Entrepreneurs Fail not because they are Stupid but because of an Anti-Business Environment

Posted by PITHOCRATES - June 16th, 2013

Week in Review

The ‘capitalism’ we have today isn’t our Founding Father’s capitalism.  Yet critics of today’s ‘capitalism’ act as if it is.  And point to the inherent flaws of this ‘capitalism’.  As an excuse to bring in more governmental regulations to fix the problems of ‘capitalism’.  Which is the reason why today’s ‘capitalism’ isn’t capitalism.  It’s not the same economic system that made the United States the number one economic power in the world.  No.  It’s moved more towards European social democracy.  The system that gave the European nations their sovereign debt crises.  But those learned intellectuals speaking from their ivory towers still talk about fixing the problems of ‘capitalism’.  Without really understanding what the real problem is.  And it ain’t capitalism.  It’s the interference of capitalism and free markets.  This is the source of all our problems today.  And unless you address these problems you’re just wasting your time (see How to Reduce ‘Infant Entrepreneur Mortality’ by Sramana Mitra posted 6/10/2013 on the Harvard Business Review Blog).

Ever since the 2008 financial crisis, intellectuals have had to ask themselves, ‘Does Capitalism Still Work..?’

Two particular problems stand out. First, Capitalism has been hijacked by speculators. Second, the system enables amassing wealth at the tip of the pyramid, leaving most of society high and dry. Both problems have resulted in a highly unstable, volatile world order that jitters and shocks markets periodically, leaving financial carnage and mass scale human suffering.

The first problem with ‘capitalism’ today is that intellectuals are trying to fix it.  There isn’t anything wrong with capitalism.  The problems we have today have nothing to do with capitalism.  Because what we have today is state capitalism.  Crony capitalism.  European social democracy.  We have too much government in capitalism.  Who are favoring their big corporate friends in exchange for big corporate campaign donations.  And the only reason we have these speculators is because of the government.  Who is pumping so much cheap money into the economy for the speculators to speculate with.  And when their crony capitalist friends fail the government bails them out with tax dollars.  Because there is no downside to speculation when you have friends in government speculators will speculate.

People like to blame the banks and Wall Street for the subprime mortgage crisis.  But they didn’t create that crisis.  They just played their part.  The government created it.  By pumping cheap money into the economy to keep interest rates artificially low.  To encourage people to buy houses.  Even those who weren’t even considering buying a house.  Or those who simply couldn’t afford to buy a house.  These people changed their behavior based on the government’s manipulation of the interest rates.  As the government intended to do.  And they made everything worse with policies to encourage more and more home ownership.  The big one being Bill Clinton’s Policy Statement on Discrimination in Lending.  Where the government threatened lenders to lend to the unqualified or else.  So they did.  Using the subprime mortgage to qualify the unqualified.  And then the government-sponsored enterprises, Fannie May and Freddie Mac, bought those toxic subprime mortgages from these lenders, chopped and diced them into investments called collateralized debt obligations.  And sold them to unsuspecting investors as high-yield, low-risk investments.  Because they were backed by the safest investment of all time.  The home mortgage.  Only they didn’t tell these investors that these mortgages were toxic subprime mortgages being paid by people who couldn’t qualify for a conventional mortgage.  The safest investment of all time.  The conventional home mortgage.  So these lenders were able to clear these toxic mortgages off of their balance sheets.  Allowing them to issue more toxic subprime mortgages.  They were making money by writing these risky subprime mortgages.  But incurred no risk.  So they kept qualifying the unqualified for more and more mortgages.  Which was profitable.  Safe.  And kept the government off of their backs as threatened in Bill Clinton’s Policy Statement on Discrimination in Lending.

This isn’t capitalism.  This is government and their crony capitalist friends using their power, privilege and influence to game the system.  To enrich themselves.  This is what caused the mess we have today.  Where speculators and those in government get richer.  While Main Street America sees its median income fall.  And entrepreneurs struggle to stay in business.

Everybody talks about the role small businesses play in growing economies and creating jobs. However, as it stands, in America alone, 600,000 businesses die in the vine every year. This colossal infant entrepreneur mortality is a product of colossal levels of ignorance about how to build and sustain businesses.

And a myriad of governmental regulations, taxes and a litigious society.  Entrepreneurs today have to spend a lot of money and time protecting their money and time.  They need accountants and tax lawyers to help them comply with an ever growing regulatory environment.  And a boatload of insurances to keep the sharks at bay who all want a piece of their wealth and will sue if given the least opportunity.  It’s so complex that if they try to navigate their own way through these enormous burdens places on business they often make mistakes.  Or simply overlook something that they shouldn’t have.  Often times they just don’t charge enough to cover all of these costs they never expected when starting their businesses.  So when, say, a tax bill comes due they simply don’t have the cash on hand to pay it.  And then the downward death spiral begins.  This is why restaurants and construction companies are the number one and number two business to fail.  Where we have brilliant chefs and trades people who can cook or build something better than anyone else.  But are so out of their element when dealing with the business side of their trade.  The regulatory costs, taxes, insurance, etc.  And find they spend more of their time not doing what they love—cooking or building—but pushing paper through a labyrinth of red tape.  And often don’t find out they are not charging enough to cover all of the regulatory costs, taxes, insurance, etc., until it’s too late.

