Keynesian Economics gave us the Subprime Mortgage Crisis, but the Government blames S&P

Posted by PITHOCRATES - August 20th, 2011

We call it the Subprime Mortgage Crisis, not the Mortgage-Backed Securities Crisis 

When responsible for a problem you can accept blame.  Or you can blame the messenger.  Or better yet, you can attack the messenger (see Criticism of Standard & Poor’s over U.S. credit rating compounds its troubles in Washington by Jim Puzzanghera, Los Angeles Times, posted 8/18/2011 on WGNtv).

The backlash against Standard & Poor’s for downgrading the U.S. credit rating adds to the company’s problems in the nation’s capital, where it faces investigations for its role in fueling the financial crisis with faulty assessments of mortgage-backed securities.

S&P and the other credit-rating firms are widely believed to have enabled the near market meltdown by giving AAA ratings to many securities backed by risky subprime mortgages.

So the credit-rating firms enabled the subprime mortgage crisis.  Interesting.  Because the bad subprime mortgages already existed by the time those mortgage-backed securities came to them for review.  And it was those preexisting mortgages that people defaulted on and caused the near market meltdown.  So I don’t think you can blame this all on S&P.  And remember, we call it the subprime mortgage crisis.  Not the mortgage-backed securities crisis.  Ergo, the cause was the subprime mortgages.  And S&P didn’t write those mortgages.

Subprime Mortgages:  Creative Financing to Qualify the Unqualified

Once upon a time you saved up 20% for the down payment on a new house.  Then you went to a savings and loan to get a mortgage.  Or a bank.  In those days, people saved their money.  They deposited it into their savings accounts and earned 3% interest.  The banks and savings and loans then loaned it at 6%.  And the bankers were on the golf course by 3 PM.  Hence the joke about the 3-6-3 industry.  It wasn’t very sexy.  But it was reliable.  Few defaulted.  Because a new home owner had a lot to lose from day 1 thanks to that 20% down payment.

But there was a problem with this.  Home ownership was restricted to only those people who could afford to buy houses.  Those who could put down a 20% down payment.  And who had a job with sufficient income to qualify for a mortgage.  Well, you can see the problem with this.  What about the poor people who couldn’t come up with the 20% down payment nor had a job with sufficient income to qualify for a mortgage?

After World War II home ownership became a national goal.  Home ownership equaled economic growth.  It became the American dream (no longer was it the liberty that the Founding Fathers gave us).  As the years went by some saw that the poor were being left out.  Included in that long list of those who could not qualify for a mortgage were a lot of blacks.  Activists claimed that banks were redlining.  Disapproving a larger percentage of black applicants than white.  There were protests.  Investigations.  Banks had to figure out a way to qualify the unqualified and fast.  To prove that they weren’t being racist.

And the subprime mortgage was born.   Adjustable Interest Rate (ARM).  No documentation.  Zero down.  Interest only.  All kinds of creative financing to qualify the unqualified for mortgages.  And it was a hit.  Poor people liked them.  But banks were still reluctant to issue many of them.  Because they were far more risky than a conventional mortgage.  And it was dangerous to have too many of them on their books.  But then federal government solved that problem.

Fannie and Freddie enabled the Mortgage Lenders to Approve Risky Mortgages

Enter Fannie Mae and Freddie MacGovernment Sponsored Enterprises.  They would buy (or guarantee) those risky mortgages from the banks.  The banks breathed a huge sigh of relief.  Then started selling the crap out of subprime mortgages.  Because they were exposed to no risk thanks to Fannie and Freddie.  And the housing market took off.  The government urged Fannie and Freddie to lower their standards and buy even more risky mortgages.  To keep the housing boom alive.  And they did.  Not only were home owners snatching them up.  But speculators, too.  And the term ‘house flipping‘ entered the American lexicon.

Fannie and Freddie then repackaged the subprime mortgages they bought and resold them.  Into so-called ‘safe’ investments.  Thanks to being tied to a mortgage, historically one of the safest investments in America.  Well, they were when people were putting 20% down, at least.  So these mortgage back securities were created.  Reviewed by the credit-rating agencies.  And sold to investors, mutual funds, pension funds, 401(k)s, etc.  Who bought them with abandon.  Because they were rated AAA.  Long after those risky mortgages were written.

They were time bombs just waiting to go off.  Not because of the credit rating agencies.  But because of Fannie and Freddie.  Who enabled the mortgage lenders to approve risky mortgages with no risk to themselves.  And a long standing government policy to put as many people as possible into homes.  Because economic growth all came from home ownership.  And then it happened.  There was a housing bubble thanks to easy monetary policy.  The economy was heating up.  Worried about inflation, the Fed tapped the brakes.  Raised interest rates.  And all of those ARMs reset at higher rates.  People couldn’t afford the new higher monthly payments.  The higher interest rates left the speculators with lots of houses.  That they bought with no money down.  That no one was buying.  And, well, the rest you know.

