The Qualified Mortgage Rule to restore Good Lending Practices destroyed by Government

Posted by PITHOCRATES - October 26th, 2013

Week in Review

Fannie Mae and Freddie Mac were largely responsible for the subprime mortgage crisis.  Because they removed risk from lenders, allowing them to sell more risky mortgages.  Something lenders wouldn’t have done if they had to carry the risk of these loans.  But once they could sell those risky loans to Fannie Mae and Freddie Mac what did they care?  So they earned their money with loan origination fees.  Not by servicing these loans.  As had been the tradition in the lending industry until the government intervened to stimulate the housing market.  Which they did.  By putting people who couldn’t afford houses into houses.  Giving us the subprime mortgage crisis.

Fannie and Freddie are still active.  In particular helping rich people who can take advantage of the Federal Reserve’s quantitative easing.  Who are the only people doing well as median household income falls in the worst economic recovery since that following the Great Depression (see US extends backing for higher-priced mortgages by Diana Olick posted 10/24/2013 on CNBC).

Federal regulators will allow Fannie Mae and Freddie Mac to continue funding higher-priced mortgages, at least through the middle of next year. President Barack Obama had called on the Federal Housing Finance Agency, the conservator of the two mortgage giants since September 2008, to lower the limits by the end of this year in order to shrink their role in the market. FHFA acting director Ed DeMarco, however, said the timing is not right just yet.

“We are not making a change there in the immediate term,” DeMarco told reporters. “I recognize and understand that the industry is very busy right now making implementation of other regulations that take effect the first of next year, and that’s enough.”

DeMarco is referring to new mortgage regulations from the Consumer Financial Protection Bureau, requiring lenders to prove a borrower has the ability to repay a loan. The so-called “Qualified Mortgage rule,” goes into effect Jan. 1, and lenders are scrambling to make sure they will be in compliance with all its requirements.

The Qualified Mortgage rule?  You know what we used to have before we had to have the Qualified Mortgage rule?  Good lending practices.  Where lenders carried their loans on their balance sheets.  And serviced those loans.  Holding on to all the risk from their lending decisions.  Which prevented them from making loans to unqualified applicants.  The way a good banking system should operate.  The way it was before the government destroyed it with their manipulation of interest rates.

Now the government wants to do what it was doing before the subprime mortgage crisis.  Putting as many people into homes who can’t afford them.  Only this time they’ve added a law to prevent lenders from qualifying the unqualified.  Even while the government is pressuring them to do so.  Just like Bill Clinton did with his Policy Statement on Discrimination in Lending that kicked off subprime lending in earnest to qualify the unqualified.  Because the Clinton administration called any denials of loans to the poor/minorities as discriminatory lending practices.  Of course, back then lenders had only good lending practices to hang their hat on.  Now they have a law to use to defend themselves against charges of discriminatory lending practices.  Which basically takes the lending industry back to where it was before the government destroyed it and gave us the subprime mortgage crisis.  Things would have been a whole lot easier and less costly if the government had just stayed out of it in the first place.

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The Left still attacks Free Market Capitalism and the Invisible Hand despite the Left’s Record of Economic Failure

Posted by PITHOCRATES - April 14th, 2012

Week in Review

No matter how many times their policies fail those on the left never give up.  The free market capitalism that gave us the Industrial Revolution was not as good as the mercantilism it replaced.  The free market capitalism that won World War II was not as good as Nazi Germany’s National Socialism.  The free market capitalism that won the Cold War was not as good as the Soviet Union’s communism.   No, any economic system that doesn’t place smart people in the government (and from our most prestigious universities) in charge is an inferior economic system.  At least, according to those on the Left (see There Is No Invisible Hand by Jonathan Schlefer posted 4/10/2012 on the Harvard Business Review).

One of the best-kept secrets in economics is that there is no case for the invisible hand. After more than a century trying to prove the opposite, economic theorists investigating the matter finally concluded in the 1970s that there is no reason to believe markets are led, as if by an invisible hand, to an optimal equilibrium — or any equilibrium at all. But the message never got through to their supposedly practical colleagues who so eagerly push advice about almost anything. Most never even heard what the theorists said, or else resolutely ignored it.

Interesting.  Using the economists of the Seventies as the authoritative position for government interventionism into the economy.  Why, that would be like having the captain of the Titanic being the authority on how to miss icebergs in the North Atlantic. 

The Seventies were the heyday of Keynesian economics.  Where the government was aggressively intervening into things economic.  And the results of their policies were so bad that we had to create new words to describe it.  Like stagflation.  A heretofore unheard of phenomenon.  And something that just wasn’t supposed to happen when the Keynesians used inflation to lower unemployment.  But it did.  Even though you weren’t supposed to get inflation and high unemployment at the same time.  Stagflation.  Like we did.  In the Seventies.

Believing far too credulously in an invisible hand, the Federal Reserve failed to see the subprime crisis coming. The principal models it used literally assumed that markets are always in instantaneous equilibrium, so how could a crisis occur? But after the crisis exploded, the Fed dropped its high-tech invisible-hand models and responded with full force to support the economy.

The subprime mortgage crisis was a government-made crisis.  Precisely because government refused to allow the Invisible Hand to guide the market place.  Instead they stepped in.  Forced lenders to make risky subprime loans to people who couldn’t qualify for a mortgage.  With tools like the infamous Adjustable Rate Mortgage (ARM).  And then they had Fannie Mae and Freddie Mac buy those risky mortgages.  To get them off the lenders’ balance sheets so they would make more risky loans.  Then Freddie and Fannie chopped up these risky loans and repackaged them into ‘safe’ investments to unload them to unsuspecting investors.  Getting these toxic mortgages off of their balance sheets.  (In case you don’t know, Fannie and Freddie are Government Sponsored Enterprises (GSE).  Which are for all intents and purposes the government.)  This house of cards imploded when the Fed raised interest rates.  After keeping them below what the Invisible Hand would have set them at for far too long.  The government created the real estate bubble.  Then blew it up when those higher interest rates reset all the AMR mortgage payments beyond the homeowner’s ability to pay.

There are many economists in the world.  And the consensus of economic thought tends to be one that supports large government intervention.  Which proves the economic consensus is wrong.  For if history supported this consensus the Soviet Union would have won the Cold War.  East Germany would have absorbed West Germany.  China would not be experimenting in ‘Invisible Hand’ capitalism.  And Cuba wouldn’t be experimenting with a little capitalism themselves to fix their broken government command economy.

All these market failures economists like to point to aren’t market failures.  They are the unintended consequences of government intervention into the market.  As the subprime mortgage crisis clearly proved.  Which never would have happened in the first place if the government didn’t try to be smarter than the Invisible Hand.

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LESSONS LEARNED #87: “In a democracy you hold the keys to the treasury. So be careful of what you ask for.” -Old Pithy

Posted by PITHOCRATES - October 13th, 2011

Keynesian Spending gave us Double Digit Interests Rates, Double Digit Inflation Rates and Stagflation

LBJ was going to end poverty.  He declared war on it.  His soldiers?  Dollars.  Lots of them.  His battle plan?  The Great Society.  Tactics?  Just throw lots of money at a problem.  Hope that some of it actually hit its target.  And further hope that some of the money that did hit its target actually did something beneficial.  Just hope for the best.

