Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - September 17th, 2013

History 101

(Originally published June 11th, 2013)

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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The Opportunity Cost of Debt

Posted by PITHOCRATES - September 16th, 2013

Economics 101

Housing Sales drive the Economy because almost Everything for Sale is for the Household

Once upon a time the rule of thumb was to buy the most expensive house we could possibly afford.  We saved 20% for a down payment on a conventional mortgage.  We lived on a shoestring budget and paid our mortgage no matter what.  Even if we had to live on meatloaf and macaroni and cheese for the next five years.  Or longer.  We did this because we would be paying that mortgage payment for 30 years.  And though tough at first during those 30 years we advanced in our careers.  And made more money along the way.  Making that mortgage payment easier to pay as time went by.

So that was the way it used to be.  And it was that way for a long time.  Until the Federal Reserve started playing with interest rates to stimulate economic activity.  Altering the banking system forever.  Instead of encouraging people to save their money so banks could loan money to homebuyers they printed money.  Flooded the market with it.  Ignited inflation.  And caused housing bubbles.  Then the government took it up a notch.

Housing sales drive the economy.  Almost everything for sale is for the household.  Furniture and appliances.  Beds and ceiling fans.  Tile and paint.  Cleaning supplies and groceries.  Dishes and cutlery.  Pots and pans.  Towels and linen.  Lawnmowers and weed-whackers.  Decks and patio furniture.  When people buy a house they start buying all of these things.  And more.  Creating a lot of economic activity with every house sold.  So the government did everything they could to encourage home ownership.  And few governments did more than the Clinton administration.  By applying pressure on lenders to qualify the unqualified for mortgages.  Which gave us the subprime mortgage crisis.

Lenders used Subprime Lending to Qualify the Unqualified to Comply with the Clinton Administration

People in poor neighbors tended to be poor.  And unable to qualify for a mortgage because they couldn’t afford the house payments.  When these poor people happened to be black the Clinton administration said the banks were racist.  They were redlining.  And advised these lenders that if they don’t start qualifying these people who couldn’t afford a house that the full weight of the government will make things difficult for them to remain in the lending business.  So they complied with the Clinton administration.  Using subprime lending to put people into homes they couldn’t afford.

The main reason why people can’t afford to buy a house is the size of the mortgage payment.  Which can be pretty high if they can’t afford much of a down payment.  So these lenders used special mortgages to bring that monthly payment down.  The adjustable rate mortgage (ARM).  Which had a lower interest rate than conventional mortgages.  Because they could raise it later if interest rates rose.  Zero-down mortgages.  Which eliminated the need for a down payment.  Coupled with an ARM when interest rates were low could put a poor person into a good sized house.  No-documentation loans.  Which removed the trouble of having to document your earnings to prove you will be able to make your house payment.  Making it easier to approve applicants when you don’t have to question what they write on their application.  Interest-only loans where you only had to pay the interest for, say, 5 years.  Greatly reducing the size of the monthly payment.  But after those 5 years you had to pay that loan back in full with a new mortgage for the full value of the house.  Which may be more costly in 5 years.

So these lenders were able to meet the Clinton administration directive.  They were putting people into homes they couldn’t afford.  Just barely.  These people had house payments they could just barely afford.  Thanks to the low interest rate of their ARM.  But then interest rates rose.  Making those mortgage payments unaffordable.  With zero-down they had little to lose by walking away.  And a lot of them did.

The Interest on the Debt is so large we have to Borrow Money to Pay for the Cost of Borrowing Money

Buying a house is a huge investment.  One that we finance.  That is, we borrow money.  Sometimes a lot of it.  Because we don’t want to wait and save money for a down payment.  And because we want so much right now we buy as much as we can with those borrowings.  Doing whatever we can to lower the monthly payment.  With little regard to long-term costs.  For example, assume a fixed 30-year interest rate of 4.5%.  And we finance a $150,000 house with zero down.  Because we have saved nothing.  The monthly payment will be $790.03.  But if we waited until we saved enough for a 10% down payment that monthly payment will only be $684.03.  And if we saved enough for 20% down the monthly payment will only be $608.02.  That’s $182.01 less each month.  The total interest paid over the life of this mortgage for zero down, 10% down and 20% down is $123,610.07, $111,249.06 and $98,888.05, respectively.  Adding that to the price of the house brings the total cost for that house to $273,010.07, $246,249.06 and $218,888.05, respectively.  So if we wait until we save a 20% down payment we will be able to buy a $150,000 house and $54,723.02 of other stuff during those 30 years.  This is the opportunity cost of debt.

