A Second Hand Conjecture

Now that the NBER has decided to endorse my view that we went into recession last December which I first first claimed last January, I think my points about the efficacy of fiscal stimulus still apply.

As for spending already pledged to save us, the figures are growing at a rate that has even astounded someone as bearish and cynical as myself. Barry Ritholtz has given us a breakdown and a spreadsheet to track it:

I suspect given the continuing issues and a President intent on expanding the government balance sheet even more than our present one that that spreadsheet will get quite a bit larger. All that money to save a $13 trillion economy. What a mess.

Meanwhile the housing market continues to collapse, as the lights repeatedly seen at the end of a tunnel seem to really just be a series of oncoming trains. Lots of charts and analysis here and here.

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Let us look at one of the ways that we are being panicked unnecessarily, and why incidentally we can help many of these financial institutions in the fashion I discussed in my post on a potential alternative plan. In my next post we will discuss ways in which we are not being misled, and why we in my mind should do something about this.
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Larry Summers and Mark Thoma argue that if done right the bailout will mean we can solve this crisis and still have everything we want, tax cuts, health care spending and all kinds of other goodies. Larry argues:

Just as a family that goes on a $500,000 vacation is $500,000 poorer but a family that buys a $500,000 home is only poorer if it overpays, the impact of the $700bn programme on the fiscal position depends on how it is deployed and how the economy performs. The American experience with financial support programmes is somewhat encouraging. The Chrysler bail-out, President Bill Clinton’s emergency loans to Mexico, and the Depression-era support programmes for housing and financial sectors all ultimately made profits for taxpayers…

Maybe, but Alex Tabarrok finds this optimism a bit ironic:

Does this sound familiar? I can hear it now. A vacation sir is consumption but a home, ah a home, that’s investment. Investments pay off. Just look at the American experience. Rising home prices! Never a downturn. Isn’t that encouraging? Hell, at prices like these you can hardly afford not to buy. Yes sir, a home that’s a wise investment. And that makes you sir, a wise investor. And a wise investor, well a wise investor can certainly afford a nice vacation.

How the economy performs isn’t really the issue as much as the housing market. Chrysler was bailed out at a cyclical low, we are not at a cyclical low in housing, we aren’t even at a cyclical average. We aren’t even close.

Nor was Chrysler such a rousing success anyway. The bailout of Detroit only postponed the pain for the American auto industry and kept them from either going out of business or becoming better, if probably somewhat smaller organizations, and the costs to us all will eventually be pretty damn high. That isn’t even factoring in cementing the idea of “too big to fail” in corporate America. That encourages larger organizations rather than more profitable ones to be created.

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(photo: 2 Dogs)

Modern China has a curious capacity to make otherwise very sensible capitalists instantly forget every experience they’ve ever had with government central planning. The Western businessman on a trip to Shanghai looks up and sees all those gleaming skyscrapers going up on the Yangtze, and he thinks massive state planning must be different somehow in the People’s Republic. It isn’t.

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From Slate

I still hate the housing bill.

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From Slate

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For those of you who love New York Times bashing, I am in rant mode at Risk and Return. What a bunch of balderdash.

Also, if you want a good idea of where housing prices may go, I also have this. Charts, I have lots of charts!

Finally, I really hate the housing bill.

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McCain takes a stand against Washington’s biggest example of “crony capitalism:”

What should be done? We are stuck with the reality that they have grown so large that we must support Fannie Mae and Freddie Mac through the current rough spell. But if a dime of taxpayer money ends up being directly invested, the management and the board should immediately be replaced, multimillion dollar salaries should be cut, and bonuses and other compensation should be eliminated. They should cease all lobbying activities and drop all payments to outside lobbyists. And taxpayers should be first in line for any repayments.

Even with those terms, sticking Main Street Americans with Wall Street’s bill is a shame on Washington. If elected, I’ll continue my crusade for the right reform of the institutions: making them go away. I will get real regulation that limits their ability to borrow, shrinks their size until they are no longer a threat to our economy, and privatizes and eliminates their links to the government.

