Skip to main content

More on the U.S. Mortgage Mess

I wrote a short entry several months ago trying to get behind the U.S. mortgage mess. I thought that was a good quick primer on how we got into the situation we're in economically. I was skimming through Mankiw's blog today, though, and came across this really funny cartoon primer on the subprime mortgage problem. It's about 45 slides, but worth the time to flip through. It's a much more amusing way of looking at what happened.

So, how does the U.S. get itself out of this situation? Bernanke this past week recommended that bank's should either lower the principal amount on at-risk mortgages or that the federal government (via the Federal Housing Administration) should back-stop those loans themselves. I can only speculate, but I imagine the Fed is worried about all of those loans continuing to default and needing to be written down. If that were to happen, the losses would continue to spiral down to other parts of the economy, feeding the "deleveraging" spiral that's currently happening. The vicious cycle of "deleveraging" basically works like this:
  • When credit was easy to obtain, homeowners, hedge funds, and other borrowers loaded up on debt (or "leveraged" up) so that they could gain a greater return on investment than their own money would allow them to do. (See the graphic above on how much total debt has increased over the last few years).
  • That easy credit has all dried up now. That means no more "no-money-down-mortgages". It also means quicker demands for loan repayments when hedge fund investments don't work out. Not only has easy credit dried up, credit has in fact tightened further. (As an example, it's very difficult to get a jumbo mortgage in SF these days). That means, as an example, bigger down-payments and higher interest rates for home buyers than normal.

The effect on the mortgage side is that ...

  • a) Tighter credit terms in effect makes homes more expensive to buy (from a buyers perspective). Those homes are then viewed as unaffordable.
  • b) Home prices must then fall until they are viewed as being affordable. (We're seeing home prices fall across the U.S.).
  • c) Falling prices make lenders nervous about the collateral that's backing their loans, so they tighten lending standards even further.

And then on the hedge fund side ...

  • a) Banks start calling in loans to hedge funds (via margin calls).
  • b) Those hedge funds are forced to sell off assets to raise cash to pay off the margin calls.
  • c) The selloff of those assets drives prices down, leading to more losses and more margin calls.

In both cases, there's a vicious cycle that is created. And without a doubt, there would be significant instability created in the economy, which the Fed generally doesn't like. The benefit of the whole thing, though, is that the market emerges eventually much healthier than it went in. It's a correction to unsustainable investment practices. So, when I read about Bernanke's recommendation, it just didn't seem quite right to me for some reason. I couldn't wait to read the opinion page in the WSJ the next day. And, of course, there was a great opinion piece on the topic.

The thing that's obviously so unfair about the whole recommendation is that you're basically just arbitrarily shifting capital to bad debtors. And you're asking either the banking system or the taxpayers to do that. Here's a good excerpt:

Mr. Bernanke's broadside might well hamper these voluntary workouts by signaling to other borrowers that they needn't do anything at all. They can merely sit tight and wait for their banker to tell them they don't owe nearly as much as they thought. Or they'll conclude they can wait for Congress to provide its own mortgage bailout, this time on the backs of taxpayers who decided not to speculate on real estate during the housing bubble, or not to purchase a more expensive home than they could afford.
And then another good one that also speaks to the system finding a healthy new bottom to start from:
The worst irony here is that the mortgage crisis is in large part the fault of the Fed's own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been, and the first step in any recovery is letting those now-falling prices find a new bottom. Government interference in that price discovery will only prolong the crisis, increasing the chances that the losses are eventually dumped onto taxpayers.
But then how painful would it be to find that bottom? And are we willing to live with that for the next few years? Or is it better to just forgive all those people of their poor investment decisions? I suppose that's where politics will come into play here.
Labels:

Comments

Post a Comment

Popular posts from this blog

Nine Prescriptions for Building the Duke Entrepreneurial Community

I think Duke can have one of the strongest entrepreneurial communities in the world. Are we there yet? Well, not yet. But there's a tremendous amount of momentum that I saw build in just the past two years while I was getting my MBA at Duke. While leading Duke's 10th annual business plan competition, the Duke Start-Up Challenge (DSC) , last year, I witnessed a near doubling of participation on campus in just a single year. The interest on the ground was clearly there and building rapidly. But now that I'm an alum, I'm looking back and wondering ... how do we rev-up the Duke entrepreneurial community even more? I read a great article by Daniel Isenberg, a professor of management at Babson, called " How to Start an Entrepreneurial Revolution " in the June edition of the Harvard Business Review. Isenberg outlines nine prescriptions for governments that want to create entrepreneurship ecosystems in their countries. Although he was focused on governments an...
3 comments
Read more

Dancing on the Edge of a Volcano

I found this opinion piece ( Democrats aren't innocent bystanders ) interesting on how both Democrats and Republicans share responsibility for polarizing the electorate and undermining some of its faith in democracy. It references two other posts that were pretty good as well: The Disease of Delegitimization The Weimarization of the American Republic The second article is really long and heavy on history.  But given all of the comparisons people make between the current times and those of post-WWI Germany, I found it interesting to dive in to understand where the comparisons are coming from and how close we really are.  The short answer is that we aren't that close (phew). Seems like post-WWI Germany was incredibly fragile.  This was a good excerpt that summarized it: So, unlike the 60s, you have a dynamic in which both sides are behaving like radicals, in which the establishment isn’t yelling “stop,” and in which oikophobia is more evenly distributed, relative to its Boo...
Post a Comment
Read more

The Fortunate 400

So there's rich, and then there's super rich. I recently read an article in the WSJ about the top 400 taxpayers based on income. Pretty incredible statistics. Those top 400, or what they call the "Fortunate 400", pulled in $85.6 billion in income in 2005. That's over $200 million each ... in one year! Here's a quick graphic to drive that home: Very impressive. There's all the obvious jaw-dropping statistics to go with that. For instance, to make the cut to be in the 400 you had to pull in at least $100 million. With an average of $200 million, that means there's people pulling in well over that number. Obviously, quite crazy numbers, and generally speaking not necessarily anything to be concerned about. I'm all for capitalism. But one of the more disheartening statistics was that adjusting for inflation, the minimum income to make the cutoff into the Fortunate 400 has nearly tripled since 1992. That's probably not a good sign as I imagine that...
Post a Comment
Read more