And thus grew the welfare state.  The recipients liked it.  Because they were the recipients.  Government liked it.  Because the recipients liked it.  Who voted for them out of gratitude.  And dependency.  And the Keynesian economists liked it.  Because government spending was stimulus.  And they love stimulus.  These Keynesian economists.  So everybody kept asking for more.  As no one saw the harm in printing money to make people feel good.

The Keynesian said this was proof that a manageable amount of continuous inflation (printing money) would do away with the business cycle.  The boom and bust that had recurring good times.  And recurring recessions.  They said let’s just have a continuous boom.  When real demand fell just create artificial demand by having the government step in.  Let the government stimulate demand by printing money to spend.  And they did.  GDP went up.  Thus proving their theory.  Or so they thought.  Until they realized printing all that money had so weakened the dollar that interests rates soared.  To double digits.  As did prices.  Giving us double digit inflation rates.  And stagflation.  That’s why the economy sucked in the Seventies.  And why Jimmy Carter was a one term president.

Bad Monetary Policy gave us Cheap Money, the Housing Bubble and the Subprime Mortgage Crisis

After the dot-com bubble burst the economy went into recession.  So the government went to their patented recession cure-all.  Monetary policy.  Playing with interest rates.  I.e., printing money.  Because housing sales have always been the key to a growing economy.  Because building a house generates a lot of economic activity.  And furnishing a house generates even more economic activity.  So the best way to kick-start the economy was to get more people into houses.  The more the better.  Whether they could afford to or not.  Because no matter what happens, people always pay their mortgage.

So the government kept interest rates low.  Artificially low.  To encourage people to borrow money.  To buy housees.  And they did.  But not enough of them did.  Poor people weren’t buying.  Mortgage bankers were turning them down.  Because they couldn’t qualify for a mortgage.  So the government pressured them to approve people even if they didn’t qualify.  Fannie Mae and Freddie Mac guaranteed these risky mortgages.  Then bought them.  It worked.  Thanks to ARMs and no-doc mortgages, anyone could walk in off the street and get a cheap mortgage with little down.  The people liked it.  And asked for more.  Thus began the housing boom.

People were buying and selling houses like there was no tomorrow.  Investors were flipping homes.  People were moving up into McMansions.  Bidding the price of houses into the stratosphere.  Paying whatever the price was.  Because the money was so cheap to borrow.  Artificially low.  Which really inflated the price of these houses.  To unsustainable levels.  Until the bubble burst.  And these prices began to correct to reflect reality.  The Fed, waking up the next morning in a stupor, saw what they had done.  And desperately tried to fix things.  To limit the damage.  They raised interest rates.  ARMs reset.  And the great Subprime Mortgage Crisis began.  And thanks to Fannie and Freddie buying those risky mortgages, the contagion spread around the world.  To everyone who bought what they thought were safe investments backed by safe mortgages.  Because people always paid their mortgages.   But were, in fact, backed by the riskiest of all investments.  Defaulting subprime mortgages.

The Social Democracies’ Spending gave European Countries Staggering Debt and a Sovereign Debt Crisis

Karl Marx was a German.  But his theories quickly swept across the Rhine.  Soon there were communists everywhere in the West.    After World II, when communism became the new enemy, Western Europe favored something called social democracies.  Communism-light.  The social welfare state.  Cradle to the grave nanny state.  With generous state benefits.  National health care.  Pensions.  You name it.  And the state gave it.

People liked it.  Asked for more.  And their governments were glad to oblige.  They spent more and more money.  Rather, they spent more and more of the taxpayers’ money.  These social democracies had some of the highest tax rates.  Which was fine with the poor receiving these generous state benefits.  But it explains why anti-capitalists like John Lennon and Bono moved out of the UK.  To escape the high taxes on the wealth they created with free market capitalism.  So there was a capital flight out of these social democracies.  While at the same time their public sectors grew.  More and more people worked for the government.  Received government pay and benefits.  And generous pensions.  The people liked this.  And asked for more.  Except Lennon and Bono, of course.  And the other superrich who fled these social democracies.

As tax rates climb and capital flees, though, economic activity stagnates.  Which forces these countries to borrow.  And borrow some of them did.  Some of the smaller countries in the Eurozone (Greece) are so in debt that they can’t even roll over their existing debt.  They are in such a mess that no one wants to take a chance loaning them money.  Because no one thinks Greece will ever be able to repay whatever they borrow.  Of course, with the common currency (Euro), Greece’s problems are everyone’s problems.  So the richer countries in the Eurozone (Germany) are pouring money into the ECB to try and rescue Greece.  And save the Euro.  What we call the European sovereign debt crisis.  While the world waits with bated breath.  Because if they fail it could very well plunge the world into another severe recession.  Or worse.  Because the world needs the Eurozone.  To buy their exports.  So they can prop up their own sick economies.

Class Warfare pits the Rich against the Poor and Middle Class, the Taxpayers against the Public Sector

Many, if not all, of the great crises countries have…are…going through is because of bad monetary policy.  Using the power of the purse to make happy voters.  Whatever the cost.  For they were always sure they could avoid paying this cost.  That they could always keep pushing this cost off onto a future generation.  But the spending grew too great.  The debt grew too high.  And, before they knew it, that future generation was here.  And it’s us.

The people grew fat and lazy on these generous benefits.  And they never worried about the cost.  Because the cost was always someone else’s problem.  Until now.  Not only are they losing some of these generous benefits.  But they now have to pay for some of them.  The cost being so great that everyone has to pay their ‘fair’ share.  Which was fair when ‘everyone’ didn’t include them.  But it now includes them.  And they don’t like it one bit.  So they’ve taken to the streets throughout Europe.  Rioting here.  Protesting there.  And demanding that the rich (anyone who is not them) pay more in taxes so they can continue to live the good life.  All funded courtesy of the taxpayers.  Who aren’t.  Living the good life.

So class warfare escalates.  Pitting the rich against the poor and middle class.  And the taxpayers against the public sector.  Placing these countries on the brink of anarchy.  All because the people learned that they could vote themselves money.  And did.  They got everything they asked for.  Including something they didn’t bargain for.  The destruction of their countries.

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Keynesian Policies gave us the Subprime Mortgage Crisis, Solyndra and Inflation while the Free Market gives us Jobs

Posted by PITHOCRATES - September 30th, 2011

The Problem with Washington is that there are too many Elitists who Think they are Smarter than Us

Now we know why we have slow economic growth.  Apparently it’s par for the course after a financial crisis (see Phony Fear Factor by Paul Krugman, Keynesian Economist, posted 9/29/2011 on The New York Times).

We might add that major financial crises are almost always followed by a period of slow growth, and U.S. experience is more or less what you should have expected given the severity of the 2008 shock.

So why do any spending?  Why have any stimulus to stimulate growth that won’t come.  Because “major financial crises are almost always followed by a period of slow growth…”  If true then we could have gotten here without that $800 billion stimulus bill.  And we could have avoided that debt ceiling debate.  And the subsequent downgrading of U.S. sovereign debt.  All because we were spending money trying to alter slow growth that was going to happen anyway.

But the Keynesian will say, “Just think how bad things would have been if we didn’t spend that $800 billion.  And how better things would be if we had just spent more.”  How do you argue with that?  When spending fails it’s because we didn’t spend enough.    By this logic, then, spending as a policy can never fail.  Even when it fails.

