Hard News: Fun while the banking system collapses
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I remember listening to a BBC podcast, oh, six months ago now, talking about the subprime crisis.
I heard the same broadcast (National Radio: sounds like us) and I was struck by the phenomenon of people walking - simply leaving the property and the mortgage behind. It goes against every value that middle-class people are supposed to hold about property.
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Lucy S:
I remember listening to a BBC podcast, oh, six months ago now, talking about the subprime crisis. They interviewed one real estate guy in California who said that they were having a huge mosquito problem for the first time in decades because there were so many empty houses with swimming pools that weren't being cleaned, due to foreclosures. And I remember thinking, my god, this is huge, why hasn't anyone noticed? How did this happen?
It just seems to have taken most of the world six months to realise exactly how much of a problem there was.
Not coincidentally, most of these foreclosures have involved McMansions:
Atlantic Monthly - The Next Slum?
Today's Orange County/Whitby, tomorrow's Compton/Mangere?
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DeepRed: Really interesting article! What were once nice suburbs are now turning into slums.
And it's not just the subprime crisis that's doing this. Simultaneously there's a transition where people are chosing to move from the suburbs into the inner city.
Interesting times!
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Type Americas tent city into google.
Tent city gathers all the victims of the subcrime crisis.
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More on the sub-priming of suburbia:
* The Suburbs Are Turning Into Crime Ridden, Cookie Cutter Hellish Barrens
* Will the Subprime Mortgage Crisis Turn the Suburbs Into Slums?
And the title of this article sums up the whole affair in one line quite nicely:
* McMansions: Unsustainable Housing Meets Unsustainable Finance
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Loved the Arctic Monkey's cover - here's another one
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I'll contribute another very readable article where a couple of economists answer some questions about the market interventions of the last few days. Very interesting.
Lehman Bros is the largest bankruptcy in US (and thus quite likely world) history, given their USD600m in pre-filing assets. The previous record was WorldCom, at a measly USD100m. Another interesting fact is that the asset-base of Fannie and Freddie is in excess of USD5 trillion. Yes, with a t! Seems that it wasn't just the Wall St part of the finance industry that took good advantage of nearly non-existent oversight.
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Robyn beat me to the Giant Pool Of Money linkage, I'll just add a downloadable MP3 version. It really is superb.
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It goes against every value that middle-class people are supposed to hold about property.
The middle classes have bettered their instruction.
M-O-R-A-L H-A-Z-A-R-D spells moral hazard both for the issuer and the consumer of debt. Bear in mind that in the US, you can walk away from mortgage debt (in some states) without any stain on your character.
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@ Matthew:
http://news.yahoo.com/s/ap/20080915/ap_on_bi_ge/lehman_brothers_bankruptcy
Lehman said that as of May 31, it had assets of $639 billion and debt of $613 billion.
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the SEC ban on some short selling looks like it could signal a total meltdown within a couple of months.
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The powerpoint about subprime is good but completely misses (deliberately?) the Govt's role in this mess. The Govt's fingerprints are all over this mess.
I am all for Govt policy to increase home ownership, but apparently the particular method devised in the 1990s had some risks that weren't appreciated. Also don't forget Greenspan's Fed holding interest rates too low for too long provided that excess liquidity that was sloshing around the financial system, some of which found its way to the housing market and pumped it up into a worldwide housing bubble. Without the bubble, we wouldn't have had the bust. If you add these factors, and the explanation below into the powerpoint presentation, you will have a pretty decent grasp of what this is and how it happened.
The self-proclaimed angels in Washington will tell you they’ve been working tirelessly to expand the American dream of homeownership by making mortgages available to people unable to plunk down 20 percent on a house. Franklin Raines, the Clinton-appointed former head of Fannie Mae from 1998 to 2004, made it his top priority to make mortgages easier to get for people with poor credit, few assets and little money for a down payment.
The fine print to this noble intent was an ill-conceived loosening of standards. For instance, the Clinton administration reinterpreted the Jimmy Carter-era Community Reinvestment Act to politicize lending practices. Under the CRA, the government forced banks to prove they weren’t “redlining” — i.e., discriminating against minorities — by approving loans to minorities. Sen. Phil Gramm called it a vast extortion scheme against America’s banks. Still, the banks were perfectly happy to pass the risky loans to Raines’ Fannie Mae, which was happy to buy them up
That’s because Raines was transforming Fannie Mae from a boring but stable financial institution dedicated to making homes more affordable into a risky venture that abused its special status as a “Government Sponsored Enterprise” (GSE) for Raines’ personal profit. Fannie bought the bad loans and bundled them together with good ones. Wall Street was glad to buy up these mortgage securities because Fannie Mae was deemed a government-insured behemoth “too big to fail.” And others followed Fannie’s lead.