There is actually a method to the madness of entrepreneurship. And while the ‘character traits’ that support entrepreneurship — courage, tolerance for risk, resilience, persistence — cannot be taught, the method of building businesses can and should be taught.

In fact, it should be taught not just at elite institutions, but at every level of society, en masse.

If we can democratize the education and incubation of entrepreneurs on a global scale, I believe that it would not only check the infant entrepreneur mortality, it would create a much more stable economic system.

No.  That’s not the answer.  The reason why a lot of people remain employees instead of going into business themselves is that these people don’t want to deal with all the regulatory headaches their bosses have to deal with.  A tradesperson would rather work their 8-hour shift and go home.  They don’t want to deal with payroll taxes, workers’ compensation insurance, liability insurance, vehicular insurances, health insurance, real property taxes, personal property taxes, quarterly tax filings, business income tax, use tax, OSHA requirements, environmental requirements, city and state inspections, permits and licenses, etc.  If a tradesperson could just throw his or her tools in a truck and go into business they would.  But they can’t.  So they won’t.  Because it’s just so much easier being an employee than an employer.  Who are always guaranteed a paycheck if they work.  While an employer only gets paid after everyone, and everything, else gets paid.

You want to reduce infant entrepreneur mortality rates?  Get the government out of the private sector.  And give these entrepreneurs a chance.  You’d be surprised at what they can do if the government just leaves them alone.  Just like Andrew Carnegie, John Rockefeller, Henry Ford, etc., did.  Who probably couldn’t do what they did today.  Not in today’s anti-business environment.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , ,

Civilian Labor Force Participation Rate and Recessions 1950-Present

Posted by PITHOCRATES - April 9th, 2013

History 101

LBJ was able to pass JFK’s Tax Cuts resulting in a Long Period of Economic Growth

The official unemployment rate is stuck around 8%.  But if you count all the people who can’t find a full-time job the actual unemployment rate is closer to 14%.  With every jobs report we hear the positive spin from the government about another down tic in the official unemployment rate.  And the hundreds of thousands of new jobs created.  But after three years or so of hearing these reports people start questioning the numbers.  And the rosy spin.  Because despite all the good news they tell us people are disappearing from the civilian labor force.  Which is the only reason why the official unemployment rate is falling.  Because they’re not counting a lot of unemployed people.  So looking at the civilian labor force may be a better indicator of the health of the economy.  Or better yet, the civilian labor force participation rate (CLFPR).  Which is basically the percent of those who can work that are working.  So let’s do that.  Starting with the Fifties.

Labor Force Participation Rate and Recessions 1950 to 1959

After World War II veterans went to college on the G.I. Bill.  These new college graduates with degrees in science, engineering and business management entered the workforce in the Fifties.  Helping the United States to develop new technologies.  New industries.  And a lot of new jobs.  American wells were busy pumping domestic oil.  Keeping gasoline cheap.  Having escaped the damage of war the American economy exported to those countries that didn’t.  And consumer spending took off.  Thanks to the new advertising industry telling Americans about all the great things to buy.  They bought houses and cars with borrowed money.  And used the new credit card to spend even more money they didn’t have.  Changing the American economy into a consumer-based economy.  Making the Fifties one of the most prosperous times in U.S. history.  Despite the Korean War.  And the Cold War.  Which was getting underway in a big way.  There was a burst of inflation to help pay for the Korean War.  When it ended they contracted the money supply to get rid of that inflation sending the economy into recession.  But once the recession ended the economy took off with all that consumerism.  Shown by the sharp rise in the CLFPR.  To correspond with the very good economic times of the Fifties.  Another monetary contraction happened in 1957 to tamp out some price inflation.  With a corresponding fall in the CLFPR.

Labor Force Participation Rate and Recessions 1960 to 1969

The Sixties started with another recession.  After it ended, though, the CLFPR continued to fall.  The recession was officially over but the economy was not doing well.  The CLFPR fell for almost three years following the recession.  Things were different from the Fifties.  For one, a lot of those war-torn economies were up and running again.  Providing some competition.  Especially a little island nation by the name of Japan.  Which one day would build all the televisions sold in America.  It was because of this fall in economic activity that JFK started talking about tax cuts in 1963.  Congress blocked his attempt to cut tax rates.  But after his assassination LBJ was able to pass the Revenue Act of 1964.  This lowered the top marginal tax rate from 91% to 70%.  And lowered the corporate income tax from 52% to 48%.  Among other favorable business measures.  Resulting in a long period of economic growth.  And a long upward trend in the CLFPR.