We are better off the less we finance.  Because long-term debts are with us for a long time.  And they don’t go away if we lose our job.  Or if interest rates go up.  Like with an ARM.  A large driver of the subprime mortgage crisis.  Let’s see what was happening before the housing bubble burst.  Let’s say we could buy that $150,000 house with a zero down mortgage with an adjustable interest rate of 2%.  Giving us a monthly payment of $554.43.  Very affordable.  Which helped get a lot of people into houses they couldn’t afford.  But then the interest rate went up.  And what did that do to someone who could just barely pay their house payment when it was $554.43?  Well, if it reset to 4% that payment increased to $716.12 ($161.69 more per month).  If it reset to 6% that payment increased to $899.33 ($344.90 more per month).  Bringing the total cost of the house to $323,757.28 ($150,000 principle + 173,757.28 interest).  Which is why a lot of these people walked away from these houses.  There was just no way they could afford them at these higher interest rates.

Interest payments on long-term debt at high interest rates can overwhelm a borrower.  Making the Clinton administration’s Policy Statement on Discrimination in Lending insidious.  It destroyed people’s lives.  Putting them into houses they couldn’t afford with subprime lending.  But if you think that’s bad consider the national debt.  These are long-term obligations just like mortgages.  And currently we owe $16,738,533,025,135.63 (as of 9/13/2013).  At an interest rate of 3.9% the annual interest we must pay on this debt comes to $652,802,787,980.29.  That’s $652.8 billion.  Which is more than we spend on welfare ($430.4 billion).  Almost what we spend on Social Security ($866.3 billion).  And more than half of the federal deficit ($972.9 billion).  This is the opportunity cost of debt.  It limits what we can spend elsewhere.  On welfare.  Social Security.  Etc.  The interest on the debt has grown so large that we even have to borrow money to pay for the cost of borrowing money.  And there is only one way this can end.  Just like the subprime mortgage crisis.  Only worse.

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Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - June 11th, 2013

History 101

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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Subprime Lending, Housing Bubble, Dot-Com Bubble, Enron, WorldCom and Obamacare

Posted by PITHOCRATES - August 14th, 2012

History 101

Dot-Com Companies used Venture Capital and Proceeds from their IPOs to pay their Expenses as they had no Revenue

The economy in the Nineties boomed.  President Bill Clinton and the Democrats say it was their policies of higher taxes on the rich that made it all happen.  At least that’s the argument you hear today in their arguments for returning to the Clinton era taxes on the wealthy.  Because it gave us the incredible economic explosion of the Nineties.  And balanced the federal budget.  But was the economy really that good?  No.  It wasn’t.  A lot of bad things happened in the Nineties.  Including something we’re still suffering from today.  The Subprime Mortgage Crisis.  Which gave us the Great Recession.

The Clinton administration told lenders to approve more mortgages for poor and minority applicants or face action from his justice department.  Lenders were not approving these applicants for reasons like lack of income and a poor credit history.  Common of people who lived in poorer sections of town because they didn’t have the income and credit history to move to a less poor section of town.  To avoid action from Clinton’s justice department lenders turned to subprime lending to qualify the unqualified.  To help these lenders unload these toxic mortgages off of their balance sheets the federal government’s GSEs Fannie Mae and Freddie Mac bought them and resold them to unsuspecting investors.  And we all know how well that turned out.  A great housing bubble blowing up.  Subprime Mortgage Crisis.  And the Great Recession.

The Nineties also gave us the dot-com bubble.  A lot of Internet start-up companies with soaring stock prices for products they never sold.  They had no revenues.  But speculators were so anxious to get in on the next Microsoft that they ran up these stock prices into the stratosphere.  And with nothing to sell these dot-coms used venture capital and proceeds from their initial public offerings (IPOs) to pay their expenses.  Giving away what they had for free.  Hoping to build brand awareness.  And to figure out a way to actually make money on the Internet.  Even cities joined in the speculation.  Spending tax dollars to build high-tech infrastructure to attract the dot-coms to their cities.  And businesses came to their cities.  Built buildings.  Filled them with employees earning good money.  It was the dawn of the new high-tech, Internet-based world.  But when all of the investor money ran out they still didn’t have anything to sell to pay their bills.  The bubble burst.  People lost their jobs en masse.  And all those new buildings sat empty in cities burdened with debt and a shrunken tax base.  While students who went to college to get degrees to let them join the dot-com world found no one was hiring when they graduated.  As few were hiring during the ‘dot-com’ stock market crash and recession of 2000-2002.

