to tighten it's own policy, and to make the kind of guarantees that investors need to put actual capital into shoring up these ugly debts. Loans from the government can only serve to increase liquidity in these organizations which will only allow them the time they need to sell off what good assets they have left at more appropriate prices. These loans will not make good debt out of bad, and they will not save dying institutions. Every investor knows that you don't make money buying bad debt, but you do make money buying stock in a good company in times of misfortune. Private investment and sensible lending policy is the only recipe' for success in a situation like this.
A better use of the Federal Government's time and money would be to address why we are a country that isn't friendly to the businesses that would hire the poor and less fortunate. To the market, people are not races they are resources. If we foster private business in this nation, we will encourage businesses to take advantage of every available resource. A person with a good job, in a strong community is a responsible lending choice. There is no way to turn an irresponsible lending choice into a responsible lending choice simply by making them a loan recipient. And there is no way to turn a bad lending choice into a good lending choice by shifting the cost of those choices onto the middle class which is already stretched by unrealistically high home prices. This is a time not to look to the government, or the giant government protected corporations. This is a time to look at private business, and encourage it's growth and prosperity, because in that prosperity lies the answers to our 'credit crisis'. The answer isn't more fake money from Washington, and more loose lending on 'main street'. The answer isn't more taxation on the working people of this nation. The answer isn't simply $700b in 'liquidity'. The answer is capital, and that only comes from work. Work comes from jobs, and jobs don't come from Uncle Sam.
In 1995 Bill Clinton and the 104th congress pushed through legislation altering the Community Reinvestment Act, in essence to promote more home ownership in what were considered to be overlooked, poorer and often minority neighborhoods. A1992 Federal Reserve Bank study on lending determined that a disproportionately small number of minorities were being approved for loans. The first instinct of Washington politicians was not that we as a country needed to address the potential issue that a disproportionately large number of minorities in America were needlessly poor and had bad credit; no the response was predictably that the banking industries method's for calculating lending risk were hopelessly outdated and wildly racist. The result was well over a decade of public policy aimed at forcing lending institutions to adopt low income and high risk neighborhoods. In order to maintain a favorable ranking with the Federal Government (a CRA ranking as came to be called) lenders had to comply or face fines, loan penalties and major roadblocks in deals like mergers and acquisitions. In order to assuage the risk that banks knew existed while complying with federal regulations and HUD policy, banks did two main things. The first was to offer mortgages at variable interest rates in order to ensure that if the cost of federal loans went up they wouldn't lose money. These adjustable rate mortgages (ARMs) meant that they could offer reasonable rates to attract high risk borrowers, as long as the FED did the same, but then they could raise rates to cover potential losses when FED rates rose. This as a banker seems like a reasonable idea until you factor in massively inflated home prices (due to too much lending) and stagnating wages.
The second thing the banking institutions did was to package extremely risky debt with extremely safe debt and sell it to larger lending institutions under the average overall risk ratings. The problem with this is of course that risk factors on main street are easier to observe in person than they are from thousands of miles away based only on a few numbers. The Federal Government added to this lending trend with the heavy the handed promotion of HUD's government backed lending institutions like Fannie May and Freddie Mac. These government backed lenders worked hard, and were encouraged by the Federal Government to promote and purchase as many of these complicated risk balanced debt packages as they could acquire. In essence the government was creating a giant banking competitor with a virtual guarantee that drove the market to deeply invest in these debt packages with no real understanding of the street level risk. There's no way the market can, by itself, escape a predatory competitor as large and unwieldy as the Federal Government and the government systems within which banks are required to operate. The result when coupled with the low interest rates and loose lending policy in a post 9/11 panic economy, is not simply the collapse of the system we are seeing now, but the precipitation of this collapse by the drastic and unrealistic increase of home prices. Take a look at every aspect of the housing market, from sales to renovation, over the last ten years and you will see the bloody opportunistic profiteering that can only occur in unrealistically sharp market increases. Entire cable TV channels sprung up over night, devoted to flipping houses in what many believed was a magically growing housing market. Prices just couldn't seem to stop multiplying.
The problem is that more and more people, responsible workers, middle class families, and careful investors went looking for that first home and saw a market that had vastly out-priced their stagnating wages, and had inflated beyond the means of their hard earned savings. What had begun as a program to promote increased lending to high risk mortgagees became the only game in town with home prices soaring to astronomical levels.
To put it another way, bad mortgages and bad mortgagees are and have been preventing responsible savers and wage earners from paying the right price for a home. When too many people move into a market with money no one should have lent them, and when at the urging of the government they overextend their reach, they compete with people who live responsibly and who do not overextend their reach. Hard working middle class Americans have been bamboozled by the entire length of this process, not just this end of it. And when we use tax dollars that come from the middle (and yes the wealthy) classes to 'bail out' these institutions, we are in actuality punishing the same people who are already being punished by higher home prices. Whats more the punishment comes in the interest of saving a system that will continue to lend irresponsibly to the segment of the population who, for better or worse, doesn't pay much if any income taxes and who will continue to buy beyond their means.
It's time for the banking industry to take it's own knocks, to tighten it's own policy, and to make the kind of guarantees that investors need to put actual capital into shoring up these ugly debts. Loans from the government can only serve to increase liquidity in these organizations which will only allow them the time they need to sell off what good assets they have left at more appropriate prices. These loans will not make good debt out of bad, and they will not save dying institutions. Every investor knows that you don't make money buying bad debt, but you do make money buying stock in a good company in times of misfortune. Private investment and sensible lending policy is the only recipe' for success in a situation like this.
A better use of the Federal Government's time and money would be to address why we are a country that isn't friendly to the businesses that would hire the poor and less fortunate. To the market, people are not races they are resources. If we foster private business in this nation, we will encourage businesses to take advantage of every available resource. A person with a good job, in a strong community is a responsible lending choice. There is no way to turn an irresponsible lending choice into a responsible lending choice simply by making them a loan recipient. And there is no way to turn a bad lending choice into a good lending choice by shifting the cost of those choices onto the middle class which is already stretched by unrealistically high home prices. This is a time not to look to the government, or the giant government protected corporations. This is a time to look at private business, and encourage it's growth and prosperity, because in that prosperity lies the answers to our 'credit crisis'. The answer isn't more fake money from Washington, and more loose lending on 'main street'. The answer isn't more taxation on the working people of this nation. The answer isn't simply $700b in 'liquidity'. The answer is capital, and that only comes from work. Work comes from jobs, and jobs don't come from Uncle Sam.
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