The Tax Cuts and Deregulation of the Eighties created one of the Longest Periods of Economic Growth

But following the Revenue Act of 1964 came the Great Society.  The Vietnam War.  And the Apollo moon program.  All paid for with a huge surge in federal spending.  Deficits began to grow.   As the government struggled to pay for everything.  And were unwilling to cut anything.

Labor Force Participation Rate and Recessions 1969 to 1979

The economy fell into a mild recession in 1970.  The CLFPR remained relatively flat.  To meet their spending needs they started printing money.  Devaluing the dollar.  Still part of Bretton Woods the dollar was still pegged to gold at $35/ounce.  That is, the U.S. agreed to exchange gold for dollars at $35/ounce.  But as they devalued the dollar our trading partners no longer wanted to hold dollars.  Because they were losing their purchasing power.  They wanted the gold instead.  So they began exchanging their dollars for gold.  Causing a great outflow of gold from the U.S.  Causing a problem for President Nixon.  He didn’t want the U.S. to lose all of their gold reserves.  But he didn’t want to cut any spending.  Which meant he didn’t want to stop printing money.  In fact, he wanted to print more money.  And the easy way out of his dilemma was by doing the most irresponsible thing.  He slammed the gold window shut in 1971.  And refused to exchange gold for dollars anymore.  And when he did there was no restriction to the amount of money they could print.  And they printed it.  A lot.  Creating double-digit inflation before the Seventies were over.  The inflation caused prices to rise.  Which Nixon tried to prevent with wage and price controls.  Causing a shortage of available rental property as people converted them into condos to get away from the rent control.  Gasoline stations ran out of gas as people filled their tanks with below-market priced gas.  And meat disappeared from grocery stores.  Wage controls kept wages from keeping pace with inflation.  So even though people had jobs they lost more and more purchasing power.  Or simply found there was nothing to purchase.  Throwing the economy into recession in 1973.  After the recession the CLFPR grew throughout the remainder of the Seventies.  But it wasn’t good growth.  It was growth sustained with double-digit inflation.  A bubble of artificial economic activity.  That would have to crash.  As all inflationary periods must crash.

Labor Force Participation Rate and Recessions 1979 to 1989

In the Eighties Paul Volcker, Federal Reserve Chairman, raised interest rates to double digits to wring out the double-digit inflation from the economy.  To restore people’s purchasing power.  And return the nation to real economic growth.  The tax cuts and deregulation of the Eighties created one of the longest sustained periods of economic growth in U.S. history.  With one of the longest upward trends in the CLFPR ever.  Indicating a growing economy.  With more and more people who could work finding work.  Proving that Reaganomics worked.  And worked very well.

If JFK or Ronald Reagan were President Today we wouldn’t be seeing a Freefall of the CLFPR

But it wouldn’t last.  Thanks to the government’s interference into the banking industry.  They had set a maximum limit on interest rates S&Ls (and banks) could offer.  When inflation took off people pulled their money from their savings accounts.  Putting it in higher earning instruments.  So they didn’t lose their savings to inflation.   This bad banking policy begat more bad banking policy.  They deregulated the S&Ls and banks.  So they could do other things to make up for their lost savings business.  And that other thing was primarily real estate.  They borrowed short-term money to make long-term loans.  Helping to create a housing bubble.  And when they began to wring that inflation out of the economy interest rates rose.  When those short-term loans came due they had to refinance them at higher interest rates.  While the interest they were earning on those long-term loans remained the same.  So their interest expense soon exceeded their interest income.  Creating the savings and loan crisis.  And a severe recession that ended the economic expansion of the Eighties.  With a corresponding fall in the CLFPR.

Labor Force Participation Rate and Recessions 1990 to 2000

Once the recession ended the CLFPR resumed a general upward growth.  But not as good as it was in the Eighties.  Also, it would turn out that much of the growth in the Nineties was artificial.  Bill Clinton’s Policy Statement on Discrimination in Lending forced lenders to lower their lending requirements.  And to qualify the unqualified.  Which created a surge in subprime lending.  And the beginning of a housing bubble.  The Internet entered the economy in the Nineties.  Just as the personal computer entered the economy in the Eighties.  Making Bill Gates a very rich man.  Investors were anxious to find the next Bill Gates.  Taking advantage of those low interest rates creating that housing bubble. And poured money into dot-com start-ups.  Companies that had no revenues.  Or products to sell.  Creating a dot-com bubble.  And a surge in computer programming jobs.  Also, as the century came to a close there was the Y2K scare.  Creating another surge in computer programming jobs.  To rewrite computer code.  Changing 2-digit date codes (i.e., ’78) to 4-digit codes (i.e., 1978).