I only wish he had named names, like Barney Frank and Chris Dodd. For a more full description of who has been backing these guys, see here. Taxpayers first in line is right. Start by eliminating the dividend, and if future lenders are going to get a guarantee, past lenders should not get a penny from our largesse for them counting on us to bail them out. Too many people make loans under the theory of too big to fail. No lenders should escape injury for having done so. We have to eliminate the massive moral hazard of assumed government rescues of bondholders and lenders (see bear Stearns for exhibit A.)

We are quick to punish equity holders, but we repatedly rescue the holders of debt. That is doubly ridiculous in the midst of a credit crisis brought on by excessive risk taking in the debt markets. Only explicit government guarantees to lenders should be honored. Only after taxpayers are reimbursed should the lenders begin recieving their payments. Not one penny before that.

Of course, the loss to other lenders might make the current crisis worse, so I suggest they begin negotiating right now to avoid any need for our financing and to help keep these guys afloat. Cut the dividend, start shrinking the portfolio and shedding assets. Tell Congress to take a hike about expanding their lending activity, etc.  (Thanks to Instapundit.)

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Cross posted at Risk and Return

You may remember the website we discussed back in January. Dale Franks just discovered their program, because they now are on Television. He asks the obvious question:

So, should the mortgage companies get off scott-free from facing the results of their poor business decisions when it comes to the loans—loans they shouldn’t have made in the first place?

From my comment there:

No, they shouldn’t. I don’t endorse walking away, but when you take out a loan, and offer collateral, it is assumed that one possible recourse is to give back the collateral. Since lenders don’t want that to happen, they are supposed to examine the worth of that collateral pretty carefully, and get some money down. That way it isn’t in the interest of the homeowner to “walk away” even if they don’t mind the damage to their credit.

The lenders didn’t do either, now people are returning the house when it is in their best interest. I don’t count on the benevolence of my bankers, I suggest they shouldn’t have counted on consumers to take it on the chin for their sake either. Nor do I want our government, or the Fed, to keep bailing them out, either directly or indirectly by helping people keep houses they cannot afford. Neither is likely to work anyway.

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The New York Times thinks housing was in a bubble and prices are too high. Their solution? Try to keep housing prices too high.

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Thanks to Don Boudreaux, I found this “Inconvenient Truth” about the struggles of the middle class. As readers here know, I have long been a bear on housing, but as always those who want their hands on our wallet can take any crisis or problem as a license to take from us. Todd Zywicki writes to the Washington Post:

In his April 27 op-ed, “Don’t Blame All Borrowers,” Robert H. Frank argued that the quest for better schools for their children has led many parents to overspend on housing. He cited “The Two-Income Trap,” a book by Elizabeth Warren and Amelia Warren Tyagi, to make this argument.

But Ms. Warren and Ms. Tyagi’s own data do not support Mr. Frank’s claim. In fact, from the 1973 to 2000, the percentage of household income dedicated to mortgage payments actually declined. So where did all the money go? To taxes — which, all told, rose a whopping 140 percent in constant dollars.

In some part, this is a result of “the two income-tax trap”: When a spouse enters the workforce, he or she is immediately taxed at a higher marginal rate than one worker would be alone. But it is also because of increases in myriad state and local taxes, notably property taxes, which have risen along with real estate prices.

If Mr. Frank is concerned about the financial plight of the middle class, the answer seems clear: He should be arguing for a reduction in the tax burden, not about some chimerical “bidding war” for homes near good schools.

TODD J. ZYWICKI

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Well, it’s all the rage now. The AHA GOTCHA! moments of political campaigning.

Some think they’ve got McCain painted in a corner by the selective use of quotes:

In a speech March 25, he said: “It is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.” He also said that any assistance shouldn’t “reward people who were irresponsible at the expense of those who weren’t.”