The Greatest Threat to American Fiscal Solvency is the Government’s growing Health Care Tab 

So S&P didn’t cause the subprime mortgage crisis.  Whether they gave those securities AAA ratings or not those subprime mortgage holders were going to default anyway.  The origins of the subprime mortgage crisis reach a lot further back than S&P.  But their credibility did take a hit.  So they’re trying to be a little more cautious these days.  And if anyone paid attention during the debt ceiling debates, they know the country’s long-term finances are in some serious trouble.

Jeffrey Miron wrote a paper about the health of the U.S. states.  He starts in the introduction by going over the state of affairs in the federal government (see The Fiscal Health of U.S. States by Jeffrey Miron posted 8/15/2011 on Mercatus Center).

As the worldwide financial crisis has eased, economic policy debates have shifted from the short-term issue of stabilization to the log-term issue of fiscal imbalance.  Current projections suggests that the U.S. federal government faces an exploding ratio of debt to GDP, driven in large part by spending on health insurance1.  If this trend continues, the United States will soon find itself unable to roll over its debt and be force to default, generating a fiscal crisis.

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1  U.S. Congressional Budget Office, “CBO’s 2011 Long-Term Budget Outlook” (Washington, DC: CBO, June 2011)

Perhaps this is why S&P downgraded U.S. debt.  Because that debt ceiling deal did nothing to address the greatest threat to American fiscal solvency.  The government’s growing health care tab.  The nation indeed may be seeing some difficult times.  As will the states.

This paper offers five conclusions. First, state government finances are not on a stable path; if spending patterns continue to follow those of recent decades, the ratio of state debt to output will increase without bound. Second, the key driver of increasing state and local expenditures is health-care costs, especially Medicaid and subsidies for health-insurance exchanges under the Patient Protection and Affordable Care Act of 2009. Third, states have large implicit debts for unfunded pension liabilities, making their net debt positions substantially worse than official debt statistics indicate. Fourth, if spending trends continue and tax revenues remain near their historical levels relative to output, most states will reach dangerous ratios of debt to GDP within 20 to 30 years. Fifth, states differ in their degrees of fiscal imbalance, but the overriding fact is that all states face fiscal meltdown in the foreseeable future.

Not a pretty picture.  This whole European Socialism model is pushing both the states and the country to default.  Like it is currently pushing European nations toward default in the Eurozone.  Whose financial crisis is worst than America’s.  So far.

Keynesian Economics stimulated the Housing Market into the Granddaddy of all Housing Bubbles 

Social engineering.  Tax and spend liberalism.  Keynesian economics.   These are what gave us the subprime mortgage crisis.  Putting people into houses who couldn’t afford them.  And keeping interest rates artificially low to stimulate the housing market into the granddaddy of all housing bubbles.  The subprime mortgage crisis.  And more of the same will only push us further down the Eurozone road.  Sadly, a road often taken throughout history.  As once great nations fell, littering this road.  The Road to Serfdom.

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Debt Ceiling Deal Light on Cuts and Sets Stage for Future Taxes

Posted by PITHOCRATES - August 1st, 2011

$2.4 Trillion Debt Ceiling Deal may spend $96.68 for each Dollar Cut

Everyone seems to hate the budget deal to raise the debt ceiling.  Conservatives are saying they’ve been screwed.  Liberals are saying they’ve been screwed.  Interesting.  So exactly what did they agree to in order to hike the debt ceiling $2.4 trillion?  Which, incidentally, is the largest increase in history (see Small spending cuts to have little economic impact by Christopher S. Rugaber, Associated Press, posted 8/1/2011 on Yahoo! News).

Discretionary spending, which excludes Social Security, Medicare and Medicaid, would be cut by only $7 billion in 2012 and $3 billion in 2013, according a summary by Senate Democrats. That’s a tiny fraction of the nation’s $14 trillion economy…

The independent Congressional Budget Office offered its own analysis Monday. It said the agreement would reduce government spending by $25 billion next year. That’s compared to current law, which factors in a projected increase in spending.

The first phase of cuts would reduce spending by $917 billion over 10 years. A congressional committee would decide on a second phase of cuts totaling $1.5 trillion.

Whoever’s numbers you believe one thing is sure.  That’s not a lot of cuts.  The cuts are dwarfed by the amount of new spending the $2.4 trillion debt ceiling increase will give.  In fact, if you use the high $25 billion number, one could say these cuts are negligible.  For if they spend that $2.4 trillion next year, the cuts will only be 1.03% of the new spending.  Or an additional $96.68 spent for each dollar cut.  Now, granted, my math skills may be outdated, but I think if you spend more than you cut while you already have a $1.6 trillion deficit, I don’t think you’re going to reduce the deficit.  But that’s just me using arithmetic.

$7 Billion is a little shy of the $4 Trillion in cuts S&P said would prevent Credit Downgrade

And this is what was important.  Deficit reduction.  To stop spending money we don’t have.  So the debt doesn’t rise so high that it threatens the full faith and credit of the United States.  As S&P warned would happen if we don’t make some serious spending cuts (see FreedomWorks Opposes Budget Control Act of 2011 by Jacqueline Bodnar posted 8/1/2011 on FreedomWorks).

“The deal has few immediate cuts totaling one half of one percent of the budget, with most savings coming in the later part of the decade,” commented Matt Kibbe, President of FreedomWorks. “How can we be serious about reducing the debt limit when we are not even talking about cutting programs like AmeriCorps and agricultural subsidies? This is not the serious reform Tea Partiers demanded last November.”

Standard & Poor’s has stated that anything less than $4 trillion in cuts will lead to an inevitable downgrade from the United States’ current AAA credit rating. “The ‘Cut, Cap, Balance Act’ is the only option on the table that would preserve the nation’s AAA credit rating and secure our long-term economic future,” added Kibbe. “

So S&P will downgrade the full faith and credit of the United States despite this deal.  So it doesn’t appear that the Republicans got much for that additional $2.4 trillion of spending.  So it would appear that the Democrats screwed the Republicans.  But that sure isn’t how some see it.

Ruthlessly dictating Terms to the Opposition is Okay as long as Liberals are doing the Dictating

In fact, some are spitting mad (see The President Surrenders by Paul Krugman posted 7/31/2011 on The New York Times).

For the deal itself, given the available information, is a disaster, and not just for President Obama and his party. It will damage an already depressed economy; it will probably make America’s long-run deficit problem worse, not better; and most important, by demonstrating that raw extortion works and carries no political cost, it will take America a long way down the road to banana-republic status.

Come on, Paul, tell us how you really feel.

And then there are the reported terms of the deal, which amount to an abject surrender on the part of the president. First, there will be big spending cuts, with no increase in revenue. Then a panel will make recommendations for further deficit reduction — and if these recommendations aren’t accepted, there will be more spending cuts…

And even now, the Obama administration could have resorted to legal maneuvering to sidestep the debt ceiling, using any of several options. In ordinary circumstances, this might have been an extreme step. But faced with the reality of what is happening, namely raw extortion on the part of a party that, after all, only controls one house of Congress, it would have been totally justifiable…

In the long run, however, Democrats won’t be the only losers. What Republicans have just gotten away with calls our whole system of government into question. After all, how can American democracy work if whichever party is most prepared to be ruthless, to threaten the nation’s economic security, gets to dictate policy? And the answer is, maybe it can’t.

I don’t recall any such concern about the Democratic process that rammed Obamacare through the Congress along strictly party lines.  As bad as it is, the current deal was bipartisan.  Which is more than you can say about what Pelosi, Reid and Obama did with their health care bill.  Even the polls showed the people didn’t want it.  And many who voted for it paid the ultimate price at the next election. 

Apparently, ruthlessly dictating terms to the opposition is okay as long as liberals are doing the dictating.  In fact, liberals would be fine with doing away with the Democratic process if they held full power.  Let’s just hope they don’t resort to any legal maneuvering to make that happen.

The Sneaky Little Bastards are going to Escape those Spending Cuts and get their Tax Hikes

Liberals aren’t idiots.  They are very pragmatic.  And they’re liars and sneaks.  I think all this protesting is just smoke to make all the Tea Party Republicans think they’ve come out as winners in this deal.  Just take a closer look at the deal.  Negligible spending cuts up front.  A panel to determine future spending cuts (probably more heavily weighted on cuts that matter like out of control health care spending).  And a trigger for when that panel fails.  Which will make half of those future spending cuts come from defense.

And it gets better.  As this last round of negotiations has shown agreeing on spending cuts is next to impossible.  Even with the trigger those Medicare spending cuts are not likely to happen.  And with Obama just getting another $2.4 trillion to spend, that deficit isn’t going to get any smaller.  In fact, it’ll only get bigger.  Which means, of course, they will have no choice but to talk about revenue again (i.e., new taxes).  Say goodbye to the Bush tax cuts.  For they will let them expire next time.  Also, Obamacare kicks in after the 2012 election.  As do all those new taxes to pay for it.  More taxes upon more taxes.  Which is a lot of new taxes.

The sneaky little bastards are going to escape those spending cuts.  And get their tax hikes.  The Great Recession will linger on.  Or fall into full blown depression.  So it’s really clear who the winners and losers are in this debate.  The Ivy League liberal ruling elite are the winners.  And the American people are the losers.  As their country is transformed into a third world banana-republic.  Where the ruling elite at the top live very well.  And everyone else is poor and oppressed.  

Viva la Revolucion, El presidente.  Viva la Revolucion.

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