These are "interest"ing times indeed. We are witnessing a convoluted economic system trying to dissolve itself, having crashed under its own weight in 2007.
The crashed economic system had first sent property prices soaring on the strength of low interest rates, falling cost of living due to super cheap imports, ARM deals, and speculation that the party can continue forever. This system gladly advanced "home equity" loans like there's no tomorrow, fuelled an unsustainable economic growth via heavy consumer spending - until it could go on no more. Interest rates had to go up at some point, the super cheap imports advanced on their own inflation cycle, and the ARMs adjusted upwards to payments that the borrowers' incomes could not bear.
Just a few percent people getting stuck on their household "balance of payments" and defaulting on their loans was sufficient to cause the crash - because those valuation levels needed unmitigated Euphoria to sustain.
It was revealed that the banks had overlent, undercreated provisions for losses, malcomputed profits, and overpaid bonuses over the years.
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With Govt. now pumping in money into the banking system, it is hoped that "credit will start flowing again" into housing and consumer debt markets, and restart "that growth" that fell off a cliff due to drying up of credit. But this is illusion.
With Home Equities gone and mortgages underwater, there is fat chance for low interest rate loans for consumer spending. No matter how low the interest rates to the banks, they will not lend cheap for consumer spending without any collateral (earlier the collateral was the "home equity") except to people that really do have the income to pay them back, along with all the loans they have on them already! But these are the very people that do not quite need consumer loans; they are doing just fine consuming on their income. Indeed banks are seen cutting back on unsecured lines of credit (like credit cards) and aggressively raising interest rates, even as they press the Govt. to reduce its rate which is near zero already!
On housing credit, banks are asking for hefty 20%+ downpayments to ensure sufficient skin in the game for borrowers, so they will not walk out of the mortgage if prices correct further, which they will. As long as a good deal of new buyers are going to have mortgage payments more than a third of their income, the prices will be perpetually susceptible to a tumble down, especially if a new waft of inflation blows or there are large enough job losses. And there sure will be a new waft of inflation because even before any money, if at all with all the 20% + downpayment caveat, comes into the housing market, banks' cash will flow into commodities speculation.
Gazillion dollars will be required to first resurrect the housing and stock markets to the pre-crash levels and get the party atmosphere again. But in this process, money will also flow into commodities speculation, for all you know even before into stock markets and property. And unless the people's incomes levels too are planned to be increased by fiat, the whole vision is a non starter, at best it'll be a short-lived euphoria for stocks and homes before living price rise will bring about the same 2007 plummet all over again. Regular people, always the last ones to enter a phony bull run - they stay skeptical until very close to the top and then give in, only to see the market "correcting" downwards soon enough - will enter and lose in all markets: stocks, commodities, and property.
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Rather, the entire issue of home ownership needs to be tackled in a totally fresh manner.
It begins with going back to the following axioms:
1. It is NOT the solemn duty of the Governments to ensure that property valuations are in a bull run all the time (same for stockmarkets actually).
2. One buys a house for living based on what one can afford over a 30 year span. For investment properties, you buy them much like stocks, based on individual assessment that their prices are likely to rise. There is no role the Govt. is playing here.
3. As in stocks, for housing too "Past performance is no predictor of future gains".
The Government needs to have a hands-off approach on housing valuations while encouraging homeownership from a distance. It is time to move away from "managing" symbols of economic performance like home prices, and spend energy on the economy bottom-up. If your shadow became smaller, no point trying to fix the shadow to sustain feeling taller and taller and taller! You need to change your angle to the light and work towards some genuine height increase!
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How about explicitly linking the TARP distributions to Foreclosure Prevention? The bank and the individual delinquent borrower agree on a reduced principal outstanding, maybe also a new interest rate, and the government stays out of it. The loan begins to perform again, it's no longer toxic, and the bank is allowed to claim say 50% of the principal reduction from the TARP funds. The bank eats half of the principal reduction, while Govt the other half, and the borrower digests the loss of home equity as fate-accompli but gets an affordable new payment.
Instead of pumping gazillions into the hazardous and unimaginably costly vision of reinflating the asset prices, perhaps the right approach is to help housing find its true bottom instead. Homeownership can be further encouraged via fiscal measures - e.g. allow housing interest deduction outside of the Std. deduction v/s itemized deductions choice.
Further help for banking system survival can be made available via methodology similar to auto industry assist - "Come with a Plan showing market size for your product/services, what share you project to capture and why, and the restructuring and re-comp proposed to adjust, survive and grow in the new market dynamic". There need not be a guarantee to help each bank coming on the table.
The bailout money handouts need to be subject to careful discretion and be limited in size; as also the tax breaks to those earning say $120K +, except homeownership incentives. The Governmental power to create new money needs to be conserved for the infrastructure, healthcare and education investments for the next generation. In fact, people, rightly skeptical about euphoric corporate growth as many industries are saddled with overcapacities already, are keeping their money in the FDIC insured bank accounts. For the socio-economic investments, the Govt. could actually borrow some of this money than print new one.
©2009 Ohm, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Thursday, January 22, 2009
Last modified: Thursday, January 22, 2009
The views expressed in this article are those of Ohm only and do not represent the views of Nolan Chart, LLC or its affiliates. Ohm is solely responsible for the contents of this article and is not an employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
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Reader Comments:
Posted By: Walt Thiessen
Date: 2009-01-23 04:47:33
The banks who got themselves in trouble should not be protected. They should not even be quasi-protected. They should be allowed to fail. The banking market needs to find the bottom in exactly the same way and for the same reason that the housing market needs to find the bottom of the market. Quasi-protecting banks deters that process from happening in a timely manner, merely postponing the inevitable at tremendous cost to the taxpayers.
The myth that there are banks that are too big to fail is just that, a myth. It is perpetuated by those who have a direct interest in the perpetuation of those banks: shareholders, officers, and customers. The failure of the biggest banks does not mean the end of the economy; it merely means the banks suffer the consequences of their own foolish practices. There are plenty of smaller banks ready and waiting to take over the accounts of the largest banks, once the largest banks fail.
Posted By: Jake, the champion of the constitution
Date: 2009-01-23 06:43:51
Dear Ohm -
Welcome to the Chart! I would be curious to hear how you think the Alt-A, balloons, options, etc, which may start defaulting mid-year will work out with your theory in finding a bottom?
Jake
Posted By: daddysteve
Date: 2009-01-23 18:22:42
It's all price fixing, whether it's stocks, houses, interest rates, etc. I thought it was determined long ago that price fixing is bad.
Posted By: Ohm
Date: 2009-01-23 19:08:12
Thanks again for your reception. Regards,Hi Jake, Walt
Many Thanks! My views are below:
GENERAL: The idea is not for the Government to make it a mission to ensure Every bank's survival but to provide help, via policy, so that not all of them close shop to leave a banking vaccuum (all of them bet along similar lines) like extinction of the dynasaurs (all had similar genes). Also, a worthwhile aim of a people's Govt is to prevent "ghost neighborhoods" of deserted homes. The quasi protection proposed coaxes banks into performing loan modifications in order to get help from the Govt and, thereby, help the struggling debt loaded home occupants out of near bankruptcy, to live again and well, be genuine consumers again using their disposable income not "home equity".
$$ It is likely even after this quasi protection, many or all, banks will still go towards closure when the derivatives and commercial real estate boomerang on them. In that event, I would hope that they go into closure one after another, so after sufficient eliminations, depending upon how much banking & "speculation services" the economy needs in the new economic conditions, rest can be saved by the Govt - and not all that we have today. If all show signs of closing down together, then Govt will have to cherry-pick which ones to save based on evaluation of their respective financial positions - on and off balance sheet - and verification. $$
My "thought-orientation" definitely has key role for the Govt in a situation like this. We know that market engineered corrections are never one-shot: there is at first, overcorrection, and then a correction to the correction itself! Staying all hands-off to let everything play out in the market when massive, chronic excesses are correcting could be annihilatory. On a purely moral plane, all these banks need to go bust, but I would like to see some of them survive because we are not ready for their extinction as a species - I am for sure not. And I am counting only banks with national and international scale.
1) Alt-A: Same assistence to banks as for subprime.
2) Balloons Payment Crisis in Commercial Real Estate: See para within $$
3) Options: See para within $$
Posted By: Ohm
Date: 2009-01-23 19:50:28
Hi daddysteve,
I'm no fan of price fixing myself. But sudden movement from price fixing and manipulation on all fronts: interest rates, currency, home valuations, and use of devices such as ARMs, HEADLONG INTO unassisted pricing via the oscillatory market mechanism, too is dangerous. The markets will overcorrect to annihilation when years of huge excesses are "ruthlessly" let go :-) Sort of like you suddenly go off nicotine after decades of smoking one pack a day! In my disposition, I am not so adventurous.
In fact, I am not so much worried about an overcorrection in home valuations and stocks valuations but about letting all banks go bust if they have all lost their capital - I would not wish to begin afresh from a "banking vaccuum". However, the no. of these institutions definitely has to fall significantly, in line with the greatly lowered demand for their services.