And now, McCain is proposing a medium sized bailout (i.e. less then the Democrats but greater then none.) So, there, he’s clearly contradicting himself. Both Obama and Hillary are starting to pump up this meme, no doubt, in an effort to distract the public from their own flaws.

Except that, he said more than those 2 sentences.

From his March 25th speech:

Let’s start with some straight talk:

I will not play election year politics with the housing crisis. I will evaluate everything in terms of whether it might be harmful or helpful to our effort to deal with the crisis we face now.

I have always been committed to the principle that it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers. Government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy.

In our effort to help deserving homeowners, no assistance should be given to speculators. Any assistance for borrowers should be focused solely on homeowners, not people who bought houses for speculative purposes, to rent or as second homes. Any assistance must be temporary and must not reward people who were irresponsible at the expense of those who weren’t. I will consider any and all proposals based on their cost and benefits. In this crisis, as in all I may face in the future, I will not allow dogma to override common sense.

When we commit taxpayer dollars as assistance, it should be accompanied by reforms that ensure that we never face this problem again. Central to those reforms should be transparency and accountability.

We may not like what he’s proposing now, but it is entirely consistent with his views in March.

That his views weren’t properly conveyed by either the media, or his political opponents shouldn’t be surprising. That they also aren’t being properly conveyed now, shouldn’t be a surprise either.

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Regular readers know that I have been harping on the likely collapse in housing since this blog began. At this point I am hardly an outlier in being concerned, which means now the politicians and experts are ready to ride to the rescue. Proposals to increase regulation, bailout mortgage insurers, banks and even homeowners are being floated. Alan Blinder wants to bring back the 1930’s era state owned mortgage business.

Most of these proposals ignore that the real problem isn’t falling prices, or non credit worthy borrowers, but that housing needs to fall in price in many areas. Thus plans to stabilize the housing market, and cost estimates assuming such a stabilization, are likely doomed to be disasters, not to mention how bad it would be if they were successful longer term. We may be buying an expensive method of merely stretching the pain out. The cure to this crisis is falling prices. Politicians however, don’t like the medicine.

Anyway, to catch up on all these proposals, the state of the market now, and various amusing aspects of this whole mess, I have a large roundup of links, observations, and plenty of visual data for the curious.

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Courtesy of Barry Ritholtz, we get a look at some black humor being passed around on the trading desks of Wall Street:

Go here to see the whole slideshow.

I would have more humor about this if I didn’t just get some bad news.

My new house has a leak in the roof, and an air conditioner that likely needs to be replaced. No big deal, that is what the home warranty I purchased is for!

Except I call today wondering why no one has gotten back to me on coming out and fixing these issues, and I get a message saying they have suspended operations.

My suspicion, just like everyone else in any business insuring any aspect of housing, they were taking on risk, taking the money from the premiums in return, and then packaging the risk for the reinsurance market. Unfortunately nobody will reinsure it anymore. Without the reinsurance they have to carry the risk on their books, which they don’t have the capital to do. Or some similar derivation.

Only a suspicion, but I’ll find out more soon. So no, I don’t apologize for the language in the slideshow.

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So claims Alex Tabarrok. Alex and his blogmate Tyler are two of my favorite bloggers, but on this matter I think Alex is wrong. Unlike for some, his argument doesn’t invite scorn from me, because humility should teach us that sometimes things are different, and we cannot always fully understand why, at least not until after the fact. Later people laugh at we fools for missing the obvious. It always seems obvious after the fact. A belief in uncertainty is a virtue in understanding markets, and history. That being said, I still think Alex is wrong.

The crux of his argument is this:

So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices. But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension). Since the peak in the second quarter of 2006 prices have dropped by about 5% at the national level (third quarter 2007).

Except the argument has never been that prices would decrease immediately or quickly. The consensus of those of us who have worried about this has been that it would be a transition which would take years. Housing doesn’t correct quickly as a rule.