Enron Cooked their Books to Overstate Sales and Assets and Underreport Liabilities

Enron came of age in the Nineties.  They were in the electricity and natural gas business.  In both distribution and generation.  They were also into other businesses.  Too many to list.  But the energy business took off in the Nineties thanks to deregulation.  And Enron became a darling of the stock market.  With its stock price rising about 300% during the Nineties.  The value of its stock was worth about 70 times earnings.  Meaning that investors saw nothing but further growth in Enron.  Why?  Because the Clinton administration was taxing the rich at higher tax rates?  Not quite.  It’s because they cooked their books.

Investors like to see strong earnings.  Lots of assets on the balance sheet.  With not so much debt (i.e., liabilities).  So Enron strived to give investors what they wanted.  By the aforementioned cooking of their books.  Using mark-to-market accounting.  As opposed to historical cost accounting.  Where you buy an asset.  You post it to the balance sheet for the value you paid for it.  Then forget about it.  Mark-to-market, on the other hand, notes the ‘fair value’ of those assets.  If an asset grows in value a company adjusts it books to reflect the current, higher value.  Making their books more attractive to investors.  To look better on the liability side they created a lot of shell companies and special purpose entities.  Posting liabilities on these off-balance-sheet companies instead of their own books.  The combination of higher asset values and underreporting of liabilities made Enron look very strong financially.  And strong revenue growth just made investors drool.

Enron traded.  They bought and sold products and services.  Providing risk management for its clients.  Think of an airline buying a contract for jet fuel for one year to lock in low prices.  How you record this transaction on your books depends on what you’re buying and selling.  If you’re a stock broker you record only your fees as revenue.  Not the value of the stock.  If you’re a retailer you record the value of what you sell as revenue.  Enron recorded their trading like a retailer would.  Which greatly increased their revenues from these trades.  They also used mark-to-market accounting on future revenue streams.  Instead of using the retailer method of recording sales and costs for a period they would calculate the value of a contract for future sales and record them as current revenue.  Pulling future revenues into the current accounting period.  This sent revenues soaring.  Increasing some 700-800% during the Nineties.  Much of which was a house of cards built upon shady accounting practices.  Long story short, they couldn’t keep cooking the books.  And the house of cards collapsed.  The stock price fell back to earth.  And landed with a thud.  Becoming worthless.  People went to prison.  Workers lost their jobs.  And their pensions.  Valued at some $2 billion (though they got a little of that back).  Shareholders lost some $74 billion.  Their accountant, Arthur Andersen, went out of business for their involvement.  And Enron went bankrupt.  The biggest bankruptcy ever.  Until WorldCom.

The Obama Administration borrowed Accounting Practices from Enron and WorldCom to Score Obamacare

WorldCom became a telecommunications titan by buying other companies.  And then with the largest merger in U.S. history when it merged with MCI Communications in 1997.  It was huge.  And it posted huge sales.  Accordingly, its stock price rose.  As the dot-com bubble burst WorldCom’s stock price fell.  As did a lot of telecoms.  To prop up their falling stock price they, too, turned to shady accounting practices.  Inflating both revenues and assets.  And like Enron they couldn’t keep up the scam.  And the fallout was similar to Enron.  Only bigger.  Interestingly, they even had the same accountant.

But it’s just not corporations playing with their accounting practices.  Even the government gets into the action.  Case in point Obamacare.  The magic number for the cost of Obamacare over 10 years was a trillion dollars.  The same cost of the Iraq War and the War in Afghanistan.  As the wars end Obamacare takes over that spending.  Making it ‘revenue neutral’.  Well, health care for everyone without adding any new government spending would be hard to say ‘no’ to.  So how do you keep it below the cost of these wars?  You borrow accounting practices from Enron and WorldCom.

The original CBO scoring of Obamacare came in at $940 billion.  They based this on the data the Obama administration gave them.  Which included 10 years of new taxes (or spending transferred from war spending to Obamacare spending).  But only 6 years of benefits.  So that $940 billion only covered 6 years of Obamacare in that 10 year period.  Greatly underreporting the costs of the program.  No one knew it at the time.  Because they fast-tracked this bill through Congress before anyone had a chance to read its two thousand pages.  So they had their CBO scoring below a trillion.  And with some shady backroom deals, voila.  Obamacare became law.  CBO has since revised their number to $1.76 trillion that includes 9 years of benefits.  Bringing it to about $2 trillion if you cover all ten years.  And closer to $3 trillion if you put back the $741 billion or so taken from Medicare.  So the government cooked the books to conceal the true costs of Obamacare.  With the true cost being approximately 300% more than they promised the American people it would cost.  This $2 trillion scam is greater than the Enron and WorldCom scams.  But the government suffers no fallout for their gross misrepresentation like Enron and WorldCom did.  Because when they do it it’s just politics.

