What the Tea Parties are about- and A theory on the housing bubble

What the Tea Parties are about

Wednesday, April 15th, 2009

I see a lot of discussion about what the “Tea Party” activists are concerned about. It isn’t really taxes. As others, including David Frum, have pointed out, taxes are not the issue right now. The rates are still fairly low by historical standards. This is what we are concerned about:

There are lots of complaints about Bush’s spending and I was unhappy with it. Still, the graph shows the difference. We have never seen anything like this before in our history. There is no way this debt can be repaid without either huge tax hikes or runaway inflation. We were already worried about paying for the Boomer generation retirement benefits in Social Security and Medicare. This will make that impossible. Obama said he wanted to change the country. That is certain unless he is stopped. That is what the tea parties are about.

A better explanation of what happened is now published in the WSJ today. It may not be the last word but it makes sense.

Why does one large asset bubble — like our dot-com bubble — do no damage to the financial system while another one leads to its collapse? Key characteristics of housing markets — momentum trading, liquidity, price-tier movements, and high-margin purchases — combine to provide a fairly complete, simple description of the housing bubble collapse, and how it engulfed the financial system and then the wider economy.

They believe that the housing bubble was unique because it involved heavy leverage and a low income segment of the population who could not service their debt once property appreciation ended. They were betting that trees grow to the sky. I have lived through other housing bubbles.

In just the past 40 years there were two other housing bubbles, with peaks in 1979 and 1989, but the largest one in U.S. history started in 1997, probably sparked by rising household income that began in 1992 combined with the elimination in 1997 of taxes on residential capital gains up to $500,000. Rising values in an asset market draw investor attention; the early stages of the housing bubble had this usual, self-reinforcing feature.

The 1979 bubble ended with inflation and high interest rates. In those days, however, the down payments and income requirements kept some level of sanity. In 1979, my partner built a custom home in a new gated section of Mission Viejo that was located on a lake. His neighbors on either side also built custom homes but, when the time came to convert from construction financing to permanent home loans, the interest rates were 21% and neither could qualify for the loan in spite of excellent incomes.

The 2001 recession might have ended the bubble, but the Federal Reserve decided to pursue an unusually expansionary monetary policy in order to counteract the downturn. When the Fed increased liquidity, money naturally flowed to the fastest expanding sector. Both the Clinton and Bush administrations aggressively pursued the goal of expanding homeownership, so credit standards eroded. Lenders and the investment banks that securitized mortgages used rising home prices to justify loans to buyers with limited assets and income.

There are You Tube videos of Franklin Raines explaining to Congress in 2004 that single family home values could never decline.

But they did decline and we have seen the consequences. Why did this bubble take down the financial sector of the economy ?

In the equities-market downturn early in this decade, declining assets were held by institutional and individual investors that either owned the assets outright, or held only a small fraction on margin, so losses were absorbed by their owners. In the current crisis, declining housing assets were often, in effect, purchased between 90% and 100% on margin. In some of the cities hit hardest, borrowers who purchased in the low-price tier at the peak of the bubble have seen their home value decline 50% or more. Over the past 18 months as housing prices have fallen, millions of homes became worth less than the loans on them, huge losses have been transmitted to lending institutions, investment banks, investors in mortgage-backed securities, sellers of credit default swaps, and the insurer of last resort, the U.S. Treasury.

I think this is as close as we will get to an explanation for a while. Now, we have to worry about efforts to reinflate the bubble, which is what seems to be going on now. Here is another data point. Home equity withdrawals have gone negative, meaning people are paying down mortgages instead of drawing cash out.

And we don’t need this.

The same banks that offered warehouse lines of credit often turned around and bought the finished product — the mortgage-backed securities. Tom Lindmark, a former banker with a background in real estate, says, “In the boom years the banks looked to the third-party originators to be their sales force.” The big commercial banks like Bank of America and Wells Fargo provided the financing on the front end and bought the securities on the back end, but the independent mortgage banks actually made the loans. The problem with this business model was that it outsourced due diligence to third parties that didn’t have skin in the game. They were under enormous pressure to keep making loans with other people’s money, so many let their standards slide.

The mortgage originators lived on fees and had no risk with default. This must be left behind as a relic of the bad practices during the bubble.

A theory on the housing bubble

Friday, March 27th, 2009 It is pretty clear by now that the origin of the bubble was the push to increase home ownership among low income people. The first action in this direction was the Community Reinvestment Act passed in the Carter Administration. The role of the CRA has been disputed by left-leaning commentators including the oddly named “Businessweek, which represents the views of few businessmen I know. Still, you can learn a lot of history by reading between the lines of opposing views.

The Community Reinvestment Act, passed in 1977, requires banks to lend in the low-income neighborhoods where they take deposits. Just the idea that a lending crisis created from 2004 to 2007 was caused by a 1977 law is silly.

Read those two sentences and note which one is fact and which is opinion.

Now, let’s look at an official site and see what it says.

The CRA requires that each insured depository institution’s record in helping meet the credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution’s application for deposit facilities, including mergers and acquisitions.

Notice the steel fist through the velvet glove ?

Here is another opinion from a different perspective. The CRA was modified and expanded in 1995. Here is more history with comments on the Clinton Administration’s expansion of the law.