Labor Force Participation Rate and Recessions 2000 to 2013

The Y2K scare proved to be greatly overblown.  Which put a lot of computer programmers out of a job in January of 2000.  And they wouldn’t find a dot-com job for the dot-com bubble burst in the same year they lost their Y2K job.  Throwing the economy into recession in 2001.  And then making everything worse came the terrorist attacks on 9/11.  Prolonging the recession.  As can be seen by the long decline in the CLFPR.  Which leveled out after the Bush tax cuts.  But then that housing bubble peaked in 2006.  And burst in 2007 into the subprime mortgage crisis.  Thanks to all those toxic mortgages Bill Clinton’s Policy Statement on Discrimination in Lending forced lenders to make.  And because Fannie Mae and Freddie Mac bought these toxic mortgages and had Wall Street package them into collateralized debt obligations this crisis spread worldwide.  Selling what they told unsuspecting investors were high yield, low risk investments.  Because they were backed by the safest of all loans.  Mortgages.  What they failed to tell these investors was that these mortgages were not safe 30-year conventional mortgages.  But highly risky subprime mortgages.  In particular adjustable rate mortgages.  Where the monthly payment would increase with an increase in interest rates.  And that is what happened.  And when it happened the unqualified could not afford the new monthly payment.  And defaulted.  Kicking off the Great Recession.  And because President Obama was more interested in national health care than ending the Great Recession he didn’t cut taxes.  Or cut regulations.  Instead, he increased taxes and regulations.  Making the current recovery one of the worst in U.S. history.  As can be seen in the greatest decline in the CLFPR since the Great Depression.  If you look at a continuous graph from 1950 to the present you can see just how bad the Obama economic policies are.

Labor Force Participation Rate and Recessions 1950 to Present

The JFK and Reagan tax cuts caused the greatest economic expansions.  And the greatest rise in the CLFPR.  Also, after most recessions there was a return to a growing CLFPR.  Interestingly, the two times that didn’t happen are tied to Bill Clinton.  Who created two of the greatest bubbles.  The dot-com bubble in the Nineties.  And the subprime mortgage bubble that was built in the Nineties and the 2000s.  The growth was so artificial in building these bubbles that the CLFPR did not recover following the bursting of these bubbles.  It might have following the dot-com bubble if the subprime mortgage crisis didn’t follow so soon after.  The current recovery is so bad that it has taken the CLFPR back to levels we haven’t seen since the Seventies.  Making the current recovery far worse than the official unemployment rate suggests.  And far worse than the government is telling us.  So why are they not telling us the truth about the economy?  Because the government wants to raise taxes.  And if the economy is improving there is no need for recession-ending tax cuts.  So they say the economy is improving.  As they hate tax cuts that much.  Unlike Ronald Reagan.  Or JFK.  And if either of them were president today we wouldn’t be seeing a freefall of the CLFPR.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Banking, Lending Standards, Dot-Com, Subprime Mortgage and Bill Clinton’s Recessions

Posted by PITHOCRATES - March 19th, 2013

History 101

Lending more made Banks more Profitable as long as they Maintained Good Lending Standards

Money is a commodity.  And like any commodity the laws of supply and demand affect it.  If a lot of people want to borrow money interest rates rise.  This helps to make sure the people who want to borrow money the most can.  As they are willing to pay the higher interest rates.  While those who don’t want the money bad enough to pay the higher interest rates will let someone else borrow that money.  If few people want to borrow money interest rates fall.  To entice those people back into the credit markets who had decided not to borrow money when interest rates were higher.

Okay, but who is out there who wants people to borrow their money?  And why do they want this?  The key to any advanced civilization and the path to a higher standard of living is a good banking system.  Because if ordinary people can borrow money ordinary people can buy a house.  Or start a business.  Not just the rich.  For a good banking system allows a thriving middle class.  As people earn money they pay their bills.  And put a little away in the bank.  When a lot of people do this all of those little amounts add up to a large sum.  Which converts small change into capital.  Allowing us to build factories, automobiles, airplanes, cell towers, etc.  Giving us the modern world.  As banks are the intermediary between left over disposable cash and investment capital.

Banks are businesses.  They provide a service for a fee.  And they make their money by loaning money to people who want to borrow it.  The more money they lend the more money they make.  They pay people to use their deposits.  By paying interest to people who deposit their money with them.  They then loan this money at a higher interest rate.  The difference between what they pay to depositors and what they collect from borrowers pays their bills.  Covers bad loans.  And gives them a little profit.   Which can be a lot of profit if they do a lot of lending.  However, the more they lend the more loans can go bad.  So they have to be very careful in qualifying those they lend money to.  Making sure they will have the ability to pay their interest payments.  And repay the loan.