If slow growth is more or less what you get were they then lying?  When they said they would keep the unemployment rate below 8%?  If Congress passed the stimulus bill?  Or did they just not understand how bad things were?  Because their understanding of economics is that bad?  Or was George W. Bush so much smarter than them that he was able to hide how bad things were?

And it also, of course, reflects the political need of the right to make everything bad in America President Obama’s fault. Never mind the fact that the housing bubble, the debt explosion and the financial crisis took place on the watch of a conservative, free-market-praising president; it’s that Democrat in the White House now who gets the blame.

But good politics can be very bad policy. The truth is that we’re in this mess because we had too little regulation, not too much. And now one of our two major parties is determined to double down on the mistakes that caused the disaster.

Who was it that pushed subprime lending to get people who couldn’t afford a house into a house?  Whose policies were those that made home ownership available to everyone, not just those with good-paying jobs that could pay their mortgage payments?  Who was it that brought suits and protests against lenders for ‘redlining’ poor and minority communities by not approving mortgages for those who could not qualify for a mortgage?  The Republicans?  The so-called servants of the wealthy?  Or the Democrats?  The so-called champion of the poor and disenfranchised?

Buying risky mortgages from banks allowed banks to make risky loans.  And who was buying those risky mortgages?  Fannie Mae and Freddie Mac.  That was government policy.  Keynesian policy.  Keeping interest rates low and removing risks from the normal risk takers in the mortgage industry.  There could not have been a Subprime Mortgage Crisis without these Keynesian government policies in place.  And we know that conservative Republicans aren’t Keynesians.  That’s why Keynesians hate conservative Republicans.  Especially when they hold up further stimulus spending in Congress.

The problem with Washington is that there are too many elitists who think they are smarter than us.  And these elitists want to double down on the mistakes that caused this crisis.  Already the Obama administration has been talking about boosting subprime lending.  Incredible.  This after that very same policy caused the worst recession since the Great Depression.

After the Benefit of a Cheap Euro runs its Course the Depreciated Euro turns into a Liability

The Keynesian’s answer to everything is more spending.  And when someone warns about igniting inflation with all of their easy monetary policy they call those people misinformed.  Monetary policy doesn’t cause inflation.  Greedy business people do.  By raising prices.  And supply shocks.  Like the OPEC oil embargo of the Seventies.  They point to the Eurozone and say, “See?  Their central banks have been keeping rates low to stimulate spending.  And where is the inflation?”  Here, apparently (see Euro-Zone Inflation Surges by Paul Hannon, Dow Jones Newswires, posted 9/30/2011 on NASDAQ).

The annual rate of inflation in the 17 countries that share the euro surged to its highest level in almost three years in September, while the number of people without work fell slightly.

The European Union’s official statistics agency Eurostat Friday said consumer prices rose 3% in the 12 months to September, up from 2.5% in August and was well above the European Central Bank’s target of just below 2%.

Prices rose faster than at any time since October 2008, and more rapidly than economists had expected. Those surveyed last week by Dow Jones Newswires had estimated that prices rose 2.5%. The last rise in the annual rate from one month to the next that was of a similar scale was in March 2010, when it picked up to 1.6% from 0.8%.

With a depressed economy businesses haven’t been able to raise their prices.  But what they couldn’t do their central bank has.  Put so much cheap money into the economy that they depreciated the Euro.  Which is another way to cause inflation.  Eventually.  After the benefits of a cheap Euro (making cheap exports) run its course.  And the depreciated Euro turns into a liability (higher input prices in the manufacturing process).

This always happens in Keynesian economics.  Yet the Keynesian ignores this reality and doubles down on the failed policies of the past.

Government Policies Favor Green Energy over Oil and Gas because Government Elitists are in Control

Keynesian economic thought is the prevailing though in most governments.  For a reason.  They’re expansionary policies.  And put government in control of that expansion.  Government officials don’t care if they work.  They just like the power it gives them.  The control over the economy.  And an open checkbook to buy votes.  So governments everywhere put Keynesians into their administrations.  Which give the Keynesians legitimacy.  People accept what they say.  Because if government adopts what they say they must know what they’re saying.

But Keynesian thought is wrong.  History has shown this.  The Austrian School of economics has a far better track record of success.  But that is not a popular school among expansionists.  Because it leaves the economy to the free market.  Not to elitists in government.  Who think they know better than the free market.

An example of this elitist intervention into the free market is government’s choice of green energy as the smart investment of the future.  Which has been failing even with heavy subsidies.  While the hated oil and gas industry, on the other hand, is creating jobs (see Gassing Up: Why America’s Future Job Growth Lies In Traditional Energy Industries by Joel Kotkin posted 9/27/2011 on Forbes).

But the biggest growth by far has taken place in the mining, oil and natural gas industries, where jobs expanded by 60%, creating a total of 500,000 new jobs…

Nor is this expansion showing signs of slowing down. Contrary to expectations pushed by “peak oil” enthusiasts, overall U.S. oil production has grown by 10% since 2008; the import share of U.S. oil consumption has dropped to 47% from 60% in 2005.  Over the next year, according to one recent industry-funded study, oil and gas could create an additional 1.5 million new jobs.

What makes this growth even more remarkable is that the month of August posted zero new jobs.  So if there were no new jobs while oil and gas was creating hundreds of thousands of jobs, hundreds of thousands of jobs in other industries must have been disappearing.  Such as in that government-backed green energy sector.

How about those “green jobs” so widely touted as the way to recover the lost blue-collar positions from the recession? Since 2006, the critical waste management and remediation sector — a critical portion of the “green” economy — actually lost over 480,000 jobs, 4% of its total employment…

The future of the rest of the “green” sector seems dimmer than widely anticipated. One big problem lies in cost per kilowatt, where wind is roughly twice as expensive and solar at least three times as expensive as electricity produced with natural gas. Given the Solyndra  bankruptcy  and their inevitable impact on the renewables industry, it’s also pretty certain that the U.S., at least in the near term, will not be powered by windmills and solar panels.

Natural gas is a clean burning fuel.  It’s so clean we use it in our homes.  In our stoves.  And our furnaces.  It’s cheap.  And it’s plentiful.  We’re getting it out of American ground that can put hundreds of thousands of Americans to work.  Without loan guarantees.  And they can bring it to market at market prices.  Without any subsidies.  It’s the hanging softball of energy policy.  But what are we pursuing?  Green energy.  A sector that is bleeding jobs.

The relative strength of the energy sector can be seen in changes in income by region over the past decade. For the most part, the largest gains have been heavily concentrated in the energy belt between the Dakotas and the Gulf of Mexico. Energy-oriented metropolitan economies such as Houston, Dallas, Bismarck and Oklahoma City have also fared relatively well. In energy-rich North Dakota there’s actually a huge labor shortage, reaching over 17,000 — one likely to get worse if production expands, as now proposed, from 6000 to over 30,000 wells over the next decade.

Why are we subsidizing green startups when we have an energy belt almost the size of the Louisiana Territory?  A labor shortage of 17,000?  And a plan to increase wells from 6,000 to 30,000 (an increase of 400%) in one state?  This is real economic growth.  Created with no government help.  I mean, if there is one thing the Obama administration isn’t known for it’s being a friend to the oil and gas industry.

So this is an industry government doesn’t help.  If anything government hinders it with heavy regulation.  And yet the gas and oil industry is blowing government-subsidized green energy away.  There’s a lesson here.  Free market works.  And when government intervenes into the market you can bet on them picking a loser.