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Housing Boom, Subprime Lending, ARMs, Housing Bubble, CDOs, Subprime Mortgage Crisis, Housing Inventories & Sales and Great Recession

Posted by PITHOCRATES - July 24th, 2012

History 101

Artificially Low Interest Rates and Federal Pressure to Qualify the Unqualified created a Housing Bubble

The federal government loves home sales.  Because they generate a lot of economic activity.  From the washing machines and refrigerators new homeowners buy to furnish them.  To the raw materials extracted from nature to make the concrete, bricks, wood, pipes, wires, shingles, glass, plastic, paints, carpeting, insulation, etc., to build them.  Enormous amounts of economic activity at every level throughout the stages of production.  It reduces down to a simple formula.  Make it easy for people to buy houses.  Enjoy a booming economy.  And how best to do that?  Make mortgages cheap.  By keeping interest rates cheap.  Artificially low.  To stimulate a housing boom.

This is Keynesian economics.  Government intervention into the private market.  By having the Federal Reserve keep interest rates lower than the market would have them.  To encourage more people to buy houses.  Then the Clinton administration took it up a notch with their Policy Statement on Discrimination in Lending.  Investor’s Business Daily reported (see Smoking-Gun Document Ties Policy To Housing Crisis by PAUL SPERRY posted 10/31/2011 on Investors.com) that this policy statement forced lenders basically to qualify the unqualified.

At President Clinton’s direction, no fewer than 10 federal agencies issued a chilling ultimatum to banks and mortgage lenders to ease credit for lower-income minorities or face investigations for lending discrimination and suffer the related adverse publicity. They also were threatened with denial of access to the all-important secondary mortgage market and stiff fines, along with other penalties…

“The agencies will not tolerate lending discrimination in any form,” the document warned financial institutions.

The unusual full-court press was predicated on a Boston Fed study showing mortgage lenders rejecting blacks and Hispanics in greater proportion than whites. The author of the 1992 study, hired by the Clinton White House, claimed it was racial “discrimination.” But it was simply good underwriting.

There was no racial discrimination.  Just people who couldn’t qualify for a mortgage.  But that didn’t stop the Clinton administration.  So there were artificially low interest rates.  And federal pressure to qualify the unqualified.  To let those who can’t afford to buy a house buy a house.  Enter subprime lending.  A way lenders could approve the unqualified for a mortgage.  With adjustable rate mortgages (ARMs).  Interest only mortgages.  Zero down mortgages.  No documentation loans (say you earn whatever you want and we’ll enter it into the application without documenting it).  Anyone who wanted to have a house could have a house.  And a lot of people bought houses.  Even those with insufficient incomes to pay their mortgage payment if interest rates ever rose.

When the Housing Bubble Burst it Destroyed a lot of Economic Activity and a lot of Jobs

The economy was heating up.  There was a housing boom.  The boom turned into a housing bubble.  Housing prices soared demand was so high.  Builders couldn’t build them fast enough.  And people couldn’t buy a house big enough.  McMansions entered the lexicon.  Houses in excess of 3,000 square feet.  For a family of four.  Or smaller.  But then these artificially low interest rates began to heat up inflation.  And it was the Federal Reserve’s responsibility to keep that from happening.  So they raised interest rates.  Causing the interest rates on those ARMs to reset at a higher rate.  Making a lot of those monthly payments beyond the homeowners’ ability to pay.  Homeowners defaulted in droves.  Causing the subprime mortgage crisis.  And the Great Recession.

Facilitating this economic carnage was the secondary mortgage market.  Fannie Mae and Freddie Mac.  Who bought those very risky mortgages from the lenders.  Repackaged them into collateralized debt obligations (CDOs).  And sold them to unsuspecting investors.  Who thought they were buying high-yield safe investments.  Because they were backed by historically the safest investment.  A mortgage.  But that was before subprime lending.  For these subprime mortgages weren’t your father’s mortgage.  These mortgages were toxic.

So when the housing bubble burst it not only destroyed a lot of economic activity, and a lot of jobs, it wreaked financial destruction in people’s investment portfolios.  All because of a formula.  Make it easy for people to buy houses.  But when you play with the economy too much you don’t create economic growth.  You created bubbles.  And the bigger the bubble the longer and the more painful the recession will be when that bubble bursts.  As those artificially high house prices fall out of the stratosphere back to real market levels.