With the Federal Reserve keeping Interest Rates low Investors Borrowed Money and Poured it into the Dot-Coms

Just as a good banking system is necessary for an advanced civilization, a higher standard of living and a thriving middle class so is good lending standards necessary for a good banking system.  And when banks follow good lending standards economic growth is more real and less of a bubble.  For when money is too easy to borrow some people may borrow it to make unwise investments.  Or malinvestments as those in the Austrian school of economics call it.  Like buying an expensive car they don’t need.  A house bigger than their needs.  Building more houses than there are people to buy them.  Or investing in an unproven business in the hopes that it will be the next Microsoft.

America became the number one economic power in the world because of a good banking system that maintained good lending standards.  Which provided investment capital for wise and prudent investments.  Then the Keynesians in government changed that.  By giving us the Federal Reserve System.  America’s central bank.  And bad monetary policy.  The Keynesians believe in an active government intervening in the private economy.  That can manipulate interest rates to create artificial economic activity.  By keeping interest rates artificially low.  To make it easier for anyone to borrow money.  No matter their ability to repay it.  Or how poor the investment they plan to make.

The Internet entered our lives in the Nineties.  Shortly after Bill Gates became a billionaire with his Microsoft.  And investors were looking for the next tech geek billionaire.  Hoping to get in on the next Microsoft.  So they poured money into dot-com companies.  Companies that had no profits.  And nothing to sell.  And with the Federal Reserve keeping interest rates artificially low investors borrowed money and poured even more into these dot-coms.  Classic malinvestments.  The stock prices for these companies that had no profits or anything to sell soared.  As investors everywhere were betting that they had found the next Microsoft.  The surging stock market made the Federal Reserve chief, Alan Greenspan, nervous.  Such overvalued stocks were likely to fall.  And fall hard.  It wasn’t so much a question of ‘if’ but of ‘when’.  He tried to warn investors to cool their profit lust.  Warning them of their irrational exuberance.  But they didn’t listen.  And once that investment capital ran out the dot-com bubble burst.  Putting all those newly graduated computer programmers out of a job.  And everyone else in all of those dot-com businesses.  Causing a painful recession in 2000.

Based on the Labor Force Participation Rate we are in one of the Worse and Longest Recession in U.S. History

Encouraging malinvestments in dot-coms was not the only mismanagement Bill Clinton did in the Nineties.  For he also destroyed the banking system.  With his Policy Statement on Discrimination in Lending.  Where he fixed nonexistent discriminatory lending practices by forcing banks to abandon good lending standards.  And to qualify the unqualified.  Putting a lot of people into houses they could not afford.  Their weapon of choice for the destruction of good lending practices?  Subprime lending.  And pressure from the Clinton Justice Department.  Warning banks to approve more loans in poor areas or else.  So if they wanted to stay in business they had to start making risky loans.  But the government helped them.  By having Fannie Mae and Freddie Mac buying those risky, toxic loans from those banks.  Getting them off the banks’ balance sheets so they would make more toxic subprime loans.  And as they did Fannie Mae and Freddie Mac passed these mortgages on to Wall Street.  Who chopped and diced them into new investment vehicles.  The collateralized debt obligation (CDO).  High-yield but low-risk investments.  Because they were backed by the safest investment in the world.  A stream of mortgage payments.  Of course what they failed to tell investors was that these were not conventional mortgages with 20% down payments.  But toxic subprime mortgages where the borrowers put little if anything down.  Making it easy for them to walk away from these mortgages.  Which they did.  Giving us the subprime mortgage crisis.  And the Great Recession.

So Bill Clinton and his Keynesian cohorts caused some of the greatest economic damage this nation had ever seen.  For Keynesian policies don’t create real economic activity.  They only create bubbles.  And bubbles eventually burst.  As those highly inflated asset prices (stocks, houses, etc.) have to come back down from the stratosphere.  The higher they rise the farther they fall.   And the more painful the recession.  For this government intrusion into the private economy caused a lot of malinvestments.  A tragic misuse of investment capital.  Directing it into investments it wouldn’t have gone into had it not been for the government’s interference with market forces.  And when the bubble can no longer be kept aloft market forces reenter the picture and begin clearing away the damage of those malinvestments.  Getting rid of the irrational exuberance.  Resetting asset prices to their true market value.  And in the process eliminating hundreds of thousands of jobs.  Jobs the market would have created elsewhere had it not been for the Keynesian interference.  We can see the extent of the damage of these two Clinton recessions if we graph the growth of gross domestic product (GDP) along with the labor force participation rate (the percentage of those who are able to work who are actually working).  As can be seen here (see Percent change from preceding period and Employment Situation Archived News Releases):

Labor Force Participation Rate and GDP Growth

The first Clinton recession caused a decline in the labor force participation rate (LFPR) that didn’t level out until after 2004.  Even though there were not two consecutive quarters of negative GDP growth during this time.  Usually what it takes to call an economic slump a recession.  But the falling LFPR clearly showed very bad economic times.  That began with the dot-com bubble bursting.  And was made worse after the terrorist attacks on 9/11.  Eventually George W. Bush pulled us out of that recession with tax cuts.  The much maligned Bush tax cuts.  Which not only caused a return to positive GDP growth.  But it arrested the decline of the LFPR.  But the good times did not last.  For the second Clinton recession was just around the corner.  The subprime mortgage crisis.  Created with President Clinton’s Policy Statement on Discrimination in Lending.  That unleashed real economic woe.  Woe so bad we call it the Great Recession.  The little brother of the Great Depression.