Industry experts say that the shift in energy exploration is moving from the Middle East to the Americas, with rich deposits of oil and gas uncovered from Brazil to the Canadian oil sands.

Much of the new action is on the U.S. mainland, including the Dakotas, Montana and Wyoming. Increasingly, there’s excitement about finds in long-challenged sections of the Midwest such as Ohio. The Utica shale formation, according to an estimate by Chesapeake Energy, could be worth roughly a half trillion dollars and be, in the words of CEO Aubrey McClendon, “the biggest to hit Ohio, since maybe the plow.”

Ohio now has over 64,000 wells, with five hundred drilled just year. Recent and potential finds, particularly in the Appalachian basin, could transform the Buckeye State into something of a Midwest Abu Dhabi, creating more than 200,000 jobs over the next decade.

A Midwest Abu Dhabi?  Creating 200,000 new jobs?  And that’s just in the oil and gas business.

The energy boom also has sparked a spate of new factory expansions, including a $650 million new steel mill to make pipes for gas pipelines. Other local firms are gearing up to make up specialized equipment like compressors.

This is real economic growth.  Created and sustained by the private sector.  Without any stimulus funding or subsidies.  The way of the Austrian School of economics.  But is anathema to expansionist Keynesians.  That’s why government policies favor green energy.  Like they favored subprime lending.  Because government elitists are in control.  Not the free market.

The Genius Elite have given us the Subprime Mortgage Crisis, Solyndra and Inflation in the Eurozone

The government bet wrong on green energy.  As smart as they are.  And as smart as their Keynesian advisers are.  Is there a lesson here?  Yes.  They are not that smart.

The oil and gas industry is booming.  Why?  Because there is enormous demand for oil and gas.  For all the Keynesians’ lament over the lack of demand you’d think they’d jump on this.  But no.  They ignore it.  Instead they impose oppressive regulations.  Impose moratoriums on Gulf drilling.  And do more to impede this industry than to help it.  To please the environmentalists.  And their friends in green energy.

The genius elite have given us the Subprime Mortgage Crisis, Solyndra and inflation in the Eurozone.  The Keynesian way.  Whereas the free market is finding domestic sources of real energy and creating jobs.  The Austrian School way.  Which was also the American way.  Once upon a time.  And it can be again.  If we listen more to the market.  And less to the Keynesian elites.

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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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LESSONS LEARNED #79: “Tax cuts stimulate. Not tax hikes.” -Old Pithy

Posted by PITHOCRATES - August 18th, 2011

With Bubbles the Ride Down is never as Enjoyable as the Ride Up

Bill Clinton dealt George W. Bush a horrible hand.  Clinton enjoyed the irrational exuberance.  He rode the good side of the dot-com bubble.  Saw the treasury awash in cash.  Dot-com people cashing in their stock options and paying huge capital gains taxes.  There was so much money pouring in that projections showed a balanced budget for the first time in a long time.  As long as the people stayed irrationally exuberant.  And that damn Alan Greenspan didn’t raise interest rates.  To rain on his parade.

But he did.  The days of free money were over.  (For awhile, at least).  Because people where bidding up stock prices for companies that hadn’t produced a product or provided a service.  Money poured into these dot-coms as investors were ever hopeful that they had found the next Microsoft.  These companies hired programmers.  Colleges couldn’t graduate enough of them.  To program whatever these companies would eventually do.  But with the spigot of free money turned off these companies ran out of startup capital.  As most of these businesses had no revenue they went out of business.  By the droves.  Throwing these programmers out onto the street.

And then the great contraction.  Which follows a bubble after it is a bubble no more.  Prices fell as deflation replaced inflation.  And as prices fell, unemployment went up.  The phantom prosperity at the end of the Nineties was being corrected.  And the ride down is never as enjoyable as the ride up. 

Easy Monetary Policy and lack of Congressional Oversight of Fannie Mae and Fannie Mac

And then there was, of course, 9/11.  Which further weakened an already weakened economy.  So that’s the backstory to the economic activity of the 2000s.  A decade that began with the aftermath of one bubble bursting.  And ended with an even worse bubble bursting.  The subprime mortgage crisis.  It was a decade of government stimulus.  George W. Bush used both tax cuts (at the beginning of his presidency).  And then a more Keynesian approach (tax rebates and tax incentives) at the end of his presidency.  In other words, tax and spend.

But the subprime mortgage crisis was so devastating that the 2008 stimulus urged by Ben Bernanke (Chairman of the Federal Reserve) to ward off a possible recession failed.  The easy monetary policy and lack of Congressional oversight of Fannie Mae and Freddie Mac caused big trouble.  And put far too many people into houses who couldn’t afford them.  The housing bubble was huge.  And because Fannie and Freddie were buying these risky mortgages and repackaging them into ‘safe’ securities, the fallout went beyond the housing market.  Pension funds, IRAs and 401(k)s that bought these ‘safe’ securities lost huge swaths of wealth.  The economic fallout was vast.  And global.

And then came Barack Obama.  A Keynesian if there was ever one.  With the economy in a free fall towards a depression, he signed into law an $800 billion stimulus package.  Not surprisingly, it turned out that about 88% of that was pure pork and earmarks.  Making his ‘stimulus’ stimulate even less than the George W. Bush $152 billion stimulus package.  And worked about as well.

Home Ownership was the Key to Economic Prosperity in the U.S.

So let’s look at the numbers.  Below is a chart graphing GDP, the unemployment rate and the inflation rate for the 2000s.  GDP is in billions of 2005 dollars.

(Sources: GDP, unemployment, inflation.  *Average to date (GDP – 2 quarters, unemployment rate – 7 months and inflation – 7 months).)

You can see the fallout of the dot-com bust.  The decade opens with deflation and a rising unemployment rate.  GDP, though, was still tracking upward.  After the bush tax cuts in 2001 (Economic Growth and Tax Relief Reconciliation Act of 2001) and 2003 (Jobs and Growth Tax Relief Reconciliation Act of 2003) you can see improvement.  Unemployment peaks out and then falls.  Inflation replaces deflation.  And GDP grows at a greater rate. 

Things were looking good.  But lurking in the background was that easy credit.  And federal policies to qualify unqualified people for mortgages.  To put them into houses they couldn’t afford.  All because home ownership was the key to economic prosperity in the U.S.

Which makes the rising rate of inflation a concern.  Rising inflation (i.e., expansionary or ‘easy’ monetary policy) created the dot-com bubble.  A rising inflation rate can be bad.  But at least during this period the growth rate of GDP is greater than the growth in the inflation rate.  Which indicates real economic growth.  Accompanied by a falling unemployment rate.  All nice.  Until…

Bernanke and Company Crapped their Pants

Those people approved for mortgages they weren’t qualified for?  Guess what?  They couldn’t make their mortgage payments.  And because Fannie and Freddie bought so many of these risky mortgages, these defaults weren’t the banks’ problems.  They were the taxpayers’ problems.  And anyone who bought those ‘safe’ securities.

Long story short, Bernanke and company crapped their pants.  He urged the $152 billion Economic Stimulus Act of 2008 to ward off a possible recession.  This was a Keynesian stimulus.  Remember that summer when you got those $300 checks?  This was that stimulus.  But it didn’t stimulate anything.  People used that money to pay down debt.  Because they were crapping their pants, too.

The good times were over.  That huge housing bubble was bursting.  And nothing was going to stop it.  Certainly not more of the same (Keynesian stimulus).  GDP fell.  Unemployment rose.  Inflation became deflation.  And Bernanke stepped in and turned the printing presses on.  Desperate not to make the same mistake the Fed made during the Great Depression.  When bad Fed policy caused all of those bank runs.

An Inflation Rate Greater than the GDP Growth Rate may Return us to Stagflation

The Obama administration (all Keynesians) pushed for a massive stimulus to fix the economy.  The best and brightest in the administration, Ivy League educated economists, guaranteed that if passed they could hold the unemployment rate under 8%.  So they passed it.  And Bernanke kept printing money.  In other words, more of the same.  More of what gave us the dot-com bubble.  And more of what gave us the housing bubble.  Inflationary monetary policy.  And more government spending.

Didn’t work.  It took a year for the deflation to end.  As the market corrected prices.  And readjusted supply to match actual demand.  The unemployment rate maxed out around 10%.  And the Obama stimulus didn’t move it much from that high. 

GDP growth resumed.  However, the growth of inflation is now greater than the growth of GDP.  A very ominous sign.  Indicating that GDP growth is not real.  And will likely collapse once the ‘free money’ Fed policies end.  Or the growth of inflation coupled with high unemployment return us to the Jimmy Carter stagflation of the Seventies.

Keynesian Stimulus is the way to go if you want Deflation and Recession 

Further Keynesian stimulus may only make a bad situation worse.  And prolong this economic ‘recovery’.  These policies make bubbles.  Which are fine and dandy until they burst.  Giving us deflation and recession.  And the bigger the bubble, the greater deflation and recession that follows.

Tax cuts stimulate.  They ended the dot-com recession.  All Keynesian attempts during the 2000s have failed.  Proving again that tax and spend doesn’t work.  Easy monetary policy and government spending does not end well.  Unless you want deflation and recession.  Then the Keynesian way is the way to go.  But if you want to stimulate economic activity.  If you want real GDP growth.  Then you have to go with tax cuts.  As their track record of success shows.

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FUNDAMENTAL TRUTH #56: “It’s competition in the private sector that makes life better. Not government regulation.” -Old Pithy

Posted by PITHOCRATES - March 8th, 2011

Government caused the Greatest Recession since the Great Depression

You hear it all the time from the Left.  If it wasn’t for all those government regulations those on the Right bitch about we wouldn’t have safe food, safe medication, safe transportation, safe merchandise, fair prices, a clean environment, quality education, etc.  It’s rather amazing to hear people in government say this.  And people on the Left say this.  Because people are people.  And people regulate people.  So why are some people better than other people?  Just because they say they are?  I find that a bit specious.

Government caused the greatest recession since the Great Depression.  It was their economic policies that put people into houses they couldn’t afford.  It was Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac that enabled the approval of very risky mortgages by buying them from the lenders.  It was the GSEs that had Wall Street create vehicles to sell these risky mortgages as high yield, low risk investments (i.e., derivatives).  It was Congress that refused to stop this risky behavior of the GSEs because Congress members were getting sweetheart mortgage deals and campaign contributions.  And it was Congress that bailed out the GSEs with our tax dollars after their dirty politics crashed the economy.  If you go down the chain of events you see one constant behind every step in the process that gave us the Great Recession.  Government, government, government.  And yet we are to trust government people every time over the private sector people.

If you remove government from the mortgage picture, though, it’s a different story.  Instead of discrimination it was just poor credit and insufficient earnings that denied mortgages for some blacks, Hispanics, single mothers, etc.  And these people wouldn’t have been in houses they couldn’t afford.  Lenders would have had far fewer risky mortgages on their books.  The GSEs would have bought far fewer risky mortgages.   Wall Street wouldn’t have spread the subprime mortgage contagion worldwide by selling boatloads of their complex derivatives.  There would have been no Great Recession.  There would be no double digit unemployment (U6 – a truer unemployment rate than the ‘official’ U3) today.  And all of this by just removing government from the beginning of this process.  And yet we are to trust government people every time over the private sector people.

A Business must please the Consumer to Survive

Let’s look at another example.  Let’s take food.  The Left say that if it wasn’t government regulation our food would be unsafe.  So let’s imagine a world where there is no government regulation.  And only two meat packing plants.  A devious, archetypical corporate villain (as the Left believes runs all corporations) runs one plant.  Let’s call him Mr. Devious.  A true free market capitalist runs the other.  Mr. Devious reinvests no money into the plant.  Doesn’t even clean it.  Has a rat infestation.  Uses rat poison to control the rat infestation.  Doesn’t care.  And sends out tainted meat that kills hundreds of people.  The true free market capitalist keeps reinvesting in his plant.  Keeps it clean.  Has no rat infestation.  And strives to put out the best quality product.  It’s not tainted and people eat it without dying.

Now suppose you’re putting together your shopping list.  You have meat on your list.  And on the television news is a story about still more deaths that are traced back to Mr. Devious’ plant.  Now, in our imaginary world, there is no government.  No government inspectors to step in to inspect Mr. Devious’ plant.  He broke no law and did not fail to maintain any regulatory standards.  No one files any legal actions against Mr. Devious because he broke no law.  Now tell me, where are you going to go to buy your meat?  Well, if you’re sane, you’re going to make damn sure the meat you buy didn’t come from Mr. Devious’ plant. 

Even in a world that has no government regulation, a Mr. Devious cannot exist.  Because there’s competition.  And the last thing a true free market capitalist wants is bad publicity.  If consumers have an unfavorable view of your company they’ll shop elsewhere.  And if you’re killing people with the food you sell, you couldn’t make a more unfavorable view of your company in the eyes of consumers.  So they won’t be buying what you’re selling.  Ever.  But guess where they will be buying from?  That’s right.  The business that puts out the best quality.  And the best price, of course.  In other words, the one that best pleases the consumer.

Competition Makes Everything Better

Hey, you’re thinking, that makes sense.  So maybe the big corporate giants care about us.  If only for their greed.  Well, greed is a powerful motivator.  You see, a profit is an incentive to do good.  And pleasing consumers it the key to profitability.  So you do everything within your power to please as many consumers as possible.  Before another business pleases them better.  We call this tug of war in the market place competition.  And you win this game by pleasing consumers better than your competitors do.  Because competition makes everything better.

Now think about the things you hate to do.  Deal with the cable company.  A utility.  Getting your driver’s license renewed.  Getting a building permit.  Getting your tax assessment reduced because your house isn’t worth as much as your city says it is.  Filling out your income taxes.  Going through airport security.  Etc.  And what do all of these things have in common?  Little to no competition (although cable companies have competition today but making a change is a pain in the you know what).  There is little need to please consumers.  And it shows.  Customer service isn’t the greatest.  And the processes are often long, complex and exasperating.  Why?  Because they can be.  Where else are we going to go?

These things also have another thing in common.  Government heavily regulates them.  Or they’re simply government itself.  Government people.  Those people we are always to side with over the private sector.  And many of us do.  Despite our not liking to do any of the things we have to do with them.

Competition can even Clean the Environment

Okay, but what about the environment?  There’s no profit in spending more money to keep the environment clean.  Surely that’s something only government regulation can do.  Well, let me ask you something.  Where are you more likely to litter?  In your backyard?  Or in the National Mall after a rally?  The National Mall, yes?  Because we take care of what we own. 

Yes, there have been polluters in the past.  And, yes, government regulations have cleaned them up.  But back when they were polluting, few cared.  Because it was normal.  I mean, once upon a time, human feces used to cover our sidewalks and streets.  And that was normal.  It isn’t anymore.  So we don’t do it anymore.  This is more a process of civilization.  A company today that leeches toxic chemicals into the ground water that kills people who drink well water is going to get a lot of bad PR (public relations, i.e., favorable publicity).  And we know what bad PR does to private companies.  So they are going to try everything in their power to not leech toxic chemicals into the ground water so they can avoid the bad PR.  Before we knew the affect of some of these chemicals, though, some companies did unknowingly kill people.  Now that we know better, they handle their chemicals differently.  In a way that will help to keep consumers as customers.  Not push them away.

BP and Exxon both suffered in the eyes of the consumer after their spills.  And a lot of consumers refused to buy their gasoline anymore.  Not only that, the BP spill shut down all offshore oil drilling in US waters.   At great cost millions of dollars of equipment had to be shipped elsewhere where they could drill.  They would have made more profits without the spill and the bad PR.  So they have a very strong incentive to prevent these environmental disasters from happening.  And considering the amount of oil they pump up from these offshore wells, their environmental record is pretty good.

Companies even look at the little things that add up.  McDonalds used to sell their hamburgers in hard, foam cartons.  They don’t anymore.  Because they felt they could please more consumers by being more environmentally friendly.  Starbucks sells their hot coffee in paper cups to be environmentally friendly.  And the sleeves they use so you can hold those hot cups of coffee contain recycled material.  You can still use foam cups by law.  But they choose not to.  To please their consumers.  So they can keep them as customers.  And be more profitable.

Without Competition Little Changes

Corporations survive on profits.  Maintaining profitability means pleasing consumers.  When something bad happens they have a powerful incentive to act fast.  Before the problem spirals out of control causing bad PR.  Making consumers go elsewhere.  They will act faster than any government bureaucracy in identifying and correcting the problem.  To limit their damages.  Because the more damage they cause the harder it will be to regain the consumers’ confidence.  And lost consumer confidence equals fewer profits in the private sector.

It’s a little different with government.  Without competition little changes.  Fannie Mae and Freddie Mac are still here.  They may go away but there is talk about replacing them with something similar.  To make sure the same housing policies that caused the Great Recession will continue.  To make sure that some people who can’t afford a house can buy a house.  And if it all blows up again, they will just pass the cost onto the taxpayers.  Again.

And yet we are to trust government people every time over the private sector people.

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Financial Crises: The Fed Giveth and the Fed Taketh Away

Posted by PITHOCRATES - December 3rd, 2010

Great Depression vs. Great Recession

Ben Bernanke is a genius.  I guess.  That’s what they keep saying at least. 

The chairman of the Federal Reserve is a student of the Great Depression, that great lesson of how NOT to implement monetary policy.  And because of his knowledge of this past great Federal Reserve boondoggle, who better to fix the present great Federal Reserve boondoggle?  What we affectionately call the Great Recession.

There are similarities between the two.  Government caused both.  But there are differences.  Bad fiscal policy brought on a recession in the 1920s.  Then bad monetary policy exasperated the problem into the Great Depression. 

Bad monetary policy played a more prominent role in the present crisis.  It was a combination of cheap money and aggressive government policy to put people into houses they couldn’t afford that set off an international debt bomb.  Thanks to Fannie Mae and Freddie Mac buying highly risky mortgages and selling them as ‘safe’ yet high-yield investments.  Those rascally things we call derivatives.

The Great Depression suffered massive bank failures because the lender of last resort (the Fed) didn’t lend.  In fact, they made it more difficult to borrow money when banks needed money most.  Why did they do this?  They thought rich people were using cheap money to invest in the stock market.  So they made money more expensive to borrow to prevent this ‘speculation’.

The Great Recession suffered massive bank failures because people took on great debt in ideal times (low interest rates and increasing home values).  When the ‘ideal’ became real (rising interest rates and falling home values), surprise surprise, these people couldn’t pay their mortgages anymore.  And all those derivatives became worthless. 

The Great Depression:  Lessons Learned.  And not Learned.

Warren G. Harding appointed Andrew Mellon as his Secretary of the Treasury.  A brilliant appointment.  The Harding administration cut taxes.  The economy surged.  Lesson learned?  Lower taxes stimulate the economy.  And brings more money into the treasury.

The Progressives in Washington, though, needed to buy votes.  So they tinkered.  They tried to protect American farmers from their own productivity.  And American manufacturers.  Also from their own productivity.  Their protectionist policies led to tariffs and an international trade war.  Lesson not learned?  When government tinkers bad things happen to the economy.

Then the Fed stepped in.  They saw economic activity.  And a weakening dollar (low interest rates were feeding the economic expansion).  So they strengthened the dollar.  To keep people from ‘speculating’ in the stock money with borrowed money.  And to meet international exchange rate requirements.  This led to bank failures and the Great Depression.  Lesson not learned?   When government tinkers bad things happen to the economy.

Easy Money Begets Bad Debt which Begets Financial Crisis

It would appear that Ben Bernanke et al learned only some of the lessons of the Great Depression.  In particular, the one about the Fed’s huge mistake in tightening the money supply.  No.  They would never do that again.  Next time, they would open the flood gates (see Fed aid in financial crisis went beyond U.S. banks to industry, foreign firms by Jia Lynn Yang, Neil Irwin and David S. Hilzenrath posted 12/2/2010 on The Washington Post).

The financial crisis stretched even farther across the economy than many had realized, as new disclosures show the Federal Reserve rushed trillions of dollars in emergency aid not just to Wall Street but also to motorcycle makers, telecom firms and foreign-owned banks in 2008 and 2009.

The Fed’s efforts to prop up the financial sector reached across a broad spectrum of the economy, benefiting stalwarts of American industry including General Electric and Caterpillar and household-name companies such as Verizon, Harley-Davidson and Toyota. The central bank’s aid programs also supported U.S. subsidiaries of banks based in East Asia, Europe and Canada while rescuing money-market mutual funds held by millions of Americans.

The Fed learned its lesson.  Their easy money gave us all that bad debt.  And we all learned just how bad ‘bad debt’ can be.  They wouldn’t make that mistake again.

The data also demonstrate how the Fed, in its scramble to keep the financial system afloat, eventually lowered its standards for the kind of collateral it allowed participating banks to post. From Citigroup, for instance, it accepted $156 million in triple-C collateral or lower – grades that indicate that the assets carried the greatest risk of default.

Well, maybe next time.

You Don’t Stop a Run by Starting a Run

With the cat out of the bag, people want to know who got these loans.  And how much each got.  But the Fed is not telling (see Fed ID’s companies that used crisis aid programs by Jeannine Aversa, AP Economics Writer, posted 12/1/2010 on Yahoo! News).

The Fed didn’t take part in that appeal. What the court case could require — but the Fed isn’t providing Wednesday — are the names of commercial banks that got low-cost emergency loans from the Fed’s “discount window” during the crisis.

The Fed has long acted as a lender of last resort, offering commercial banks loans through its discount window when they couldn’t obtain financing elsewhere. The Fed has kept secret the identities of such borrowers. It’s expressed fear that naming such a bank could cause a run on it, defeating the purpose of the program.

I can’t argue with that.  For this was an important lesson of the Great Depression.  When you’re trying to stop bank runs, you don’t advertise which banks are having financial problems.  A bank can survive a run.  If everyone doesn’t try to withdraw their money at the same time.  Which they may if the Fed advertises that a bank is going through difficult times.

When Fiscal Responsibility Fails, Try Extortion

Why does government always tinker and get themselves into trouble?  Because they like to spend money.  And control things.  No matter what the lessons of history have taught us.

Cutting taxes stimulate the economy.  But it doesn’t buy votes.  You need people to be dependent on government for that.  So no matter what mess government makes, they NEVER fix their mess by shrinking government or cutting taxes.  Even at the city level. 

When over budget what does a city do?  Why, they go to a favored tactic.  Threaten our personal safety (see Camden City Council Approves Massive Police And Fire Layoffs Reported by David Madden, KYW Newsradio 1060, posted 12/2/2010 on philadelphia.cbslocal.com).

Camden City Council, as expected, voted Thursday to lay off almost 400 workers, half of them police officers and firefighters, to bridge a $26.5 million deficit.

There’s a word for this.  And it’s not fiscal responsibility.  Some would call it extortion.

It’s never the pay and benefits of the other city workers.  It’s always the cops and firefighters.  Why?  Because cutting the pay and benefits of a bloated bureaucracy doesn’t put the fear of God into anyone.

Here we go Again

We never learn.  And you know what George Santayana said.  “Those who cannot remember the past are condemned to repeat it.”  And here we are.  Living in the past.  Again.

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LESSONS LEARNED #35: “Not only is ignorance bliss, but it’s a godsend to Big Government.” -Old Pithy

Posted by PITHOCRATES - October 14th, 2010

If Jefferson Could Talk from the Grave He’d Be Hoarse from Shouting by Now

Politicians.  They’re all the same.  Well, most of them.  They enter politics for one thing.  For a career.  And what do people want from a career?  Great success.  Great prestige.  Great wealth.  Great power.  And a little revenge.  The pencil-neck, computer-nerd geek takes great pleasure in seeing a jock from his high school days emptying his trash while boarding his private jet. “Those wedgies and swirlies were a bitch but look at us now.”  It’s true.  The best revenge is living well.

But some people lack any talent or ability.  Some of them will never amount to anything.  They’ll never know the joy of looking down on people better than them with sweet condescension.  So these people go into politics.  Where people with no talent or ability can live well.  It’s a simple formula.  Sell your soul.  Whore yourself out.  Shake down businesses with taxation and regulation (and get even with all those people who have far more talent and ability than you ever had).  Collect tribute.  Consolidate power.  Hold those you serve in contempt.

Lord Acton wrote in 1887, “Power tends to corrupt, and absolute power corrupts absolutely.”  A century earlier, Thomas Jefferson fought tirelessly to prevent great money and federal power from conjoining.  The Old World capitals consolidated money and power.  And this concentrated the money and power into fewer and fewer hands.  Kings ruled by whim.  And oppressed their hapless subjects.  It’s a story as old as time.  And is still true today.  To the great chagrin of Jefferson.

Go West, Young Man

The transcontinental railroad was making poor progress during the Civil War.  Because it was starved for capital.  No one would invest.  Few doubted that they could build it.  Even if they could, few doubted it would ever make money.  The West was mostly raw, unsettled land.  There was nothing to transport.  Nothing to earn revenue.  It was a huge investment with a huge risk.  Investors are smart when it comes to money.  And they saw the transcontinental railroad as a one-way road that their money would go down and never return.  They needed something.  Big Government.

When it comes to throwing money away on a losing investment there is but one place to go.  Uncle Sam.  With the power to tax, the federal government has huge piles of money to play with.  So here’s what happened to build that railroad.  Union Pacific (UP) created a shell company called Crédit Mobilier (CM) to finance and build the railroad.  These companies were one and the same.  Without getting too complicated, UP sold their ‘worthless’ stock to CM at par.  Now, CM being a finance and construction company, a train never had to run over the road they were building to make a profit.  Union Pacific, on the other hand, needed trains running on that new track.  They were a transportation company.  They earned a profit from transporting goods on their trains.  This meant it could take years before UP could even hope to earn a profit on the new transcontinental railroad.  CM, on the other hand, could start earning a profit with the first invoice they submitted for construction.  And they did.

CM had strong revenues.  They submitted grossly inflated construction invoices to UP.  UP added a small construction management fee and submitted them to the government.  The government paid UP.  UP paid CM.  With revenues far exceeding their costs, CM made obscene profits.  CM stock took off into the stratosphere.  Some of which was sold to Congressmen at a deep discount who in turn realized obscene capital gains if they sold their stock.  Or collected obscene dividends if they held onto their stock.  In return for this sweetheart deal, they approved all cost overruns.  Killed any legislation unfavorable to UP/CM.  Provided lucrative incentives to build track on the worst ground in the most indirect path (to maximize the railroad’s mineral rights).  Provided little to no oversight on the construction of the road (some track was built on ice, with cheap steel and flimsy wooden trestles wherever possible).  When east met west the different railroads kept on building, parallel to each other to keep billing Uncle Sam.  All paid by the public treasury.  By the taxpayer.  The little guy.  Being raped and pillaged by their own representatives.

Affordable Housing for Those Who Vote Democrat

Politicians buy votes.  Pad the federal payroll.  Steal from the treasury.  Break the law.  Violate our trust.  You know, politician stuff.  Because of the inconvenience of elections, they can’t be too blatant about their rape and pillage.  So they do things that are in the best interest of the public.  Or so they say.  Like affordable housing.  You see, the Left buys the votes of the poor and minorities by throwing bones to them.  And there are a lot of minorities in the inner cities of the bluest of blue cities.  So they threw big bones to them.  Houses.

Despite their War on Poverty, the Left just can’t help these people.  The truth is, of course, that they don’t want to help them.  If they’re poor and dependent on the government, the Left can count on their vote.  If they escape poverty and don’t need Big Government to provide for them, these people are of no use to the Left.  Ergo, they never escape poverty.

Of course, the problem of remaining in abject poverty is that you can’t qualify for a mortgage.  Banks are funny that way.  They only loan money to people who can pay them back.  So they declined a lot of mortgages to these poor inner city minorities.  Well, this was just too good for Big Government to pass up.  A large group of minorities (i.e., a large Democrat voting bloc) being denied mortgages?  Why, that’s racism.  So they drafted a lot of legislation and unleashed their justice department with extreme prejudice.  The message?  Approve these loans.  Or face the consequences (revoking a bank’s charter, a federal lawsuit, a public demonstration headed by Jesse Jackson, Charlie Rangel, et al, etc.).  So they found creative ways to approve loans.  And they got a little help from Uncle Sam.

The Subprime Mortgage Crisis is a Lot Like the Crédit Mobilier Scandal

By a little I mean a lot.  Uncle Sam screwed the mortgage bankers by making them approve extremely risky loans.  So, to help the mortgage bankers, Uncle Sam screwed the American people.  They guaranteed those highly risky mortgages, thus transferring the risk from them to us, the taxpayer.  And to further mitigate the bankers’ risks, they purchased a lot of those highly risky mortgages to remove them from the banks’ balance sheets.  It’s called the secondary mortgage market.  And the primary players are none other than Fannie Mae and Freddie Mac, ground zero of the subprime mortgage crisis.

Once upon a time, a mortgage was one of the safest investments.  People saved up to pay a 20% down payment.  With their life savings invested, people paid their mortgage payment and they paid them on time.  And if you could afford a 20% down payment, mortgage bankers had a lot of confidence that you would be able to service your mortgage.  But in the day of 5%, 3% and 0% down, a person doesn’t have a whole lot to lose.  This makes the first few years of these mortgages especially risky.  The introduction of ‘no documentation’ mortgages meant people could lie about their income (or include overtime earnings).  Add to that the Adjustable Rate Mortgage (ARM) and the interest-only mortgage and you just made these especially risky mortgages even more risky.  Sure, these will get almost anyone into a home, but they get in by the skin of their teeth.  But if they lose their overtime due to a weakened economy, if their interest rate on their ARM resets at a higher rate or a balloon payment is due on their interest-only loan, guess what?  That stream of mortgage payments could very well stop.

Now that would be a BIG problem.  Because of what Freddie and Fannie did with those mortgages they bought.  They sliced them up and built creative investment vehicles.  Derivatives.  Mortgage backed securities called collateralized debt obligations.  Wall Street repackaged all these risky mortgages into highly profitable investments.  Everybody bought them.  Pension funds.  Trust funds.  In America.  And throughout the world.  Big gains with a low risk.  Or so it would seem.  You see, they never eliminated the risk.  They only transferred it to someone else.  And once people couldn’t pay their mortgage payments anymore, the house of cards came crashing down.  We call it the subprime mortgage crisis of 2008.  It caused a worldwide recession.  And cost the American taxpayer dearly.  Even those not born yet.

Yes We Can…Screw the American Taxpayer

The subprime mortgage crisis of 2008 is a government creation.  Their quest of affordable housing to buy votes put more and more people into houses they couldn’t afford.  They created legislation akin to extortion of the banking industry.  They used the Justice Department to apply the muscle for that extortion.  They had their friends in the media and the activists for racial equality to further pressure the banking industry.  Their lack of oversight of Fannie and Freddie (thank you Barney Frank and Chris Dodd) let them make extremely risky loans.  And their policies of buying extremely risky mortgages ultimately transferred all risk to the taxpayer.  Why?  Because like all good government scandals, the seekers of favors rewarded our representatives well for their complicity with sweetheart mortgage deals, vacation junkets, fat contributions to their campaign war chests, etc.  In other words, politics as usual.  But on a grand scale.

Why do they do it?  Because they can.  They count on you being ignorant of history.  And accepting every lie they tell you.  Because they hold you in contempt.  They look down on you with sweet condescension.  These pencil-neck geeks who could never amount to anything on their own merit or ability.  But some sold souls later and they have finally gotten even with those who were better than them.  And here they are.  Still living well.  Even during the worst recession since the Great Depression.

www.PITHOCRATES.com

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How Long Can We Rob Poor Old Peter?

Posted by PITHOCRATES - October 3rd, 2010

How Much for Your Vote?

Imagine that you have 5 good friends.  You meet one day each week to relax and decompress over drinks and good bar food.  Let’s say each of you spends $20 on food and another $20 on your bar bill.  So that’s a total of $40 spent each week on a frivolous benefit you don’t need but enjoy.  Your spouse isn’t all that enthused but it’s only $40.  So you get a pass.  Because you work so hard to earn your pay that your spouse can’t begrudge you this little stress reliever.

So, each week, you each spend $40 for a total weekly cost of $240 (6 X $40).

Now let’s say Friend 1 loses his/her job.  You feel bad for your good friend.  You want to help cheer him/her up during a difficult time.  So you insist that he/she still joins you on your weekly stress reliever.  The others will split his/her tab.  So that’s $240 split 5 ways.  Each of the 5 now pays $48 each, or $8 more each week.  If you do this for 4 weeks, that’s an additional $32 out of pocket per month (assuming a nice even number of 4 weeks per month).

Let’s say Friend 2 also loses his/her job.  You insist he/she still joins your weekly gathering.  So that’s $240 split 4 ways.  Each of the 4 now pays $60 each, or $20 more each week.  If you do this for 4 weeks, that’s an additional $80 out of pocket per ‘month’.

Let’s say Friend 3 also loses his/her job.  So that’s $240 split 3 ways.  Each of the 3 now pays $80 each, or $40 more each week.  If you do this for 4 weeks, that’s an additional $160 out of pocket per ‘month’.

Let’s say Friend 4 also loses his/her job.  So that’s $240 split 2 ways.  Each of the 2 now pays $120 each, or $80 more each week.  If you do this for 4 weeks, that’s an additional $320 out of pocket per ‘month’.

Let’s say Friend 5 also loses his/her job.  So that’s $240 split 1 way.  You now pay $240, or $200 more each week.  If you do this for 4 weeks, that’s an additional $800 out of pocket per ‘month’.

Get the picture?  You’re generosity will eventually cost you a house payment. 

The lesson here is that the more generous we are with other people’s money, the more those ‘other people’ have to sacrifice.   Not the people collecting the benefits.  It’s always the same.  People always have the best of intentions.  But they only make things worse in the long run.

This is what is happening in advanced welfare states all over the world.  And in the United States.  It’s not the greed of Wall Street.  It’s our greed.  And the insatiable greed of Washington.  For our money.  So they can give it to people in exchange for their vote.

Learning from the Past

Trend analysis is an invaluable tool.  People use it to determine which stocks to buy.  Businesses use it to judge the results of past business decisions.  Why?  Because we learn from history.  At least when we choose to.  And that’s the problem with government and an entitlement-based constituency.  They refuse to learn the lessons of history.

The more generous government gets with other people’s money, the more demanding we get for government benefits, the trend is clear.  The worse the life of that poor, dumb bastard who still has a job gets.

And yet people persist in blaming the greed of Wall Street.  Thomas Jefferson warned about the corruption of government by Big Finance and we see it happening.  But we blame Wall Street.  Not Big Government.  Who received boatloads of money from Wall Street for relaxing the mortgage requirements and having Freddie Mac and Fannie Mae buy up all those risky mortgages (giving us the subprime mortgage crisis and the Great Recession of 2008 – (to be determined)).  And a slew of other sweetheart deals they made with each other.

Or we blame the greed of the doctors, hospitals and the drug manufacturers.  Not ourselves for wanting other people to pay for more and more of our health care needs.  Or government for forcing doctors and hospitals to charge the private health insurers more to cover the costs they incur when the government discounts their Medicaid and Medicare invoices.  Or the lawyers for the huge cost of litigation they cause with their numerous lawsuits against the doctors, the hospitals and the drug manufacturers (so numerous that it’s a wonder anyone actually survives from using their products or services).  All which taken together provide fodder for government to take action to solve the ‘health care crisis’.

No, we the people need to point our finger at the truly greedy.  Government.  And ourselves (those who seek all those government benefits).

Give Pete a Chance

With that primer, now read America on the brink of a Second Revolution by Paul B. Farrell of MarketWatch.  It’s not necessarily a cheery outlook.  But it does note that things could get better if we had another Ronald Reagan.  And they would.  Speaking of learning the lessons of history, we all would do well to learn the very good lessons of the Reagan years.  Not the lies and misinformation put out by those in Big Government and the mainstream media.

You can’t keep robbing Peter to pay Paul.  Because eventually Peter will have no more money.  What about Paul then?  How will he get by when there is no one left to rob?  Well, stay tune, Paul.  You’re going to learn the hard way pretty darn quick.

www.PITHOCRATES.com

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