The CRA regulations were substantially revised again in 1995, in response to a directive to the agencies from President Clinton to review and revise the CRA regulations to make them more performance-based, and to make examinations more consistent, clarify performance standards, and reduce cost and compliance burden. This directive addressed criticisms that the regulations, and the agencies’ implementation of them through the examination process, were too process-oriented, burdensome, and not sufficiently focused on actual results. The agencies also changed the CRA examination process to incorporate these revisions.

That means quotas, of course.

The financial collapse had other causes, as well, and I don’t want to reargue the entire story. Bush allowed the Fed to keep interest rates too low in the mid-2000s. Investment banks got too enamored of exotic derivatives like credit default swaps, which was bad enough. What was worse was an informal market in trading derivatives of the derivatives.

What I am interested in is where this all began. I would like to suggest that Margaret Thatcher had something to do with it. In the late 1960s, a concept arose called The Right To Buy, which allowed council housing tenants to buy the home they were living in, with a discount for the rent they had paid for some period of time. This quickly became popular and the theory was that owners would take better care of the home they owned than a renter would. Labour, once she had passed form the scene, adopted the same policy and she is now being blamed for the British housing bubble in similar fashion.

The theory was probably right so long as the house being bought was modest and within the means of the buyer to maintain. Once housing prices began to rise, disaster followed.

A glimpse of the future

Tuesday, March 17th, 2009

Today, a bankruptcy judge gave us a glimpse of the future in the public pension situation. It will not be pretty.

In the first ruling of its kind, a bankruptcy judge held the city of Vallejo, Calif. has the authority to void its existing union contracts in its effort to reorganize, holding public workers do not enjoy the same protections Congress gave union workers at private companies.

Municipal bankruptcy is so rare that no judge had yet ruled on whether Congressional reforms in the 1990s that required companies to provide worker protections before attempting to dissolve union contracts also applied to public workers’ union contracts

U.S. Bankruptcy Judge Michael McManus held March 13 that when Congress enacted 11 U.S.C. sec. 1113 to limit companies from outright rejection of union contracts it limited it to Chapter 11 bankruptcies. By failing to extend the limits to Chapter 9, which covers municipal bankruptcy, McManus said cities have broader latitude to break existing union pacts, In re City of Vallejo, 08-26813-A-9 (E. Dist. Calif.)

All I can say is “Holy Shit!”

The public employee unions will be racing to have Congress change the law but it may be too late.

California is next.

Welcome to fascism

Saturday, February 14th, 2009

UPDATE #2: The political left is already deciding which barrier to their agenda will be taken down next. The filibuster has to go, of course. ACORN is working on vote fraud.

UPDATE: Michael Ledeen sees it. His second column is here.

What is happening now–and Newsweek is honest enough to say so down in the body of the article–is an expansion of the state’s role, an increase in public/private joint ventures and partnerships, and much more state regulation of business. Yes, it’s very “European,” and some of the Europeans even call it “social democracy,” but it isn’t.

It’s fascism. Nobody calls it by its proper name, for two basic reasons: first, because “fascism” has long since lost its actual, historical, content; it’s been a pure epithet for many decades. Lots of the people writing about current events like what Obama et. al. are doing, and wouldn’t want to stigmatize it with that “f” epithet.

Second, not one person in a thousand knows what fascist political economy was. Yet during the great economic crisis of the 1930s, fascism was widely regarded as a possible solution, indeed as the only acceptable solution to a spasm that had shaken the entire First World, and beyond. It was hailed as a “third way” between two failed systems (communism and capitalism), retaining the best of each. Private property was preserved, as the role of the state was expanded. This was necessary because the Great Depression was defined as a crisis “of the system,” not just a glitch “in the system.” And so Mussolini created the “Corporate State,” in which, in theory at least, the big national enterprises were entrusted to state ownership (or substantial state ownership) and of course state management.

Maxine Waters was on This Week today. That is a scary prospect and it was as bad as it sounds. A grinning fool is in charge of our future.

I have worried about Obama and the fascist tendencies of the left. This “stimulus bill” is an example. It is a spending orgy of Democrat priorities, mostly to reward and strengthen constituencies. Thus, we see ACORN get billions even while they are prosecuted for election fraud. They are a core constituency of Obama’s and were even behind a lot of the real estate abuses that brought on the crisis. No matter. They will be rewarded.

Obama is not a communist. Fascism is a form of socialism that includes private property. It is often supported by private interests that think they have an inside track with the government. One example is big business, which loves this bill. The “Progressives” of the early 20th century were interested in power and control, not necessarily public ownership of the means of production. They also used censorship, just as threats of the “Fairness Doctrine” circulate in Washington now.

Why would Obama want to roll back welfare reform? That was Clintons great accomplishment but it was really, like most of his accomplishments, an act of the Republican Congress. Democrats have no interest in reducing the welfare rolls. Those are voters ! Why risk the possibility that they might stray as they gain self confidence in the work force?

The economic stimulus bill had very little economic stimulus in it, if you mean a solution to the crisis. That comes next. Banks will be bailed out on condition they continue to fund Democratic party imperatives like loans to risky borrowers. After all, there are few Democrats who understand economics.

I suspect we have begun our own “lost decade.” The Japanese used exactly the same sort of spending priorities in the early 1990s and built billions of dollars of infrastructure projects, many useless and redundant. We are about to do the same with the same result. Stagflation, here we come!

The political risk is an even worse consequence as we have a fascist in the White House.

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