This recession not only had two consecutive quarters of negative GDP growth but five of six consecutive quarters showed negative growth.  And one of those quarters nearly reached a negative ten percent.  Which is when a recession becomes a depression.  This recession was so long and so painful because those artificially low interest rates and the pressure on bankers to lower their lending standards created a huge housing bubble.  Pushing housing prices so high that when the housing bubble burst those prices had a very long way to fall.  Worse, President Obama kept to the Keynesian policies that caused the recession.  Trying to spend the economy out of recession.  Instead of cutting taxes.  Like George W. Bush did to pull the economy out of the first Clinton recession.  Worse, anti-business policies and regulations stifled any recovery.  And then there was Obamacare.  The great job killer.  Which he helped pass into law instead of trying to end the Great Recession.  GDP growth eventually returned to positive growth.  And the official unemployment fell.  A little.  But the president’s policies did nothing to reverse one of the greatest declines in the LFPR.  More people than ever have disappeared from the labor force.  That will take a lot of time and a lot of new, real economic activity to bring them back into the labor force.  And no matter what the current GDP growth rate or the official unemployment rate are it doesn’t change the reality of the economy.  Based on the LFPR it is in one of the worse and longest recession in U.S. history.  And the worse recovery since the Great Depression.  Because of President Obama’s embrace of Keynesian policies.  Which do more to increase the size of government than help the economy.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

The Great Housing Bubble and The Subprime Mortgage Crisis

Posted by PITHOCRATES - December 27th, 2011

History 101

Putting People into Houses trumped Sound Monetary Policy, a Sound Currency and good Lending Practices

Housing has for a long time been the key to economic prosperity.  Because to build a house you need a lot of economic activity.  Industries produce lumber, concrete, sheetrock, brick, shingles, door frames, doors, windows, glass, flooring, plumbing pipes, plumbing fixtures, sump pumps, furnaces, heating ducts, insulation, air conditioners, electrical wiring and fixtures, carpeting, tile, linoleum, etc.  The bigger the house the more of this stuff there is.  Once built people have to buy them (stimulating the mortgage banking industry) and then furnish them.  This triggers a monsoon of economic activity.  Drapes, shades, blinds, paint, washers, dryers, stoves, refrigerators, freezers, microwave ovens, toasters, blenders, food processers, plates, dishes, knives, silverware, ceiling fans, televisions, home theaters, sound systems, computers, cable and internet services, utilities, shelving, furniture, beds, cribs, art, etc.  And, of course, the exterior of the house creates further economic activity.

This is why one of the most important economic indicators is new housing starts.  For each new house we build we create a whirlwind of economic activity.  So much that it boggles the mind trying to think about it.  That’s why governments do whatever they can to stimulate this particular economic activity.  They encourage borrowing by allowing us to deduct the interest we pay on our mortgages.  They use monetary policy to keep interest rates as low as possible.  They’ve created federal programs to help veterans.  To help low income people.  And to remove risk from lenders to encourage more risky lending (as in Fannie Mae and Freddie Mac).  They’ve even used the power of government to force mortgage lenders to qualify the unqualified (Policy Statement on Discrimination in Lending).

You see, putting people into houses trumped everything else.  Sound monetary policy.  A sound currency.  Good lending practices.  Everything.  Because that was the key to a healthy economy.  A happy constituent.  And healthy tax revenue.  Not to mention you can score a lot of points with the poor and minorities by helping them into houses they can’t afford.  So this coordinated effort to put people into houses did two things.  Made money cheap and easy to borrow.  And created a boom in new housing starts.  Which resulted in a third thing.  A housing bubble.

Subprime Mortgages were for those who didn’t have Good Credit or Stable Employment with Reliable Income

Builders couldn’t build enough houses.  People were buying them faster than they built them.  And the houses they bought were getting bigger and bigger.  As they qualified for ever larger mortgages.  Poor people and people with bad credit could walk into a bank and get approved without documenting income.  House flippers could walk in day after day and get loans to buy houses.  Fix them up.  And put them back on the market.  Without using any of their own money. The market was soon flooded with new McMansions.  And refurbished smaller homes that people were moving out of.  Demand for homes was high.  And interest rates were low.  So the supply of homes swelled.  As did home prices.