Alex feels the market has shifted to a new higher equilibrium:

If we don’t see the massive drop back to “normal” levels then the run up in prices should be described as a shift to a new equilibrium – much as happened during World War II – see the chart. (It’s an important question to ask what changed and why?). In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.

I actually agree that in some markets we may see a new higher equilibrium, say California, but it will take a large drop first. Here is the chart showing price declines from above, but updated to reflect recent declines (Alex’s chart is old)

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Have you ever met a politician who didn’t make promises that could not be delivered? I haven’t, either.

Of course, there are promises… and then there are promises.

If you are someone with an adjustable rate mortgage who has run aground, then you might like Hillary Clinton’s promise to freeze interest rates for five years. If you’re all the rest of us, however….

The Clinton proposal is a blunt tool applied too broadly to problems that are, in principle, contained and specific. Only 3.1 percent of prime (good credit) ARM loans are seriously (90 days or more) delinquent. The disconcerting delinquency rate of 16 percent is for the subprime sector–which is alarming, to be sure, but 84 percent are not seriously delinquent. Over the last three years there was an unusually large volume of aggressive lending activity with flaws at several levels. Some borrowers were led into loans they did not understand. These people deserve some concern. Other loans were made to speculators who do not live in the homes and were betting that house prices would continue to go up. The inhabitants of these homes deserve our concern, but the investors do not. It is now clear that there were too few checks and controls to assure reasonable loan underwriting practices (for example, no escrow accounts for taxes and insurance) or even good recordkeeping.

An accurate assessment of the current mortgage problem would probably reveal no more than 700,000 loans with distressed borrowers. Why, then, would the U.S. government rewrite eleven million loans, or even all 3.4 million subprime mortgages? Any intervention should be targeted at the borrowers who are truly in trouble, especially those who were likely duped by unscrupulous mortgage lenders. The numbers suggest these victims are disproportionately poor, young, and African American. Looking forward, the government needs to take steps to make this market more transparent and make it easier for borrowers to make good choices. But it would be irresponsible to do this by ruling millions of legal contracts null and void.

Senator Clinton’s policy amounts to a command-and-control approach to economic policy in which the government announces prices and tells suppliers what to produce. Undertaking such an intervention can only raise interest rates on mortgages (and maybe other interest rates as well) as markets attempt to incorporate risk premiums to cope with possible future interventions. Promising the American people that you can fix things by just lowering their interest rates is dishonest, a fairy tale that won’t come true.

I’m all for examining various remedies to modify the pain from the current mortgage and housing difficulties. Yet, the notion that we should undertake to destroy contracts and the relationships between investors and lenders is a bit frightening.

Of course, I find a lot about Senator Clinton to be on the frightening side….

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youwalkaway.com

I really have little to add to my declaration of extreme discomfort.

Much more on this here.

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 (cross posted at Risk and Return)

Ben Bernanke gives Congress and the President the green light to take steps to stimulate the economy along with a warning:
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Chris asked what he thought the Federal Reserve could have done differently. I gave him an answer, but there was more to be said. My full answer is here. Scroll around, there is a lot more on the what could have been done, what might be done, and the general risks which now surround our economy.

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From a post at the Minneapolis Star Tribune’s buzz.com describing the impact on neighborhoods in Minneapolis of the spiraling number of foreclosures. Each pin is a foreclosure. 725 total in North Side. (HT: Instapundit)

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(cross posted at Risk and Return)

Paper Economy has taken a close look at what it will take to get inflation adjusted housing prices in Massachusetts back to trend over a five year period. It should be noted that for this to happen sooner the decline would have to be deeper (due to inflation doing less of the work for us.)

The following chart (click for much larger version) shows that in order to bring Massachusetts “real” home prices (as tracked by the OFHEO home price index for Massachusetts) in-line with the average annual return of 2.5% seen since the early 1970s, nominal prices have to complete a 16.8% decline (or 28.8% in “real” terms) from the latest peak.

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