The Current Gulf between Housing Inventories and Sales is what made this Recession the Great Recession

If you look at the housing inventories and housing sales for the decade from 2001 to 2011 you can see how bad the recession was.  And will continue to be.  We took housing data from the United States Census Bureau.   Housing inventories from Table 7A.  And housing sales from Houses Sold.  The data shows housing units in inventory and sold.  We used 2001 as a base year, dividing each number by the 2001 base numbers.  Graphing the results shows how inventories and sales trended for this decade.

From 2001 to 2005 housing sales were rising at a greater rate than inventories.  Indicating demand for houses was greater than the supply of houses.  Causing house prices to rise.  Encouraging builders to build more houses.  Heating up the housing market.  Sending prices higher.  Creating the great housing bubble.  Then around 2005 the Federal Reserve began to raise interest rates to tamp out inflation.  And those ARMs began to reset at higher rates.  Causing housing sales to fall.  From about 2005 to 2008 inventories continued to rise while sales collapsed.  Leaving the available housing supply far outstripping demand.  Causing house prices to collapse.  Leaving people underwater in their mortgage (owing more than their house is worth).  Or living in paid-off houses that lost up to half their value.  Or more.

The gulf between inventories and sales is what made this recession the Great Recession.  And is why the Great Recession lingers on.  There are just so many more houses than people want to buy.  Killing new housing starts.  And all that economic activity that building a house generates.

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FT122: “Japan’s Lost Decade helped the Clinton economy by reducing imports while the global slowdown does nothing for the Obama economy.” -Old Pithy

Posted by PITHOCRATES - June 15th, 2012

Fundamental Truth

The Japanese Government made Money Cheap and Plentiful to Borrow creating a Keynesian Dream but an Austrian Nightmare

Once upon a time Americans feared the Japanese.  Their awesome might.  And their relentless advances.  One by one the Japanese added new properties to their international portfolio.  They appeared unstoppable.  Throughout the Eighties everything was made in Japan.  Government partnered with business and formed Japan Inc.  And they dominated the world economy in the Eighties.  A U.S. Democrat nominee for president held up Japan Inc. as the model to follow.  For they had clearly shown how government can make the free market better.  Or so this candidate said.

But it didn’t last.  Why?  Because in the end the Japanese just interfered too much with market forces.  Businesses invested in each other.  Insulating themselves from the capital markets.  Allowing them to make bad investments to sustain bad business planning.  All facilitated with cheap credit.  Government made money cheap and plentiful to borrow.  And they borrowed.  A Keynesian dream.  But an Austrian nightmare.  Because they used that money to make even more bad investments (or ‘malinvestments’ in the vernacular of the Austrian school of economics).  Creating a real estate bubble.  And a stock market bubble.  Bubbles are never good, though.  Because they can’t last.  They must pop.  And when they do it isn’t pretty.

The U.S. just went through real estate bubble that peaked in 2006.  Money was so cheap to borrow that people were buying $300,000+ McMansions.  Anyone could walk in and get a no-documentation loan with nothing down.  People were buying houses and flipping them.  And people who couldn’t qualify for a mortgage could get a subprime mortgage.  Further pushing house prices higher.  Not because of real demand.  But because of this artificial tweaking of the free market by the government.  Making that money so cheap to borrow.  And when all that cheap credit caused inflation elsewhere in the economy the Fed finally tapped the brakes.  And increased interest rates.  Raising monthly payments on all those subprime mortgages.  Leading to a wave of defaults.  The subprime mortgage crisis.  And the Great Recession.

Japan’s Deflationary Spiral gave American Domestic Manufacturers a Huge Advantage

This is basically what happened in Japan during the Nineties.  The government had juiced the economy so much that they grew great big bubbles.  Ran up asset prices to incredible heights.  But then the bubble burst.  And those prices all fell.  They fell for so long and so far that Japan suffered a deflationary spiral.  Throughout the Nineties (and counting).  The Nineties were a painful economic time.  After a decade or so of inflation the market corrected that with a decade of recession.  And deflation.  A decade of economic activity the Japanese just lost.  The Lost Decade.  But it wasn’t all bad.

At least, in America.  There was still some Reaganomics in the American economy.  Producing real economic growth.  But there was also a bubble.  In the stock market.  The dot-com bubble.  The Internet was brand new and everybody was hoping to be in on the next big thing.  The next Microsoft.  Or the next Apple.  Also, unable (or unwilling) to learn from the mistakes of the Japanese real estate bubble the Clinton administration was making it very uncomfortable for banks to NOT approve mortgage applications for people who were unqualified.  Putting more people into houses who couldn’t afford them.

So while the Clinton administration was trying to change America (during the first 2 years they tried to nationalize health care against the will of the people) the economy did well.  For awhile.  Irrational exuberance was pushing the stock market to new heights as investors poured money into companies that didn’t have a dime of revenue yet.  And never would.  Clinton had to renege on his promise on the middle class tax cut because things were worse than he thought when he promised to make that middle class tax cut.  (Isn’t it always the way that when it comes to tax cuts some politicians can’t keep their promise because they were too stupid to know how bad things really were?)  Added into this mix was Japan’s Lost Decade.  Their deflationary spiral increased the value of the Yen.  And made their exports more expensive.  Giving the American domestic manufacturers a huge advantage.  The economy boomed during the Nineties.  For a mix of reasons.  They even projected a budget surplus thanks to the economic woe of the Japanese.  But then the dot-com bubble burst.  Giving Bill Clinton’s successor a nasty recession.

When a Recession ails you the Best Medicine has been and always will be Reaganomics

The Left always talks about fair trade.  And about the unfair practice of foreign manufacturers giving Americans inexpensive goods that they want to buy.  So their answer to make these unfair trade practices fair is to slap an import tariff on those inexpensive foreign goods.  To protect the domestic manufacturers.  For they believe it’s that simple.  And plug their ears and sing “la la la” when you discuss David Ricardo’s Comparative Advantage.  Ricardo says countries should specialize in the things they’re good at.  And import the things others are better at.  When everyone does this we use our resources most efficiently.  And the overall wealth in the international economy increases.  Making the world a better place.  And increases our standard of living.  But the rent-seekers disagree with this.  They want high tariffs.  And obstacles for foreign imports.  To protect the domestic businesses that can’t sell as inexpensively or at such high levels of quality.

Some would point to Japan’s Lost Decade as proof.  Where their deflationary spiral removed a lot of foreign competition to American manufacturing.  Allowing them to sell at higher prices and lower quality.  All the while protecting American jobs.  And, yes, Japan’s woes did help the American domestic manufacturers during the Nineties.  But it wasn’t because they could raise prices and lower quality in the face of low foreign competition.  It was because there was still enough Reaganomics in the country to produce some vibrant economic activity.  That encouraged entrepreneurs to take chances and bring new things to market.  Which is a huge difference from the current economic picture.

The Eurozone sovereign debt crisis has plunged Europe into a recessionary freefall.  Much like the Japanese suffered in the Nineties.  Yet the American domestic manufacturers aren’t benefiting from this huge decline in foreign competition.  Why?  Because the Obama administration has excised any remaining vestiges of Reaganomics out of the economy.  Everything the rent-seekers could ever hope for they have.  Only without tariffs.  And yet the Obama economy still lingers in recession.  Because irrational exuberance and barriers to free trade don’t create real economic growth.  And an administration hostile to capitalism doesn’t inspire entrepreneurs to take chances.  No.  What encourages them to take chances are low taxes.  And less costly and less punishing regulations.  For programs like Obamacare just scare businesses from hiring any new employees.  Because they have no idea the ultimate costs of those new employees. 

Now contrast that to the low taxation and relaxed regulatory climate of Reaganomics.  That produced solid economic growth.  And this growth was BEFORE Japan’s Lost Decade.  Which just goes to show you how solid that growth was.  And proved David Ricardo’s Comparative Advantage.  For both Japan and the United States did well during the Eighties.  Unlike Clinton’s economy in the Nineties that only did well because Japan did not.  But the good times only lasted until the irrational exuberance of the dot-com bubble brought on an American recession.  Which George W. Bush pulled us out of with a little Reaganomics.  Tax cuts.  Proving yet again that higher taxes and higher regulations don’t create economic activity. Tax cuts do.  And fewer regulations.  In other words, when a recession ails you the best medicine has been and always will be Reaganomics.

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The NHS prefers Midwives delivering Babies at Home while Hillary Clinton prefers Expensive Hospital Stays for Childbirth

Posted by PITHOCRATES - June 3rd, 2012

Week in Review

The Clinton administration tried to nationalize health care with Hillary Clinton designing the system.  In secret.  Which didn’t go over well with the people.  They didn’t trust her or what she was going to do to their quality health care.  And rejected her and her health care plans within a year.  Before anything was ever passed into law.

The Obama administration was able to do what the Clintons could not.  Buy off enough Congress people to pass Obamacare.  All the while during this process to nationalize health care both Clinton and Obama attacked the private system.  The greed of doctors, hospitals, pharmaceuticals and insurance companies.  President Obama even saying perhaps Granny should take a pill to manage her pain while she dies instead of wasting money to try and save her life.  And despite this hatred towards the health care industry here’s Secretary Clinton in the Obama administration pledging aid for maternal health everywhere.  To allow them to have the same kind of expensive hospital stay Secretary Clinton enjoyed when she had her baby (see U.S., Norway pledge $150 million for maternal health by Arshad Mohammed posted 6/2/2012 on Reuters).

Recalling the 1980 birth of her daughter, Chelsea, U.S. Secretary of State Hillary Clinton mused about how she would have felt had she not had a healthcare facility with skilled doctors and nurses and the equipment and expertise to handle emergencies.

Interesting.  How she wants everyone to have an expensive hospital birth just like she had.  While in perhaps the best know national health care system in the world, Britain’s National Health Service (NHS), a health care system they would so love to see Obamacare evolve into, encourages women to give birth at home with a midwife.  Because child birth is not a life threatening disease and rarely requires hospitalization (see Midwives in push for more homebirths by Cathy O’Leary posted 6/2/2012 on The West Australian).

Homebirth supporters want to convince WA women and GPs that most pregnancies do not need a doctor to manage them, let alone an obstetrician.

They say WA women have among the highest rates of caesareans and medical interventions in the world and women are conditioned to see childbirth as an operation before a stay in a hotel-type hospital…

Childbirth educator Pip Wynn Owen said WA was way behind Britain where midwives handled most births and doctors took only risky cases.

“Doctors have done a good job of selling caesareans as normal and they like doing low-risk births, because that’s their bread and butter, when they should be concentrating on abnormal pregnancies,” she said.

“In WA, many women have private health insurance so they’re encouraged to choose a hotel-type hospital with their own doctor and private room…”

Private practice midwife Liza Kennedy said she was gobsmacked at the medicalisation of birth in WA when she moved from Britain five years ago. “There is a lot of sinister fear around birth perpetuated by the medical profession so women give away their power very readily,” she said. “Homebirth is made out to be odd when it’s the gold standard in terms of continuity of care and gives huge satisfaction.”

Pam Hogarth-Gray, 32, chose a homebirth for Sequoia five months ago after having her older children in hospital.

“It was amazing. I recovered in five minutes and felt like Wonder Woman,” she said. “I was glowing on a natural high and still am.

It would appear that childbirth in a hospital is more about the revenue than the birthing.  And yet the cost-conscious architects of Obamacare not only want American women to have their babies during expensive hospital stays.  They want to pay for women everywhere in the world to have their babies during expensive hospital stays. 

Giving birth isn’t a disease.  It’s painful.  And rather unpleasant.  And often is accompanied by an inadvertent bowel movement.  But it is a natural thing.  Much like breastfeeding.  Which liberals want to have mothers everywhere to do as much in public as possible instead of using high-tech formula.  But they draw the line on childbirth.  Because that is too complex not to do surrounded by machines and doctors and nurses.  Which I find amusing.  For one of my grandfathers delivered a child or two while my grandmother was sitting on the toilet at home.  Go back a couple of hundred years and all children were born at home.  Because there were no hospitals.  Which was the norm for some 200,000 years of our existence on this planet.  And here we are.  Our forefathers having successfully delivered babies at home for all those years to propagate the species.  To give us time to invent the expensive hospital stay.  After fire, farming and irrigation.  And a few other things more critical for our survival.

Perhaps the reason why Secretary Clinton wants women to have babies in hospitals is because she tends to look at pregnancy as a disease.  It would explain their aggressive policies on abortions and birth control.  To minimize the suffering from this unfortunate disease that can be brought about from having a good time.  For as those on the Left say these are women’s health issues.  And interfering with them is tantamount to resurrecting the plague.   Of course some 200,000 years of history would disagree with that.

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LESSONS LEARNED #10: “Conservatives like the Rule of Law whereas Liberals prefer militant, radical change.” -Old Pithy

Posted by PITHOCRATES - April 22nd, 2010

WHEN IT COMES to change, conservatives prefer gradual change within the established institutions.  They like things done within the Rule of Law.  Peacefully and quietly.  Everything has a place and everything should be in its place.  Including change.  If they don’t understand an issue, they study it.  Rationally.  They control their passions.  Some say too much.  Always so prim and proper, it’s like they have a stick up their butt.  They wouldn’t know fun if it bit them in the ass.  Or some would say.

A radical likes to excite the masses.  They like anarchy.  They like to get into the faces of their opposition.  They’re loud and angry and do radical things.  Throw a punch.  Blow things up.  And anyone who disagrees with them had better watch out.  They live by their passions.  Act first, think later.

TIMOTHY McVEIGH WAS a radical.  He wasn’t a conservative.  By definition.  Conservatives don’t blow things up.  Radicals do.  And it was indeed a radical that blew up the Alfred P. Murrah Federal Building in Oklahoma City in 1995.  And he didn’t do this because of a conservative agenda.  He did it because he was pissed off about what happened at the Branch Davidian compound near Waco Texas in 1993.   This upset a lot of people.  Only one bombed something, though.  One radical.

The Clinton administration tried to blame McVeigh’s actions on conservative talk radio.   As conservatism does not endorse radicalism, this makes no sense.  Conservatives, in general, are about as threatening as a box of kittens.  They’re law-abiding people.  And you don’t show your support for the Rule of Law by violating the Rule of Law.

THE WEATHER UNDERGROUND was a radical, leftist organization.  They hated America.  They were anti-capitalists.  Their movement grew from the anti-war movements on college campuses in the sixties.   Their goal was similar to the communists in 1969 Vietnam.  Coordinated attacks in South Vietnam, known as the Tet Offensive, had the goal of causing rebellion in the south.  If successful, the dictatorship of the proletariat of the north would spread throughout Vietnam.  The Weather Underground tried to do the same in America.  They wanted to establish a dictatorship of the proletariat in America.  Both failed.  The communists in Vietnam would prove successful, though, some 7 years later due in part to the anti-war movement in America.  But I digress.

The Tet Offensive was defeated in bloody combat.  The Underground’s offensive was far from the Tet Offensive military campaign, but its ultimate goal was the same.  Their bombing campaign, though, had little effect.  Instead of stirring rebellion, it forced their members further underground. 

Though they committed sedition against the United States government, the feds dropped most charges or reduced them.  A Supreme Court decision regarding wiretaps made the wiretaps used to collect evidence illegal.   And inadmissible.  And a trial would have required revelations that would have damaged ongoing and future operations.  So most of them skated and reintegrated into ‘normal’ life.  One would even go on to associate with a presidential candidate.  Bill Ayers.  He was one of the ‘radical associates’ noted by some media outlets of then candidate Barack Obama during the 2008 presidential election.

THE REAGAN REVOLUTION was a conservative revolution.  And, as revolutions go, it was pretty benign.  There were no mobs.  No gunfire.  No bombings.  In typical conservative fashion, it was a revolution of ideas.

Reagan campaigned as a conservative.  He governed as a conservative.  His message was consistent.  And this consistency led to stability.  You knew what you got with him.  Voters returned him to office with an overwhelming majority; he carried 49 of 50 states.

Reagan’s popularity indicates the power of conservatism.  When debated in the arena of ideas, conservatism wins.  Not by intimidating voters.  Not by redrawing congressional districts.  Not by voter fraud.  Not by hiding your true political beliefs.  Not by misleading voters.  No.  Conservatism wins by honest debate.  The Reagan Democrats are proof of this.  These Democrats voted for Reagan because they supported his conservative platform.  And when you vote against your own party, you don’t do that lightly.  There’s conviction behind that vote.  And that conviction comes from listening intently to that debate in the arena of ideas.

THERE IS ANOTHER conservative revolution underway.  And it’s a peaceful one, too.  As conservative movements are wont to be.  Because true conservatives respect the Rule of Law.  These conservatives gather in peaceful assemblies called Tea Parties.  And the Left hates them.

The Left knows its history.  They know that they lose in the arena of ideas.  And they don’t want another Reagan Revolution on their hands.  So they are attacking this peaceful movement and are calling them every name in the book.  One in particular refers to a crude sexual act.  And this name originated in the Mainstream Media.  This would have been unthinkable in the days of Cronkite and Brinkley.  But, then again, today’s media is not the media of Cronkite and Brinkley.

On the anniversary of the Oklahoma City Bombing, the Left is warning of parallels between the ‘group’ that produced a Timothy McVeigh and the Tea Party movement.  But there was no ‘group’ that produced McVeigh.  He was a radical who was angry at the federal government for what he saw in Waco Texas.  He didn’t think.  He acted.  Much like the Weather Underground. 

Rational thinking about the possible outcomes of both their actions likely would have prevented their actions.  But radicals don’t think about the consequences of their actions.  At least, not before they act.  Conservatives do.  And the Tea Party people are conservatives.  That’s why they choose peaceful assembly to change public opinion over militant, radical action.  Because true change follows when you win hearts and minds.  Not by bullying.

THERE MAY BE individual radicals in the Tea Party movement.  Most groups have their radicals.  But the group as a whole is not radical.  And not a threat.  They’re like a box full of kittens.  But with an agenda.  A peaceful agenda.  And that agenda?  To engage in debate in the arena of ideas.

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