The current financial crisis stems in large part from the fact that people who shouldn’t have been buying a home, or who bought more home than they could afford, now can’t pay their bills. Their bad mortgages are mixed up with the good mortgages. And thanks in part to new accounting rules set up after Enron (aggressive mark to market rules), the bad mortgages have contaminated the whole pile, reducing the value of even stable mortgages.
Of course, there are other important factors at work here, having to do with changing technology among other things. And even if the bad mortgages weren’t in the system, we’d still have the hangover from the end of the housing boom. But the financial system could have handled that with the usual corrections. The biggest dose of poison entered the financial bloodstream through Washington. And some people warned us. In 2005, Fannie Mae revealed it overstated earnings by $10.6 billion and that it didn’t really know what was going on. The Bush administration pushed for reforms, but those efforts were rebuffed by Congress, with Democrats Barney Frank and Christopher Dodd taking point, because Fannie and Freddie have spent millions in campaign contributions.
In 2005, McCain sponsored legislation to thwart what he later called “the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole.”
Obama, the Senate’s second-greatest recipient of donations from Fannie and Freddie after Dodd, did nothing.
Meanwhile, Raines, the head of a government-supported institution, made $52 million of his $90 million compensation package thanks in part to fraudulent earnings statements.
But, ah yes, the greedy criminals responsible for this mess must be somewhere on Wall Street.
I remember when the accounting irregularities at Fannie were exposed and Raines getting kicked out of Fannie because of it. I didn't appreciate the scale of what he had done and its implications.
And Raines is not just a big Obama guy, but an Obama campaign advisor. I wonder how much of that $90m Raines made fleecing Fannie (and setting up this week's disaster) has found its way into Obama's campaign? Obama is not exactly who you would want to sort this out. He has no experience and no clue, and his closest advisors are upto their eyeballs in causing this mess.
This is all horrible. Not the end of the world or the US, but horrible. While the Govt is putting itself on the hook for huge sums, the actual final cost to the US Govt wont be nearly as much as the headlines because the US Govt is providing short term liquidity and will get the proceeds of an orderly disposition of the assets over time, many of the assets are good assets wrapped up in instruments tainted by some genuinely crappy loans. To give you a feel for scale, the total of subprime loans in some form of delinquincy is about $140b, or about 1% of the $11trillion US housing market. BTW, that $140b wont end up being worth zero either, probably 60 to 70c on the dollar (I am not suggesting that the Govts costs or exposure is limited to this amount, but to give you a feel for how bad the underlaying situation actually is). The Govt will most likely make money on its AIG package.
There are no shortage of regulations in US financial markets. Some regulations were misguided (overly aggressive mark to market rules)and some needed measures were missing (ratings agencies which gave these packages of loans decent ratings & the uptick rule on shorts). The key is to make sure the right policies and rules and regulations are in place going forward.
Say what you like about the Bush Admin but at least he got Hank Paulsen onboard at Treasury as he one of the few guys in the world with the smarts and credibility to navigate this storm.
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I'll contribute another very readable article where a couple of economists answer some questions about the market interventions of the last few days. Very interesting
Very helpful Matthew. I now grasp the fundamentals, I find that if the fundamentals are strong well then....................
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James, will you come to my next party? I think it would be really fun to play a 'How Can James Manage To Blame Any Conceivable Problem On Clinton?' drinking game.
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And things are getting even more interesting.
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James,the Republican-controlled US congress in 1999 repealed Depression-era laws which separated commercial banks and investment banks.That move allowed the sector to take far greater risks with borrowed money to preserve profit margins and pump up executive salaries.
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Nice link Stephen, and it had a related story that was also interesting
Brown is hardly alone in her criticism of the derivatives. Five years ago, billionaire investor Warren Buffett called them a "time bomb" and "financial weapons of mass destruction" and directed the insurance arm of his Berkshire Hathaway Inc to exit the business.
that Buffet dude always seems to know what's coming ...
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Bear in mind that in the US, you can walk away from mortgage debt (in some states) without any stain on your character.
I got the shock of my life about 2 weeks ago watching an item on the ABC (US) news. They were showing how middle class folk were buying new $400-500k 'better' homes on better mortgage terms and then walking away from their existing homes. Evidently the existing home was (say) worth $300k (due to the drop in house prices) but still carried (say) $350+k in mortgage debt at a higher interest rate.
Evidently one can just 'foreclose' and leave the house with the bank. At which point the 'debt' becomes their problem. According to ABC, Banks are now taking another look at their lending policies, with a view to changing criteria about buying second homes!! A pity they didn't wise up sooner. Never underestimate Man's ability to rort a system to their own advantage. It's human nature.
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The claims above that Fannie Mae and Freddie Mac are responsible for the sub-prime crisis are just silly. "Sub-prime" mortgages in the USA are (by definition) ones that the Fannie and Freddie wouldn't touch.
Freddie & Fannie getting caught with a liquidity problem was a symptom of this whole mess, not a cause of it, and it wasn't because they engaged in sub-prime lending.
Freddie & Fannie's share of backing the US mortgage market dropped as the real estate boom got silly, because they *wouldn't* engage in buying dept related to truly absurd mortgate practices - like lending to people with no deposit and no income.
Freddie & Fannie problems were that they ran on not enough capital, which meant that they got caught out when defaults rose sharply due to the end of a real estate boom. In other times they'd have borrowed to cover it, but because the market is shaky no-one would lend to them. Of course the Senate Banking committee let them run down their capital - but neither Obama nor McCain were involved in that.
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Much scarier than any subprime details is the current state of the TED.
The TED is the difference between the 3-month US dollar LIBOR rate (that is, the rate at which the big commercial 5 banks lend to each) and the interest rate yield they accept on US dollar Treasury bills.
So it's the difference between the 3-month rate a bank wants on US govt debt vs the 3-month rate a bank wants from another big bank. That means its a measure of credit risk of banks. It's a credit spread - an addition to the safe interest rate to get a rate adjusted by credit risk.
Typically the TED is around 0.05% - that is, the banks assume there's a 0% chance the US Treasury will go bankrupt but 5 in 10,000 chance that a solid commercial bank will.
Right now it's over 3%. That is, the banks are betting that the safest most stable commercial banks on the planet have a 3% chance of going under. You just can't run a modern financial system under such a climate of fear. It just won't work. No-one knows what happens next.
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"Lehman said that as of May 31, it had assets of $639 billion and debt of $613 billion."
Okay people, lets talk briefly about how derivatives work. Because those numbers don't mean as much as you think they do.
Any sane bank hedges its positions. So typically you're buying an asset (an obligation owed to you) worth 50 million at 5.92%, and then selling a different organisations 5 similar debts (obligations owed to someone else) worth 10 million each at 5.94%. If they actually are the same as each other (perfectly hedged) then you end up with no risk and make 0.02%/year on 50 million. No risk, no problems, pure profit, and yet on paper you now have an asset of 50 million and a debt of 50 million.
Of course, some hedges aren't perfect (that's where the difference between "similar to" and "exactly the same as" can bite you). And some positions are NOT hedged because you bet on the market going one way and it doesn't. But the point is that the notional "600 billion" figure is not what's important. It's the gap of 26 billion between assets and liabilities that's important.
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And Raines is not just a big Obama guy, but an Obama campaign advisor
Twaddle James, and everyone is saying that apart from the McCain camp, who once again have their pants down caught making things up. He was and is no such thing.
When you factor that into your spiel, and then, as Danielle says, throw in your Clinton (and Carter) are responsible for everything loop, I think I'd rather leave your factors out and get my fundamentals on the US economy from someone a little more reliably even than you. Thanks anyway.
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Here's an interesting comparison:
A transcript of Obama's statement on the crisis, in which he barely breaks stride as he moves to the Q&A with reporters. He comes across as knowledgeable and lucid.
And McCain's speech notes on the same topic. It includes frankly insane passages like this:
My friends, this is the problem with Washington. People like Senator Obama have been too busy gaming the system and haven’t ever done a thing to actually challenge the system.
We’ve heard a lot of words from Senator Obama over the course of this campaign. But maybe just this once he could spare us the lectures, and admit to his own poor judgment in contributing to these problems. The crisis on Wall Street started in the Washington culture of lobbying and influence peddling, and he was square in the middle of it.
The financial crisis is Obama's fault?
Meanwhile, it is noted that McCain's capaign manager Rick Davis earned hundreds of thousands of dollars running the Homeownership Aliiance, a lobby group created by Fannie and Freddie to oppose banking regulation.
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Palin's latest Troopergate excuse falls apart with the emergence of an official document showing that Monegan's "unauthorised" trip to Washington -- the alleged "last straw" that let to his sacking -- was in fact specifically authorised by her chief of staff.
Far out. She just seems to lie as a matter of course.
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