Interest rates were low.  But they didn’t stay low.  All this coordinated effort to put as many people into homes as possible created a lot of artificial demand.  Heating up the economy.  Increasing prices higher than they had been.  Leading to inflationary worries.  So the Federal Reserve began to raise interest rates.  To temper that inflation.  Which didn’t sit well with those low income house owners.  Who got into their homes with the help of the Policy Statement on Discrimination in Lending.  Which forced lenders to get creative in qualifying the unqualified.  To avoid undo federal attention.  And legal actions against them.  So a lot of poor people had subprime mortgages.  As did all of those house flippers.  People who used little of their own money.  Who put little down.  And had little to lose.

What is a subprime mortgage?  In a word, risky.  It isn’t a 30-year fixed-rate mortgage at a good interest rate.  No, for those you need a good credit score and years of stable employment with reliable income.  And enough money saved up to put close to 20% down.  Subprime mortgages were for those who didn’t have a good credit score.  Years of stable employment with reliable income.  Or any savings.  These people didn’t get the ‘prime’ mortgages.  They got the expensive ones.  The ones with the higher interest rates.  And the higher monthly payments.  Why?  Because risk determined the interest rate.  And the higher the risk the higher the interest rate.

In their Effort to sustain Economic Activity the Government caused the Worst Recession since the Great Depression

But this posed a problem.  Because of the Policy Statement on Discrimination in Lending.  Making loans available to the unqualified was no good if the unqualified couldn’t afford them.  Enter the adjustable rate mortgage (ARM).  These mortgages had lower interest rates.  And lower monthly payments.  How you ask?  By making them adjustable.  A fixed-rate mortgage has to account for inflation.  And adjustable-rate mortgage doesn’t.  Because if there is inflation and the interest rates go up the ARM resets to a higher value.  Which is what happened right about the time housing prices peaked.

When the ARMs reset a lot of people couldn’t make their monthly payments anymore.  Having put little down and having made few monthly payments, these homeowners had little to lose by walking away from their homes.  And a lot of them did.  Including those house flippers.  And that was just the beginning.  With higher interest rates the new home market contracted.  Those artificially high house prices began to fall.  And when the ARMs reset they caused an avalanche of defaults and foreclosures.  The market was correcting.  There were far more houses for sale than there were buyers looking to buy.  Home values began to fall to reflect this real demand.  People who bought the biggest house they could afford because they thought real estate prices always went up soon discovered that wasn’t true.  People were making monthly payments on a mortgage that was greater than the value of their house.  Some walked away.  Some got out with short sales.  Where the lender agreed to eat the loss equity.

The housing market was imploding.  Thanks to a great real estate bubble created by the government.  In their quest to put as many people into houses as possible.  By making mortgages cheap and easy to get.  Relaxing lending standards.  And encouraging risky lending.  None of which would have happened had they left the housing market to market forces.  Where the market sets interest rates.  And housing prices.  The irony of the subprime mortgage crisis is that in their effort to sustain economic activity the government caused the worst recession since the Great Depression.  The Great Recession.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

The Subprime Mortgage Crisis and Great Recession was caused by Bill Clinton and Fannie Mae and Freddie Mac

Posted by PITHOCRATES - December 18th, 2011

Week in Review

The Securities and Exchange Commission (SEC) has filed civil fraud charges against Fannie Mae and Freddie Mac for their part in the subprime mortgage crisis.  The charges say they misled investors about their subprime mortgage risk exposure (see SEC charges ex-Fannie, Freddie CEOs with fraud by Derek Kravitz, Associated Press, posted 12/16/2011 on The Washington Times).

According to the lawsuit, Fannie told investors in 2007 that it had roughly $4.8 billion worth of subprime loans on its books, or just 0.2 percent of its portfolio. The SEC says that Fannie actually had about $43 billion worth of products targeted to borrowers with weak credit, or 11 percent of its holdings…

Freddie told investors in 2006 that it held between $2 billion and $6 billion of subprime mortgages on its books. The SEC says its holdings were actually closer to $141 billion, or 10 percent of its portfolio in 2006, and $244 billion, or 14 percent, by 2008.

In a May 2007 speech in New York, Syron said Freddie had “basically no subprime exposure,” according to the suit.

Not 0.2% but 11%.  Not 0% but 10-14%.  This is some serious misrepresentation of the subprime mortgage risk exposure.  It goes from virtually no risk to a risk great enough to cause, well, a Great Recession.

Fannie and Freddie buy home loans from banks and other lenders, package them into bonds with a guarantee against default and then sell them to investors around the world…

Fannie and Freddie had traditionally purchased a small number of subprime mortgage loans, which involved borrowers with credit problems who could not qualify for cheaper prime loans. But starting in the late 1990s many firms started purchasing subprime loans, and Fannie and Freddie followed suit.

