Recession accomplished
I just got back from visiting some friends who work in the banking industry and they think the country is headed for the worst recession in a generation, possibly the worst since the 1930s. Paul Krugman seems to think very much the same thing:
Krugman: Actually, I think home prices will fall enough for us to produce about 20 million people with negative equity. That’s almost a quarter of U.S. homes. If home prices are rising, or if there’s positive equity, you can refinance or sell. But if you have negative equity, you can end up being foreclosed on, and then some people will just find it to their advantage to walk away. We’re probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there - $400 billion or $500 billion in losses - are too low. I think there’ll be $1 trillion of losses on mortgage-backed securities showing up somewhere.
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My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We’ll probably basically retrace all that. So that’s about a 25% decline in overall home prices. Only a fraction of that’s happened so far.
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The financial stuff looks like a combination of 1990 and 2001, and probably bigger than both combined. You’ve got the financial disruption, which is probably bigger than the savings and loan crisis. And you’ve got the loss of wealth from the housing bust, which is bigger than the dot-com bust. So this looks fairly nasty. And then everybody who’s paying attention is worrying about the Japan analogy. Japan never had a really severe recession. It just started with a recession and never really had a recovery for a whole decade. And that’s the kind of thing we’re afraid of.
The sale of Bear Sterns for $250 million yesterday should give everyone great pause. Bear Stern’s corporate offices are worth $1.2 billion and they had a total market capitalization of $35 billion not long ago.
Now, a few questions:
(1) What caused this and how much of it is the fault of the the federal government? I’ve heard various answers about this. The standard party line is that once lenders were able to sell the mortgages to banks who then bundled them up into bonds — some of which were given AAA ratings by the bond ratings agencies — these lenders had much less incentive to make sure their lendees could actually pay. That became someone else’s problem, in effect.
However, one friend of mine believes that the bankruptcy bill played a major role as well. The ability of creditors to go after more of a debtor’s assets made the calculations involving risky loans quite different then they were before. It’s also worth noting that Barney Frank, in particular, has been pushing lending reform bills (which were widely ignored) for quite some time now. And of course the 3 trillion plus trillion dollars we’re blowing on the Iraq war limits the government’s ability to fight a crisis such as this. Nobel Prize winning economist Joseph Stiglitz wrote that:
…our ability to implement a truly effective economic-stimulus package is crimped by expenditures of close to $200 billion on the two wars this year alone and by a skyrocketing national debt.The United States is a rich and strong country, but even rich and strong countries squander trillions of dollars at their peril.
(2) What can the government do about the looming recession? Probably not much, beyond cutting interest rates. Here’s some more from the interview with Paul Krugman:
What can Fed chairman Ben Bernanke do in terms of cutting rates? You wrote on your blog recently, “Keep cutting, Ben!”
Yeah, that’s right. I’m now reasonably sure that they will cut again and again and again. A few cuts of 75 basis points and we’ll be down to zero. And there’s a pretty good chance that we’re heading to zero, and that there’s going to be a Japan-style ZIRP, zero-interest-rate policy.
There may also be some value in passing some reforms of the mortgage market (though it’s a bit locking the barn door after the animals have left). A former vice-chair of the fed writes in today’s Washington Post:
…our best hope for leadership from Washington may now be in Congress. Rep. Barney Frank (D-Mass.) and Sen. Chris Dodd (D-Conn.) are working on a fine bill that, by easing some of the stresses in the mortgage market, could do some real good. I urge Frank, Dodd and the Democratic leadership to expedite the process, and congressional Republicans should stop standing in the way.
(3) What will the effect be on the 2008 election? Potentially, it’s massive. And it’s likely to help Democrats at the national level, as I see it (we touched a bit on this earlier). For one thing, the recession will be seen as Bush’s doing. For another, modern Republicans are woefully ignorant of complex policy details. Here’s John McCain:
“The issue of economics is not something I’ve understood as well as I should,” McCain said. “I’ve got Greenspan’s book.”
Funny that he chose Greenspan, given that the noted Ayn Rand fan is widely criticized for his handling of the crisis (as this google search illustrates better than a single article could).
Can you imagine Randy Kuhl trying to discuss adjustable rate mortgages, mortgage-backed bonds, liquidity issues, and the like at a townhall meeting? The modern Republican attitude towards all issues, great and small, has been “I don’t need no book learnin’, just what’s in the Bible and what my gut tells me.”
I don’t think that’s going to cut it this time.
Here’s another perspective:
http://www.prospect.org/cs/articles?article=the_bubble_economy
This author thinks the root of the problem is lax regulation.
That’s an interesting article.
Well, to start with, let me say that standing close to financial buildings in New York is not a wise thing right now. And if you absolutely have to, please make sure to be on guard for falling members of The Investor Class.
As for what the government can do, sending $600 checks in the mail probably wasn’t the best idea. As has been discussed in many places, all people are going to do with that money is pay down mortgages, credit cards and loans, not spend it in the marketplace. Moreover, the problem right now has nothing to do with consumer spending, and trying to offset it with consumer spending just goes to show what utter nimrods the Administration is populated with.
The best the government can do is use its influence to try to make things happen in the industry. Project Lifeline has made it very clear to anyone who is paying attention that things have gone WAY too far. When banks eventually decide to start cutting their losses and renegotiating their mortgage debts based on the current value of homes, things will begin to stabilize, but we’re probably looking at several months more of foreclosures even if they start right now. There are indications that they are starting to renegotiate.
The government needs to exercise real leadership, not inadequate bail-outs and rebates that do nothing. Unfortunately, from Iraq to Afghanistan to Russia to China to Iran to NOLA, one thing that cannot be said of this administration is that it is capable of leadership.
But, it’s all just one more collapsed institution under the belt of our Failure in Chief, George Bush.
Oh, yeah, I meant to point out one other thing:
On #1 and the bankruptcy bill: this is partly cause and partially effect. By this I mean that by the time of the bankruptcy bill’s passage, the bundling and superfunding of mortgages was already well under way as a means of generating bank revenue, and passing this bill was an indication of just how worried banks were already getting about the problem by 2003.
The rise in subprime lending has to do with “feeding the beast,” once banks began to realize that they could make money off of commoditizing mortgage debt. So is the over-valuation of homes, particularly in California and Florida. They are all part in parcel of the same idea: the value of homes is made up, the value of commoditized mortgages is made up, and when someone calls the bluff, POOF!
Also, there are indications that, at the end, giving away subprimes like candy was effectively “robbing Peter to pay Paul.”
It’s pretty clear that the commoditizing of debt — in a way that didn’t reflect actual risk — is what went wrong here at a basic level, I agree. And that’s probably something where the government couldn’t do all that much. Banks want to sell screwed up financial instruments to each other, who’s to stop them?
More specifically, The Problem is that commoditizing debt and selling it on the stock market puts it outside the umbrella of insurance represented by FDIC. The banks rewired the system and left itself exposed, clearly against the spirit and intent of the laws that founded FDIC. If, through either a new law or through executive order, the basics of FDIC were more clearly outlined, this would solve the problem. We cannot allow banks to commoditize debt.
This is not the first time in the history of finance that this has been done. It’s a way to make money where there is none left. The Spaniards did it right before the disaster in England that shattered the Spanish Armada. The English did it right before the disaster of the first World War. Its never a good sign when religion, bad debt and war mongering dominate the thinking of an empire.
Just last fall I cut a check to Bear Sterns for back taxes my sister owed. They handled the foreclosures and tax liens against tax payers in arrears for property taxes for the Commonwealth of PA. One thing that struck me as odd was my request for a receipt for the satisfaction of her debt and verification of the property’s removal from the auction block. They were very hesitant to do so and asked me to trust them that it was taken care of. I’m all out of trust.
On another related note, I asked my brother-in-law (VP, Fed of NY) for his opinion on the topic at hand. His response to a relative by marriage. “No comment.” That’s not comforting.
My frustration with all of this is the end result of the collapse - who made millions off of the under-regulated mortgage bubble, and who gets left holding the bag?
A lot of what you would call “fat cats” got hammered when Bear went at a fire sale price. Speaking to my friends in NYC, it sounds as though a surprising number of people at these banks have a surprising (maybe stupid would be a better word) amount of money in stock in the banks at which they work. Partly it’s that their bonuses are paid in restricted stock they can’t sell right away, partly it’s some kind of (misplaced) confidence in their own company.
Here is an article describing the effect on some Bear Stearns employees, and you are right, many have lost tons of their life savings.
Yeah, not that I’m going to shed tears for people who have to sell the second house on the Hamptons, but most of these people didn’t exactly take the money and run. They deserve some kind of credit for that. (Though mostly I think they were stupid not to sell more of their unrestricted stock.)
It’s not just the financial “wizards” at Bear Stearns who have lost most of their life savings; its secretaries, IT professionals, carpet cleaners and those scumbag vice presidents. I do feel sorry for the regular workers at Bear Stearns. You could make the case that they shouldn’t have invested so much in their own company, but hindsight is 20-20 and many companies want their employees to buy their stock — and go out of their way to make sure that the employees do buy their companies stock.
From Paige’s NYT link
“For James E. Cayne, the firm’s chairman and former chief executive, holding on to his Bear stock was a point of pride, and he rarely, if ever, sold. A billionaire just over a year ago when Bear’s stock soared past $160, his 5.8 million shares are now worth about $28 million at Monday’s closing price of $4.81.”
It’s kind weird, isn’t it, to be watching the real estate market collapse while living in Rochester. It’s like looking in from the outside. It’s so stable and steady here.
Yes, that’s my feeling exactly. It’s even more pronounced when you’ve just visited one of the places where the sky is really falling.
Great thread– excellent comments. Economics geek that I am, I have been following this as it unfolds in gory detail for the last year– actually, given a particular interest in predatory lending, kinda even before that. “Worst recession in a generation” is now socially-acceptable speech (it was not even as short a time ago as December); am wondering how long we have to wait before it is ok to utter “Possibly the worst recession on record.” While it is true that there are numerous historical precedents, from the ones DragonFlyEye mentions to the original bubble-template, the Dutch Tulipmania, there has never before been the combination of massive global economic integration and the other conditions for major recession/depression. The bigger you build the tower, the further it falls (but, just as fast, or, with computerized assistance, maybe faster).
Itchy is right about relative stability in upstate NY during phase 1. Unfortunately, the ripples (indirect effects) will be more widely distributed. If you always wanted to get around to volunteering at the food pantry, now would be a good time to sign up.
One upside: it isn’t, in fact, all about the failures of governance and regulation, although Barney Frank is spot-on about changes needed there, and DragonFlyEye is certainly accurate about our Misleader, and the change in bankruptcy law, dropping Glass-Steagal, and the unregulated commoditization of debt all are contributing cause. Our culture has also, however, come to praise, respect and honor a kind of people who are basically “indirect theives”– wealthy off of complicated stuff that can be traced to cons and usuary. Many of them are about to loose the accoutrements of power, and be exposed for the talentless, moralless people they really are. The people we should respect are volunteering at the food pantry (and, some of them are lining up for food there, to feed their families, too).
Great comment! Thanks.
Recession what recession
Alfred w Bush
http://politicalhumor.about.com/library/images/blbushpic8.htm
The greed that has led to the collapse is not only in the housing market. Corporate greed at all levels contributed to this. The bar was set.
If you do some reading on Reaganomics, the crux of the story is a plan where those who are in positions of power make money, and those who want to be in positions of power need to work harder to achieve “greatness” and riches.
It’s the old “the rich get rich, and the poor get poorer”. Eventually people will realize that the philosophy of the GOP sustains them at all levels. To hell with the rest of you.
When you set a national philosophy of greed, which has manifested itself over and over throughout history, combine that with an oil-hungry, hell bent on revenge leader with no mind of his own, led by the same power mongers that have been involved in running the nation for over 40 years, it’s pretty obvious that its all part of the plan.
At least I now know why Jeff Bezos of Amazon.com fame is building a spaceship. He is mocked by many…rich boy with the big toy…but I’m beginning to believe its part of an exit strategy
[...] This past week continued to see the trickle down GOP policies take their toll on, oh, everything. If you read nothing else in this post read this piece on the recession. [...]