Yes, the late 1990s.  Just after the Clinton White House began pressuring lenders to qualify more unqualified borrowers.  In their Policy Statement on Discrimination in Lending.  As noted in a previous post.

Wall Street isn’t to blame for the subprime mortgage crisis.  Bill Clinton started it with his Policy Statement on Discrimination in Lending.  And then Fannie and Freddie bought these high risk mortgages and sold them as safe investments.  If anyone is to blame for the Great Recession it’s government.  And the government sponsored enterprises Fannie and Freddie.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , ,

Bill Clinton created the Subprime Mortgage Crisis with his Policy Statement on Discrimination in Lending

Posted by PITHOCRATES - November 6th, 2011

Week in Review

The proof is in the pudding.  And that pudding is the Federal Register.  Or as some would say the smoking gun in the subprime mortgage crisis (see Smoking-Gun Document Ties Policy To Housing Crisis by PAUL SPERRY posted 10/31/2011 on Investors.com).

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 threat was codified in a 20-page “Policy Statement on Discrimination in Lending” and entered into the Federal Register on April 15, 1994, by the Interagency Task Force on Fair Lending. Clinton set up the little-known body to coordinate an unprecedented crackdown on alleged bank redlining.

The edict — completely overlooked by the Financial Crisis Inquiry Commission and the mainstream media — was signed by then-HUD Secretary Henry Cisneros, Attorney General Janet Reno, Comptroller of the Currency Eugene Ludwig and Federal Reserve Chairman Alan Greenspan, along with the heads of six other financial regulatory agencies.

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

So this is where it all started.  In 1994.  When the government pressured lenders to qualify the unqualified.  To put people into houses they couldn’t afford.  Or else.

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.

It took private analysts, as well as at least one FDIC economist, little time to determine the Boston Fed study was terminally flawed. In addition to finding embarrassing mistakes in the data, they concluded that more relevant measures of a borrower’s credit history — such as past delinquencies and whether the borrower met lenders credit standards — explained the gap in lending between whites and blacks, who on average had poorer credit and higher defaults.

The study did not take into account a host of other relevant data factoring into denials, including applicants’ net worth, debt burden and employment record. Other variables, such as the size of down payments and the amount of the loans sought to the value of the property being bought, also were left out of the analysis. It also failed to consider whether the borrower submitted information that could not be verified, the presence of a cosigner and even the loan amount.

When these missing data were factored in, it became clear that the rejection rates were based on legitimate business decisions, not racism.

Still, the study was used to support a wholesale abandonment of traditional underwriting standards — the root cause of the mortgage crisis.

So there was no racism.  No redlining.  Just good mortgage lending practices.  But good mortgage lending practices don’t buy you votes.  Or get you kickbacks from mortgage lenders.

Confronted with the combined force of 10 federal regulators, lenders naturally toed the line, and were soon aggressively marketing subprime mortgages in urban areas. The marching orders threw such a scare into the industry that the American Bankers Association issued a “fair-lending tool kit” to every member. The Mortgage Bankers Association of America signed a “fair-lending” contract with HUD. So did Countrywide.

HUD also pushed Fannie and Freddie, which in effect set industry underwriting standards, to buy subprime mortgages, freeing lenders to originate even more high-risk loans.

So how do you qualify the unqualified and avoid the wrath of the federal government?  That’s easy.  You create the subprime mortgage market.  And then you get Fannie Mae and Freddie Mac to buy these toxic mortgages and pass them on to unsuspecting investors.  Freeing up the mortgage lenders to make more bad loans.  And putting the world on a course to financial calamity.

All in a day’s work for an activist, corrupt, Big Government.

Clinton’s task force survived the Bush administration, during which it produced fair-lending brochures in Spanish for immigrant home-loan applicants.

And it’s still alive today. Obama is building on the fair-lending infrastructure Clinton put in place.

As IBD first reported in July, Attorney General Eric Holder has launched a witch hunt vs. “racist” banks.

“It’s a more aggressive fair-lending enforcement approach now,” said Washington lawyer Andrew Sandler of Buckley Sandler LLP in a recent interview. “It is well beyond anything we saw during the Clinton administration.”

Guess we haven’t learned the lessons of the subprime mortgage crisis.  Or we have and just don’t care.  Because buying votes and getting kickbacks from mortgage lenders is more important than preventing another subprime mortgage crisis.

All of this, of course, means that Wall Street didn’t cause the mess we’re in now.  Bill Clinton did.  And his racist lending policies.  To correct for a racism in mortgage lending that wasn’t there.  By qualifying the unqualified.  And putting them into houses they couldn’t afford.  Which the Obama administration appears to be doubling down on.

Boy.  I’d hate to be in our shoes.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , ,