EconoMonitor

Nouriel Roubini's Global EconoMonitor

Who is to Blame for the Mortgage Carnage and Coming Financial Disaster? Unregulated Free Market Fundamentalism Zealotry

The sub-prime and overall mortgage carnage is now likely to lead to a financial crisis whose cleanup and bailout costs will make the S&L bailout bill look like spare change. We are only at the beginning of this fallout but, already, several proposals and bills in Congress have been submitted to help millions of sub-prime homeowners on the verge of bankruptcy and foreclosure. The prospect of millions of homeowners thrown homeless on the street is already shaking politicians of every stripe. The relatively modest bailout envisaged by the first bills currently proposed in Congress will mushroom into a much bigger fiscal bailout of homeowners, borrowers and lenders once the garbage of sub-prime, near-prime and pseudo-prime toxic waste spreads around the economy and likely leads to a hard landing recession that will cause a much bigger financial and banking crisis.

 

Given the fallout and real, social and financial costs of this disaster the political blame game will soon start. So it is important to make sure that the self-serving spin game that accompanied the game of those who happily ignored since last summer the looming housing, mortgage and economic mess will not be repeated again. Powerful political and financial interests will spin their self-serving ideological spin on who is to blame for this mess. Specifically be ready for a cabal of supply side voodoo ideologues – from the Wall Street Journal editorial page (and its invited op-ed writers) to hacks (calling them economists would be an insult to my profession) such as Arthur Laffer, Steve Hanke and other assorted voodoo religion priests – to start spinning a tale blaming government regulation and interference for this disaster that has instead its core in the lack of sensible government regulation, not the existence of such regulation.  In the meanwhile powerful financial interests that repeat the mantra – or better the proof-less dogma – of unregulated free markets and do not like any – even sensible – supervision and regulation of the financial system will happily blame government action – rather than their own reckless greed and stupidity – for this disaster while happily demanding and receiving billions in bailout funds from the same government that they so happily disdain. This will be the most appalling form of corporate welfare: privatize the profits in good times and socialize the losses in bad times.

 

This fairy tale spinned by free market supply side voodoo fundamentalism zealots will blame the otherwise appropriate current Congressional action on predatory lending for being one of the main causes of the credit crunch that will lead to a painful recession (as the WSJ editorial page recently claimed) while forgetting that predatory lending practices developed by free unregulated markets created the toxic waste that is subprime and near-prime mortgages.. This voodoo religion cabal will also incorrectly blame regulators –  whose true blame was being asleep at the wheel for six years while being drugged by a philosophy of “laissez-faire” non-interference with free markets while this free market garbage was being originated – for now finally starting to crack down on monstrous “free market” practices such as zero downpayments on mortgages or NINJA (No Income, No Jobs and Assets) loans; this cabal will thus now blame regulators for “destroying” the sub-prime and near-prime mortgage market with their intervention into “self-regulating free markets”. The same voodoo economics religion priests has and will incorrectly blame the “easy” Fed monetary policy – rather than the lack of any sensible regulation of credit and mortgage market lending – for creating the housing bubble and letting it fester for too long.  It will also incorrectly blame the GSEs for creating “moral hazard” via guarantees of mortgages and thus causing this mess when, instead, the GSEs largely got out of the subprime business in the last few years – and let the free market flourish to originate this toxic waste – when politicians and policy makers started to bash the GSEs for their “excessive” role in the mortgage market.

 

Since a lot of nonsense and financially self-interested ideological spin will be written and said in the months and years to come it is important – from the beginning – to be clear about who is at fault for this utter housing and financial disaster. The answer is clear: the blame lies with free market zealot and fanatics and voodoo economics ideologues who captured US economic policy in the last six years in the same way in which a bunch of neo-cons high-jacked US foreign policy to bring “democracy” to the Middle East while instead leading the country into the Iraq and Mid-East quagmire and now disaster.

 

According to these ideologues – listen for example Larry Kudlow extolling every evening on CNBC the virtue of unregulated wild-west cowboy capitalism – government is always utter evil and the economy could never have a financial or economic crisis if taxes are low, government spending is minimal and government intervention and regulation of the economy and of financial systems is inexistent. This nonsense about bubbles, financial crises and recessions being impossible unless the government over-regulates the economy and/or makes monetary policy mistakes is the main religious dogma of this cabal, an axis of ideological zealotry that goes from the WSJ editorial page to a gang of voodoo economic hacks and to some segments of the financial television.

 

The truth is the contrary: unregulated free market capitalism that has no sensible rules, regulation and supervision and sensible countercyclical monetary and fiscal policies of financial markets leads to credit and asset bubbles, financial excesses and economic and financial crashes. Economic and financial booms and busts were much more severe in the US in the 19th when there was no central bank and no welfare state fiscal actor trying to fine tune the economic business cycle. And business cycle swings have become less frequent since Keynesian countercyclical use of monetary and fiscal policy has been introduced from the Great Depression on.

 

The reality of the last three US recessions – the 1990 recession, the 2001 recession and the coming 2007 hard landing – is that each of these recessions started when the government stopped regulating and supervising in moderate and sensible ways financial institutions and allowed credit and financial and investment bubbles to rise and fester until they ended up in bursting bubbles and leading to recessions.

 

Take the latest subprime and mortgage disaster: the WSJ editorial page will certainly in due time blame the coming recession (that it now happens to predict as likely) on Congress meddling with markets on predatory lending, on excessive regulation of what financial institutions do and on the moral hazard evils of expected bailouts of mortgage lenders and borrowers. But this argument is confusing totally cause and effect. The housing and mortgage and subprime bubble and bust did not occur because of government interference and regulation of free markets. It did instead occur because government regulators were asleep at the wheel while a bunch of voodoo priests of laissez-faire capitalism were running US economic policy and let the housing and mortgage bubble fester. Blaming the now too late government crackdown on free market mortgage practices that were utterly reckless for the final bust and crash is like blaming the doctor for imposing bitter medicine to cure the disease of a  reckless patient who lived in a bubble and spent the last few years on a diet of booze, drugs and artery clogging junk food. This latest mortgage carnage did not happen because of excessive over-regulation of markets by the gove
rnment: it happened instead because – blinded by the anti-regulation dogmas of a bunch of priests of a voodoo religion – the government and regulators did nothing to sensibly regulate the housing and mortgage market and thus allowed this cancer to grow and fester.

 

Booms and busts are regular features of market economies that do not have sensible government supervision and regulation of financial and credit markets. The S&L crisis that led to the credit crunch that caused the 1990 recession started when previously regulated S&Ls were deregulated and there was no sensible supervision of their activities while deposit insurance led them to “gambling for redemption” reckless lending. And blaming  “evil” government-provided deposit insurance for their moral hazard gambles is again confusing cause and effect: financial institution that do strictly need deposit insurance to avoid free-market capitalism liquidity and bank runs during panic episodes do require sensible government-imposed and monitored capital adequacy ratios as well as supervision and regulation of their lending activities to avoid moral hazard-induced distortions in their lending behavior. It is not government-generated moral hazard via insurance that lead to reckless gambling for redemption: it is the lack of sensible government-based regulation and supervision that leads to credit and asset bubbles.

 

In the 1980s this deregulation of S&L then led to a real estate bubble – both in commercial and residential real estate in the South of the US – that ended up in a bust once a glut of shopping strips, shopping malls, office centers, and residential homes piled up as a result of unregulated credit creation by the S&L. Then, the ensuing credit crunch – rather than the necessary but late government intervention to control this free market made disaster – led to a painful recession in 1990-1991, a systemic banking crisis and a bailout of these S&Ls that ended up costing the US Treasury – or better the US taxpayer – about $200 billion. Unregulated wild-west capitalism without rules and regulations was the cause of the S&L boom and bust, not the eventual government intervention to deal with this mess as the priests of the free markets voodoo religion would want you to believe.

 

Similarly, the last six years’ housing and subprime mortgage bubble and bust had little to do with excessive government intervention – either ex-ante or ex-post. Instead they had all to do with the lack of any basic sensible government regulation of the mortgage market, regulation in practice rather than in theory. Dozens of new subprime lenders emerged and were allowed to lend via monstrous credit practices – liar or NINJA loans, no down-payment loans, interest rate only loans, negative amortization loans, teaser rates, option ARMs with no limits or controls  – that should have never been allowed in the first place. Even now that regulators are starting to crack down on the most patent monstrosities such as zero down-payment and no documentation of income, jobs and assets the voodoo priests and their acolytes in the mortgage industry are starting to blame the government for interfering with free market practices: in their ideological view there were optimal reasons for all of such practices: in market fundamentalism if such practices emerged there was a good reason for them and now the government interfering with these monstrosities will cause a credit crunch that will damage the mortgage market and cause a nasty credit crunch that will lead to an economy-wide recession. What a bunch of nonsense and self-interested baloney!

 

These practices instead emerged because the voodoo free market system of financial incentives for lenders –  deceive borrowers with predatory practices, originate reckless mortgages to pile up fees, then securitize those mortgages and shove them on some other investors who had no clue of which toxic waste they were buying – became a whole con scheme. The way a senior and unnamed market participant put it in a bit exaggerated terms this was “an unregulated scam where a bunch of con artists fooled a bunch of clueless deadbeat borrowers”.

 

So do not blame excessive government regulation; it was the lack of any basic regulation that created the bubble.  Do not blame Congress for being the cause of the coming credit crunch because of it totally appropriate predatory lending investigations and soon legislation. If such legislation will lead – as some recent analyses have suggested to the disappearance of one third of the subprime mortgage market, so be it as part of these subprime loans were deceptive, predatory and should have never been made in the first place. Lenders were systematically deceiving poor and uninformed borrowers, many of which minorities who had no clue of what they were getting into. Suppose you were a poor African American or Hispanic or a white poor with low income and no assets who wanted to pursue the American Dream of home ownership and you did not qualify for a regular mortgage because of your low income.  No problem – told you the mortgage broker – we will give you a NINJA (no income, no job and assets) or liar loan, i.e. a loan with no documentation of your income and assets.  You did not afford any down-payment because of little assets? No problem as we will let you to put zero down-payment so that you start with zero equity in your home. You could not afford principal payments? No problem as we will give you an interest only loan. You could not afford a fixed rate mortgage? We will give you a 2-28 ARM where the rate is fixed at low level for two years and then you move to much higher market rates. You did afford even that? We will give you a teaser rate for a little while. You could not afford even that? We will let you capitalize interest on a higher face value of the mortgage for a while so that you will have negative amortization and you pile up negative equity on your home from the very beginning.  And the poor, hapless and clueless borrowers said yes to all of this as the lender never told him that after two years its debt servicing rate would balloon by 500% once he/she had to start paying high market rates and principal on an ever increasing –not decreasing – stock of mortgage debt.  So do not blame Congress for necessary legislation on predatory lending for causing the current credit crunch; it was the lack of such legislation in the first place that allowed millions of mortgages that should have not been originated in the first place to mushroom without control.

 

Also, did the originators care or had any interest or incentive to warn the borrower that he/she could not afford such predatory and deceptive mortgages? No way as the originator would get very fat originations fees/commissions. then package this toxic waste into mortgage backed securities, get a nice rating on that garbage from oligopolistic credit rating agencies whose income derived from giving a high rating to this junk – under the pretense that tens of thousands of piles of toxic waste would turn by miracle into gourmet food – and then sell this securitized toxic junk as if it was fresh roses to even more clueless “savvy” investors desperately searching for yield and being dumbly ignorant of the risks that they were taking. These investors were not innocent victims; they were blinded by their own search-for-yield greed and did not bother to figure out non-transparent and totally opaque new financial instruments may be toxic waste.

 

Then this entire housing and mortgage and securitization bubble fed an entire industry of originators, brokers, banks, broker dealers who created and securitized this junk and created CDOs, synthetic CDOs,  CDOs of CDOs (CDO squared) , CDOs of CDOs of CDOs (CDOs cubed) and another totally not-transparent fog of credit derivatives – that were being priced based on intuition rather than true analysis of risk. These credit derivatives went, in less than a decad
e, from non-existent to a notional value of over $26 trillion. In the meanwhile this industry sold this garbage and provided financing for these investments as well as a variety of other prime broker services to a rising mountain of  thousands of hedge funds. The fortunes of some of these broker dealers were partly fed for a decade from lending to home builders, to subprime originators or originating the mortgages themselves, securitizing the mortgages into RMBS, creating and managing the CDOs (and all their endless synthetic and cubed variants of them), offering aggressive prime brokerage services to the hedge funds buying this toxic waste, as well as trading on their own accounts the variety of these new instruments. No wonder these broker dealers and large financial institutions stocks are now under pressure while their arguments that they are only marginally directly exposed to subprime sound so lame: they are directly and indirectly exposed to this toxic waste via a dozen of different channels.

 

Also, please do not blame the GSEs (Fannie and Freddie) for this mess even if the GSE do have very different problems that need to be addressed. The GSEs were bashed for years by Greenspan, Treasury, Bernanke and a wide variety of observers for their excessive size and role in the mortgage market (securitization and guarantees of mortgages), for how they were managing their risks and for the potential moral hazard deriving from an alleged implicit bailout guarantee that allowed them to borrow at quasi-sovereign rates. Indeed some of these critiques of the GSEs do have some merit.

 

But the paradoxical effect of the backlash against the GSEs has been that in the last few years these institutions have significantly reduced their role in securitizing and guaranteeing mortgages. Specifically Fannie and Fannie significantly reduced their presence in the MBS market, especially among subprime mortgages and the MBS related to them. Reacting to the persistent arguments from many fronts that the two GSEs should reduce their role in the MBS market, in the last few years the job of originating and securitizing subprime mortgages and many near-prime mortgages was mostly taken over by private sectors institutions. As the GSEs got out of this business, subprime lenders and other major financial institutions originated sub-prime and near-prime mortgages, repackaged them and securitized into MBS then sold to investors and to CDOs. So, the growth of subprime and near-prime toxic waste had little or nothing to do with the role of the GSE in the mortgage market. Fannie and Freddie may have many faults but this subprime disaster is certainly not one of them. So beware of misleading attempts to blame the GSEs and moral hazard distortions from their perceived semi-public status in contributing to this subprime and mortgage disaster.  

 

The paradox is instead the fact that pulling the GSEs from any role in the subprime market allowed the “free market” to develop the excesses and monstrosities that the rise of subprime and near-prime mortgages generated in the last six years. It was the absence of the GSEs from this market, not their presence that contributed to this mess; and it was the presence of an unregulated free market system that allowed this monstrous bubble to be created, to be allowed to fester and to now burst with the nasty collateral damage that is coming with it.

 

Given the total lack of a role of the GSEs in this subprime and near-prime disaster it is really paradoxical that Bernanke, in his speech last week about the GSEs, pushed for reducing further their financial portfolios and recommended that the main role that they should have from now on should be the one of help support “affordable housing”, i.e. originating or underwriting and securitizing subprime mortgages. After years of ideological battles against them and after they moved out of the subprime market, and after the unregulated free market was allowed to develop the subprime market and create the toxic disaster whose collateral damage will now be paid by the US taxpayer Bernanke is now telling us that the subprime mortgage business (“affordable housing”) should not be managed by the private sector but should instead be fully given to the GSEs. He formally fudged the proposal by saying that greater role of GSEs in affordable housing finance does not mean a greater role in the subprime market. But he contradicted himself: having GSEs having a center role in affordable housing means a central role in securitizing subprime mortgages. This is the same ideology that led to the subprime disaster in the first place: privatize the profits of greed and unregulated gambling for redemption; and socialize the costs and losses when disaster from free market fundamentalism occurs. This is outright corporate welfare chutzpah.

 

Also, it is now clear that making subprime loans is clearly not an economically rational business for the private sector given the current subprime disaster. However whether Fannie and Freddie should do it instead or not is not obvious. If there is a role for the government in this markt then one may want to tax those who can afford to finance the subsidies for affordable housing. So Bernanke wants to reduce the GSE’s interference with free markets by giving them and the public sector a greater role in affordable housing. But if the GSE have to do – and be perceived as doing – business as private sector firms that do not benefit from moral hazard related government how can they subsidize affordable housing and make a profit? If they get a role in affordable housing effectively Bernanke is telling us that they are public institutions, not private ones. So implicitly Bernanke is undermining all his attempts and those of others to make the GSEs truly private institutions that are not perceived as being protected by a Treasury bailout guarantee.

 

The same free market fundamentalist zealots – at the WSJ editorial page, among voodoo economics hacks and among the policy makers that mis-managed US economic policy for the last few years – who bashed the GSEs were also pushing the other mantra of the benefits for growth of low taxation of capital. But take housing. The taxation of investment in housing – an effectively unproductive form of capital – not only is not heavy; it is rather tax-preferred relative to other productive forms of capital. The zealots who want low taxation of capital got it all in the tax-favorite status of housing investment by households. The result has been another monstrosity: a decade of massive overinvestment by the US in one of the most unproductive forms of capital, housing. This overinvestment fed by low taxation of housing investment has led to large current account deficits – via the increase in housing investment and the fall in private savings that the housing wealth effect had on consumption – and to the accumulation of trillions of foreign liabilities. So instead on increasing its stock of productive physical capital the US has spent a decade piling up trillions  of dollars of investment in unproductive housing capital that has no effects on the rate of productivity of the economy. The rest of the world spent the last decade investing in factories that produce world class, high-quality and low costs goods; the US invested in McMansions that have zero productivity value and spillovers for the economy. Again thank the free market fundamentalist zealots who love no regulation and little taxation of capital for this sorry state.

 

The same free market zealots have now started to blame the Fed for causing the housing bubble. In their view the Fed, by aggressively easing rates after 2001 and keeping the Fed Funds rates too low for too long, created the housing bubble that is now bursting. So they blame the Fed for a disaster that had its source in the private sector behavior and actions. The same free marketers argue that the Fed created
the tech bubble that burst in 2000 and led to the 2001 recession.

 

But while easy Fed policy had some role in the three private sector bubbles of the last two decades that ended up in a recession bust –  late 1980s real estate bubble that led to S&L bust and 1990s recession, the late 1990s tech bubble that led to the 2000 tech bust and the 2001 recession,  the 2000s housing bubble that led to the housing bust of 2006 and the coming recession of 2007 – the center of the problem  in each one of these three booms and busts was not – as voodoo religion hacks and zealots spin it now – excessively easy monetary policy by the Fed but rather proper regulation of financial and credit markets.

 

The center cause of these disasters was the lack of appropriate regulation of free markets. First, in the 1980s S&L were deregulated and wild-west capitalism became the norm of the credit policies of the S&Ls in the South and South-West of the US: then, a bunch of greedy cowboys and at time criminal con artists high-jacked the credit policies of the S&Ls and triggered a private sector real estate boom that, like today, created a massive amount of  toxic waste in real estate. This toxic garbage then exploded in the late 1980s in a nasty bust that triggered a credit crunch that was the main cause of the 1990-91 recession.

 

Second, in the 1990s, the attempt to avoid the liquidity run and crunch caused by another unregulated private sector-related reckless leverage – the near collapse of LTCM and its collateral damage – induced the Fed to ease the Fed Funds rate by 75bps in the fall of 1998 and let the tech sector “irrational exuberance” – that Greenspan had already identified in 1996 – to fester even longer. But higher Fed Funds rates would have not stopped this private sector crazed mania. What was necessary then was again better regulation of the financial system: much tighter margin requirements on leveraged stock market investments; control of leverage in the financial system and among highly leveraged institutions such as hedge funds. Failure to implement sensible regulation – such as margin requirements on leveraged tech investments – allowed the tech bubble to fester, then go bust in 2000-2001 and cause a painful recession in 2001 .

 

Third, this time around it is not true – like the WSJ editorial page has repeatedly and wrongly argued – that the housing bubble was mostly caused by a Fed that kept the Fed Funds rate too low for too long. Higher interest rates sooner would have made only little difference, especially in a world where long rates and mortgage rates depended more on global factors – that kept such rates low – rather than on monetary policy. The central Fed failure was not that of keeping the Fed Funds rate too low for too long (that was only a modest misdemeanor)  but rather its failure (as well as that of other banking regulators) to control the credit bubble in the housing market via appropriate supervision and regulation of mortgage finance and via prevention of monster lending practices.

 

Greenspan allowed the tech bubble to fester by first warning about irrational exuberance and then doing nothing about via either monetary policy or, better, proper regulation of the financial system while at the same time becoming the “cheerleader of the new economy”. And Greenspan/Bernanke allowed the housing bubble to develop in three ways of increasing importance: first, easy Fed Funds policy (but this was a minor role); second, being asleep at the wheel (together with all the banking regulators) in regulating housing lending; third, by becoming the cheerleaders of the monstrosities that were going under the name of “financial innovations” of housing finance. Specifically, Greenspan explicitly supported in public speeches the development and growth of the risky option ARMs and other exotic mortgage innovations that allowed the subprime and near-prime toxic waste to mushroom.

 

In a world where the leading ideology was to reduce regulation to a minimum, not only closing one’s eyes on monster lending practices but rather actively praising them as brilliant financial innovations, bashing GSEs in the name of letting the superior private sector to take a bigger role in monster housing finance, it is not a surprise that the biggest bubble in U.S. history was created, incentivated and allowed to fester until it imploded. Free market fundamentalist zealotry that did not understand that market capitalism needs some basic and sensible rules, regulation and supervision to control excesses, bubbles, greed and investors’ manias and panics.

 

The political neo-con freedom and liberty fundamentalists deluded themselves that free elections and military invasions will automatically lead to democracy in the Middle East. Instead, their free elections and freedom-agenda ended up getting Hamas, Hizbollah and Shite fanatics to come to power in Gaza, Lebanon and Iraq and while destabilizing Iraq and soon a good chunk of Middle-East. In the same way the free market fundamentalism zealots deluded themselves that unregulated free markets and low taxes could never do anything wrong or harm. Too bad that unregulated free markets that systematically lead – as two hundred years of US economic history show – to bubbles that end up in busts and nasty recessions have been the source of the last two US recessions. The implementation of this ideology is also the source of the latest housing boom and bust that is already leading to a severe credit crunch in the mortgage market and that will lead to an economy-wide recession in 2007 that will be deeper and more painful than those in 1990 and 2001.

 

So it was a vast range of dogmas and free market fundamentalism pushed by a bunch of ideological zealots – that were handmaiden to financial interests that enjoy private profits in good times and corporate welfare paid by the US taxpayer when their free market greed and excesses lead to nasty financial busts – that created this disaster. It was not an evil, large and over-regulating government that created this disaster. It was instead an ideology and practice of unregulated free markets that fed this mess.

 

Now that the mess has occurred and the financial costs of widespread bankruptcies among borrowers and lenders will be severe the issue will be the one of how to clean up this mess by helping the true victims while not bailing out the true culprits.

 

The main challenge will be to help the victims of this disaster – those households that were duped into predatory mortgages and who are now unable to service their resetting ARMs – without bailing out the private “free market” institutions that created this mess in the first place. Market capitalism works if equity holders first and bondholders second take the losses of their own investment mistakes. So wide-scale public bail-out of financial institutions should be strictly avoided and minimized. The trouble is that when deposit-taking institutions fail because their net worth is negative (as a consequence of bad lending) deposit insurance limits the losses that can be inflicted on these effectively senior creditors of these banks. Thus first losses should be taken by shareholders and other unsecured bondholders and creditors of the banks. In the case of the subprime lenders until now the failures have been concentrated among institutions that relied on capital markets for funding, rather than on insured bank deposits. Thus losses can and should be allocated to owners and bondholders of these institutions with no use of public money to bailout anyone. However, we cannot exclude that in due time some commercial banks and other deposit-taking institutions will get into trouble and public money may be needed to clean up the balance sheets of such institutions.

 

Public funds to help borrowers should be used with care for several reasons. First, some forms of borrowers’ financial support end up
bailing out also the culprits of this mess; thus, these specific forms of support of homeowners under financial distress should be avoided. For example, direct subsidies to households who cannot afford their now-reset and excessively high mortgage payments end up helping the victims as well as the culprits. Thus, this kind of support should be avoided.

 

Second, across the board support of all sub-prime borrowers would be inappropriate: while many borrowers were duped into predatory mortgages by lenders who did not explain to them what were the true terms of these loans, a minority of borrowers recklessly borrowed well knowing they could not afford the terms of the mortgage. They borrowed either gambling into capital gains that never occurred (speculative investment in homes) or planning strategic early default on their mortgage. The latter phenomenon is represented by the epidemic of early payments defaults that we have seem among some subprime mortgages: given the time that it takes to foreclose a home some borrowers intentionally took mortgages that they were not planning to service at all to enjoy the benefits of a few months of free rent of a home. However, these few deadbeat borrowers were able to dupe lenders because underwriting standards of originators were recklessly loose to begin with: anyone lying about their income, job and asset could get a mortgage.

 

The analysis above suggests some principles for the coming financial support that will be given with public funds to clean up the unfolding mortgage disaster. First, distinguish between true victims of predatory lending and deadbeat borrowers who were into early strategic default. Early payments default is a clear way to distinguish between inability to pay and unwillingness to pay. Also, means testing for financial support is crucial: low income and low asset households who were pursuing the American Dream and were deceived by lenders may deserve support. But subprime borrowers with higher incomes and/or assets do not deserve support and should be pushed into foreclosure if they are unable or unwilling to service their mortgages. Also, condo-flippers and other individuals who bought homes for speculative purposes such as speculating on price increases (i.e. folks who were not first time homeowners who lived in their homes) would get no financial relief at all and will be forced to foreclose if they are unable or unwilling to service their mortgage.  Second, financial support to households who were victims of predatory lending (and owners of overvalued homes whose value was incorrectly assessed as much higher than equilibrium) should take the form of reduced debt servicing (as in some recent proposals) rather than subsidies to borrowers; this to prevent the support of the borrowing victims from indirectly bailing out the culprits of reckless or predatory lending.

 

For example, suppose that the value of a home (with zero down-payment) has fallen 10% (following the current housing bust) and that the borrower cannot now pay the full value of the mortgage debt servicing payments that are now being reset at much higher interest rates. Then, if the borrower can afford a lower string of service payments  that, in NPV terms, is 10% lower than the initial terms of the mortgage (and equal to the true value of the home), the solution will be to allow a reduction of 10% (in NPV terms) of the debt-servicing payments for the borrower. Instead, a public subsidy to the borrower in the same amount would have the same effect on the borrower while bailing out a reckless or predatory lender. 

 

Suppose instead that the home value has fallen 10% but the household cannot afford even a 10% NPV reduction of the stream of debt payments associated with the initial mortgage (say at zero initial down-payment). Then, the household – duped or not – was buying a home with a bundle of housing services that was too large relative to its ability to afford it even after the value of the mortgage has been adjusted to the lower market value of the home. In this case if it takes more than a 10% reduction in the NPV of the debt payments to allow the household to be able (or equivalently willing) to afford the home. Thus, it make sense to foreclose the home and not provide financial support to the household: duped or not the household had bought a home whose real housing services were too large relative to even its ability to afford it at a reduced market value. Thus, financial support of the household is not warranted and foreclosure is a socially efficient solution. The bank should take the loss of a mortgage with a home value lower than the mortgage. And such household should rent a lower amount of housing services by renting a smaller home/apartment rather than own a home with a bundle of housing services that it cannot afford.

 

Finally, if deposit-taking institutions whose depositors benefit of deposit insurance go bankrupt (have negative net worth) because of housing related losses, equity holders should be wiped out first and unsecured bondholders should suffer next before any public funds are used to recapitalize and fiscalize the losses of the bank. This simple principle would minimize the fiscal costs of cleaning up distressed banks while minimizing the moral hazard distortions of deposit insurance.

 

In summary, lack of sensible supervision and regulation of banks, mortgage lenders and other financial institution – partly induced by an ideology of free market fundamentalism – has been the core cause of this private sector created disaster, not excesses of regulation or of government policy. Thus, to minimize the fiscal costs of cleaning up this mess, use of public funds should be carefully managed and targeted to help the true victims of this mess – borrowers duped by predatory lending practices – while avoiding any bail-out of the culprits of this mess. Privatizing profits in good times while socializing losses in bad times is another form of reckless corporate welfare that generates moral hazard while fostering new bubbles.  Ideological supply side voodoo zealots should not be allowed to spin a tale where evil government intervention caused this disaster. And the private sector institutions and investors that indulged in this unregulated reckless behavior should take their losses. Market economies are the best economic system but they work properly when private greed, manias, panics, stupidity and recklessness is tempered by sensible supervision and regulation. And may the unfolding mortgage disaster bury once and for all the neo-con supply side voodoo economics religion of unregulated free markets fundamentalism.

 

117 Responses to “Who is to Blame for the Mortgage Carnage and Coming Financial Disaster? Unregulated Free Market Fundamentalism Zealotry”

HellasiousMarch 19th, 2007 at 3:51 am

Historical comparisons are usually of limited value, confined to the impact of human psychology extremes in the formation of bubbles and panics.  However, there IS a direct comparison between the current existence of nested, multi-leveraged debt instruments (e.g. CDO-cubed, CDO’s made of CDS’s, etc), with the wide popularity of stock-market “Trusts” in the 1920’s. In this instance, “Trust” does not refer to monopolistic operations a la Standard Oil, but the following: a “Trust” would be formed to purchase listed shares in holding companies of dubious assets, sometimes on margin. That Trust would then itself list on the NYSE, ASE (Curb) or trade OTC.  Furthermore, there were Trusts of Trusts (ToT’s) formed, also listed and traded, that bought shares in many other Trusts. Most frequently, those ToT’s also used margin to buy the underlying Trusts. The effective leverage vs. the original assets in those ToT’s frequently exceeded 10-to-1 or even 20-to-1.  But today we are, of course, much more sophisticated and would never allow such ludicrous leverage to threaten our self-regulated, “free-market knows best” financial system.  Now, on the subject of hedge funds…

GuestMarch 19th, 2007 at 3:54 am

Senate considering helping 2.2 subprime borrowers…   Senate Weighs Aid to 2.2 Million Subprime Borrowers (Update4)   By James Tyson  March 13 (Bloomberg) — U.S. lawmakers will have to consider providing aid to about 2.2 million subprime mortgage borrowers who are at risk of defaulting and losing their homes, Senate Banking Committee Chairman Christopher Dodd said today.   “The impact of losing 2.2 million homes I suspect will be in a lot of areas of our cities and towns that are already pretty hard hit, so we clearly want to look at that and legislate,” Dodd, a Democrat from Connecticut, told reporters in Washington after a speech to the National League of Cities.   Foreclosures involving homeowners who took out subprime loans from 1998 until 2006 could cost $164 billion, Dodd said, citing a December study by the Center for Responsible Lending in Durham, North Carolina. The government needs to provide at-risk homeowners “forbearance or something like that to give them a chance to work through and get a new financial instrument here that they can manage financially better,” Dodd said.   Delinquencies among subprime mortgage borrowers hit a four- year high in the fourth quarter, the Washington-based Mortgage Bankers Association said today. The trade group said 13.33 percent of subprime borrowers were behind on payments in the quarter, the highest rate since the third quarter of 2002.   More than two dozen mortgage lenders have gone bankrupt, closed operations or sought buyers since the beginning of last year as the effect of looser lending standards, slowing home- price gains, and less wage growth left banks holding bad loans.   Looking to Help   Congress “may need to do something much more quickly to provide some protection or you could end up with a lot of poverty and blight,” Dodd said. Federal aid of a few billion dollars “may be a lot less costly” than $164 billion in lost wealth, he said.   Mortgage defaults during the next two years may rise to $225 billion, with about $170 billion tied to subprime loans, according to a report yesterday by analyst at Lehman Brothers Holdings Inc. led by Srinivas Modukuri. Subprime borrowers are those with poor or limited credit backgrounds or high debt.   Dodd didn’t specify the channel through which federal aid would be offered. “I don’t want to settle on the specifics of it, but clearly we are looking at what we can do to help out.”   Any formal legislation would have to be approved by Dodd’s committee, then passed by both the full Senate and the House of Representatives before being signed into law by the president.   Costly Solution   Federal aid “would come at a cost,” said Douglas Duncan, chief economist at the Mortgage Bankers Association. “It has to be paid for and the question is would the 34 percent of homeowners who have no mortgage be willing to pay taxes to support the bailout of people who traditionally have not managed credit well?”   Duncan expressed doubt that 2.2 million subprime mortgage borrowers will lose their homes, noting that the association lists only 300,000 such borrowers as being in foreclosure now.   Senator Richard Durbin, the No. 2 Senate Democratic leader, said he is open to the idea of helping subprime borrowers while noting that Democratic leaders haven’t decided whether to do so.   “We have not discussed it, but that doesn’t mean that we can’t or shouldn’t,” Durbin said in an interview. “Senator Dodd is in a key position on the Banking Committee and he’s talked to us about the scope of this problem and what the reasonable response might be. I’m sensitive to it. There’s nothing worse than a person losing their home.”   Durbin said that Democratic leaders will look to Dodd for recommendations as Dodd’s committee examines the issue.   New Bill   Representative Barney Frank, a Democrat from Massachusetts and chairman of the House Financial Services Committee, reiterated today that he intends to introduce a bill to deter lenders from offering consumers mortgages they can’t afford.   “We plan to legislate to restrict those kinds of mortgages going forward,” Frank said after a hearing in Washington. He declined to elaborate on the timing or details of such legislation.   Dodd reaffirmed a plan to introduce a bill that would combat predatory lending. “There is a difference between a subprime lender and a predator, and I don’t want to lose the subprime lender,” he said.   The Federal Reserve, Federal Deposit Insurance Corp and other U.S. regulators on March 2 directed banks to scrutinize underwriting standards, provide more information to customers about borrowing risks and ensure borrowers are able to repay loans.   “Finally the federal regulators are beginning to indicate that they want to start requiring similar standards to be used for prime and subprime lending,” Dodd said, referring to the new guidelines.   “I am a strong advocate of subprime lending,” Dodd said. “I don’t want that word to become a pejorative as junk bonds did.”   While not constituting a drag on the economy, defaults may increase to $300 billion if home prices fall and borrowers forgo refinancing because of stricter lending standards, Lehman said.   

GuestMarch 19th, 2007 at 4:13 am

Senator Clinton’s proposal is consistent with helping subprime borrowers without bailing out the predatory lenders….  Clinton Urges Lower Rates for Subprime Borrowers (Update2)   By Alison Vekshin  March 15 (Bloomberg) — New York Senator Hillary Clinton said the federal government should take steps to reduce interest rates and fees for borrowers with weak credit who are losing their homes at record rates as the subprime mortgage market collapses.   “This market is clearly broken and if we don’t fix it, it could threaten our entire housing market, which in turn would threaten our entire economy,” Clinton, a 2008 Democratic presidential candidate, said today at a National Community Reinvestment Coalition conference in Washington.   Clinton said she will reintroduce legislation to add employees and improve technology at the Federal Housing Administration, which provides mortgage insurance to approved lenders. The changes would help the agency develop new mortgage products and serve a larger number of borrowers, Clinton said.   Turmoil in the subprime mortgage market is grabbing the attention of Congress, regulators and consumer groups in the face of a surge in delinquencies and foreclosures. Late payments on U.S. subprime loans reached a four-year high of 13.3 percent in the fourth quarter, while foreclosures on all home loans reached record levels, the Washington-based Mortgage Bankers Association announced this week.   “The market will not address the millions of families trapped in unworkable mortgages hounded by delinquency and facing the grim possibility of foreclosure,” Clinton said.   Pre-Payment Penalties   Clinton proposed eliminating pre-payment penalties that she said are “designed to trap borrowers” by imposing high fees for paying off loans ahead of time. Such penalties apply to 70 percent of subprime loans and less than 5 percent of prime loans, she said.   Lenders should give borrowers who fall behind on their mortgages a “foreclosure timeout” to allow them time develop a payment plan, Clinton said.   She also called for independent counseling to help borrowers avoid becoming saddled with high interest rates and penalties.   The FHA has proposed its own legislative changes to give the agency additional authority. Steve O’Halloran, a spokesman for the agency, welcomed Clinton’s proposals in an e-mailed statement.   John Taylor, the president of the Washington-based coalition sponsoring the conference, blamed the Federal Reserve for the problems faced by subprime borrowers.   Consumers Not Protected   The central bank had the regulatory authority to protect consumers and go after lenders using deceptive practices “and simply has chosen not to do it,” he said.   Fed spokeswoman Susan Stawick declined to comment.   Taylor called for legislation that improves loan underwriting standards and curbs “unsustainable loans.”   “Once and for all, we need to have legislation that will not allow anybody in the lending industry to be able to push a loan toward a person that any reasonable person would agree they should not have gotten,” Taylor said.   A House subcommittee is scheduled to hold a hearing on predatory lending in the subprime market on March 27.   

GuestMarch 19th, 2007 at 4:22 am

Selected sample quotations from Bernanke’s speech on role of GSE’s in “affordable housing” and “subprime market” (http://www.federalreserve.gov/boarddocs/speeches/2007/20070306/). The last paragraph where he says that having a central role in affordable housing does not imply a greater role in the subprime market is altogether contradictory of the previous paragraphs.  “Thus, a standard for determining the public benefit of Fannie’s and Freddie’s portfolios seems readily available: Do the GSE portfolios support affordable housing? At the present time, Fannie and Freddie appear to fail this test. Indeed, by OFHEO’s estimation, less than 30 percent of the GSEs’ current portfolio holdings are oriented toward affordable housing (Lockhart, 2007).  “A straightforward means of anchoring the GSE portfolios to a clear public mission would be to require Fannie and Freddie to focus their portfolios almost exclusively on holdings of mortgages or mortgage-backed securities that support affordable housing.  “… Given the size and depth of the secondary market for most residential mortgages, the GSEs’ purchase and retention of highly rated mortgages and of their own MBS are unlikely to do much to enhance liquidity in the secondary markets for these assets or to promote affordable housing.  “… the market for affordable-housing products–particularly mortgages extended to households with below-median-income–is less deep and liquid than the broader market for residential mortgages. GSE portfolio purchases might add significant liquidity to the secondary markets for such assets, thereby reducing costs and increasing credit availability to prospective home purchasers. In addition, increasing the presence of the GSEs in the market for affordable housing could help banks fulfill their CRA obligations by providing them with greater opportunities for securitizing such loans. In all, from a social perspective, focusing the GSE portfolios on affordable housing could provide benefits that might offset some of the risks that these more-targeted portfolios might pose to financial markets and to taxpayers. The key principle here is that the GSEs’ senior debt–which investors view as government-backed–should be used only to finance assets (such as affordable-housing mortgages) that have, in the view of the Congress, a clear and measurable public benefit.16 Such an approach would set some functional limits on the size of the portfolios and on the range of assets that GSEs would be allowed to purchase, while preserving the ability of these companies to operate profitably.”  “To be clear, I am not advocating a change in the exposure of GSEs to subprime loans.17 Orienting the GSEs’ portfolios more toward affordable housing is an approach which can succeed under the current GSE credit standards. Indeed, the credit risks associated with an affordable-housing portfolio need not be any greater than mortgage portfolios generally, so long as the GSEs continue to adhere to sound underwriting practices. Moreover, a renewal of the GSE affordable-housing mission might stimulate the development of innovative approaches to measuring and managing the credit risks associated with such mortgages.”  http://www.federalreserve.gov/boarddocs/speeches/2007/20070306/ 

GuestMarch 19th, 2007 at 4:42 am

It was expected that the Government would seek to put a bid under sub-prime market, but Bernanke’s speech is remarkable for what he is proposing.   Note that the main effort of Bernankes’s proposal would be to rein in the GSE’s. The Govt’s efforts to do so, waged over the past 5+ years, have largely failed. Bernanke appears to have devised a politically attractive way to re-direct the GSE’s so as to shrink their role:  1. Reduce their profitability (offset current income with loan losses). 2. Reduce their leverage (because of the danger of large losses). 3. Increase their “social utility” to the public by giving them a role in the subprime/affordable housing space.  The political appeal of supporting homeownership for low income families might suffice to defeat the massive political strength of the housing industry. Note that the banks will want to help eliminate this powerful competitor.  

Dave ChiangMarch 19th, 2007 at 6:47 am

 From German Economist Dr. Kurt Richebacher:  The Ponzi US Bubble Economy http://www.prudentbear.com/articles/show/1721  Trying to assess the U.S. economy’s prospects, the first thing to realize is that past cyclical experience offers no guidance to the present downturn because it has completely different causes and also a completely different pattern.   All past recessions had their main cause in monetary tightening. As soon as the Federal Reserve loosened its shackles, the economy promptly took off again, propelled by pent-up demand. For the first time in history, the U.S. economy went into recession against the backdrop of most rampant money and credit growth.   Manifestly, the forces depressing the economy this time are radically different from past experience. The typical, major imbalance in post-war business cycles has usually been in inventories. To correct it, retailers and manufacturers temporarily sold from stock, depressing production. Once the stocks were down to desired levels, production came into its right again. At the heart of the regular V-shaped business cycles was the inventory cycle.   In contrast, the present downturn has its brunt in the combination of a profit and capital-spending crisis. At the same time, there has accumulated an array of economic and financial dislocations that tend to depress the economy in many ways, such as extremely poor profits, badly ravaged balance sheets, a variety of asset bubbles in different stages of development, excessive leverage in the whole financial system and shrinking cash flow. There is nothing normal anymore in the U.S. economy and its financial system.  For the old economists, investment in tangible assets — factories, commercial buildings and machinery — was paramount in creating both economic growth and wealth. It creates demand, employment and income as the capital goods are produced. And with their installment, all these new buildings, plant and equipment create increased supply along with increasing employment and income with increased productivity.  The United States has always been a low-savings and low-investment economy. Putting it in reverse: a high-consumption economy. But all three went to unprecedented extremes over the past several years. Savings and investment have been run down to atrociously low levels that are typical for underdeveloped countries.  To repeat: Investment in tangible assets is paramount in creating everything that is decisive in generating our wealth and raising our living standards. Given the low levels of saving and investment in the United States, American policymakers and economists in recent years have elevated productivity growth to the single most important achievement of an economy. But just by itself, productivity growth creates only unemployment. It is the normally associated capital spending that makes for the necessary, simultaneous demand and employment growth.   This simple recognition — gross lack of saving and capital formation — is really at the root of our controversial and highly critical view of the U.S. economy’s sanity and vitality. True, its growth rate has been the highest among the industrial countries for years. But it has all the time been economic growth of the most miserable quality. The striking hallmarks of this extremely poor quality were collapsing savings, low rates of business fixed investment, a profit carnage that began at the height of the boom, exploding consumer and business debts and an exploding trade deficit.  Today’s economists have at their disposal information in quantity and speed as never before. But reading numerous reports, we have the impression that very few are making use of it.   Particularly shocking in this respect were the immediate euphoric reports about growth acceleration in the second quarter.  During the 1960–70s, by the way, the U.S. accumulated on average about 1.5 dollars of additional debt for each dollar of additional GDP. Just extrapolate this escalating relationship between the use of debt and economic activity. And think of it: the GDP growth of today is tomorrow a thing of the past, while the debts incurred remain.   Plainly, Greenspan’s policy has collapsed into uncontrolled money and debt creation that has rapidly diminishing returns on economic activity. The late economist Hyman P. Mynsky would call this a Ponzi economy, where debt payments on outstanding and soaring indebtedness are no longer met out of current income, but through new borrowing. Soaring unpaid interests become capitalized.   P.S. We keep asking the question of the American economists: Are they providing deliberate misinformation or simply performing slipshod work? In our view, as usual, the latter rings true.  

DecraenMarch 19th, 2007 at 8:05 am

BEN STEIN from finance.yahoo.com ;))   Barely Blip-worthy  Today, the reason is supposedly terror in the subprime mortgage market. To put this as frankly as possible, this is just nonsense.  Even if subprime delinquencies and defaults are up, they’re a tiny portion of total mortgages. Suppose 13 percent of subprime mortgages are in default. Subprime itself is less than 15 percent of total mortgage debt, so that means that roughly 2 percent of mortgage debt is delinquent or in default.  Yes, that’s more than it used to be, and is a disaster for the subprime mortgage companies.  But when a mortgage defaults, the lender takes back the house or condo, sells it, and usually recovers about 75 percent of the loan value or more. That means the real loss would be about 25 percent of 2 percent, or 1/2 of 1 percent.  In the context of a market as huge as the nation’s mortgage market, that’s not a lot. A few companies will go bankrupt, and someone will make a killing buying their bonds and portfolios at a huge discount as they turn out to be worth a lot more than people thought in March 2007. But it won’t mean a lot to a roughly $14 trillion economy, of which the subprime mortgage market is a tiny blip. 

HellasiousMarch 19th, 2007 at 8:28 am

Even if the defaults are contained in the sub-prime, Alt-A, etc market, the fallout could be much greater through CDO infection.  Additional CDO’s were created from pools of CDS’s written on “original” CDO’s. Since there are no limits whatever on the amounts of CDS’s that can be written against those “original” CDO’s, who knows how many such synthetic CDO’s are in existence today. There must be plenty because such CDO issuance was furious until recently.  What does this piled alphabetization mean? That one bum loan can infect multiple CDO’s, creating vertical infection.

CMCMarch 19th, 2007 at 9:20 am

While a government bail-out may be necessary in the end to save the economy from imploding, there is the issue of moral hazard. Why should government bail out those speculators who bought those exotic securitized instruments? And just how does the government effectively differentiate between borrowers who were genuinely duped and speculators who should be responsible for their reckless actions? And is it fair to tax-payers who did not benefit at all from this subprime bubble? It just seems morally worng that speculators who got us into this mess in the first place wind up getting bailed out by government. That is incentive for further abuse — just make sure the abuse is big enough to take the entire system hostage so government will bail them out again.

GammaMarch 19th, 2007 at 9:46 am

A bailout will bankrupt the country eventually as capital flows too easily. It is ridiculous to think that people with money are going to simply hand it over to the incompetent and debt-addicted via higher taxes, weak currency, etc. Moral hazard will drive capital elsewhere.

NourielMarch 19th, 2007 at 9:46 am

CMC, I explicitly discussed proposals to target support to victims, to minimize free riding and reduce the moral hazard of government financial support. If you have specific better ideas on how to implement principles we agree upon let me know. 

NourielMarch 19th, 2007 at 9:53 am

Hellasious, I agree on your point on vertical infection, something i have written about. Still we do have estimated of the total stocks and flows of CDOs, cash, synthetic or otherwise; even if we do not know the full amount of CDS issued to buy/sell protection against subprime, other mortgages and MBS. So we have some sense of the size of the problem even if not the full size of it. Harder problem is to understand this black box of mortgages, RMBS, CDOs, ABX, TABX and what are the systemic issues involved in potential losses and disruptions in any of these markets. 

Claus CMarch 19th, 2007 at 9:57 am

“This overinvestment fed by low taxation of housing investment has led to large current account deficits – via the increase in housing investment and the fall in private savings that the housing wealth effect had on consumption – and to the accumulation of trillions of foreign liabilities.  (…) The rest of the world spent the last decade investing in factories that produce world class, high-quality and low costs goods; the US invested in McMansions that have zero productivity value and spillovers for the economy. Again thank the free market fundamentalist zealots who love no regulation and little taxation of capital for this sorry state.”  Very true and important to understand the effect on wealth of all this.   I’m afraid that Europe and other parts of the world have similar problems with housing bubbles because of easy hosing credit and low taxation of housing investment.  What should be done in the long run:   higher taxation on housing (might do too much damage in the short run): tight lending regulation,  low corporate taxation (to improve investment in productive assets – Ireland and some East European countries have booming economies because of low corporate taxes),  higher progressive personal income taxation (to reduce consumption),  tax deduction of pension plan investments (to improve savings) more public investments in research, education, infrastructure etc. (to improve investments in productive assets) 

JMaMarch 19th, 2007 at 10:03 am

I did not buy into the insanity of this bubble. The billboard by my house of realtors saying “Hot Propery – Expose Yourself” “Hot Property Everywhere” The one new condo building called “The Bomb” which means the “The Best” to the younger crowd or something to that effect for those not familiar with the expression.  Hot Property is For Sale Everywhere now, and a bomb may be the best solution for the 5 zillion empty and under construction condo units for sale in the US. I am renting, avoided the mania and now I should pay taxes to subsidize the last fools in ?  Are there handouts coming ? Should I buy now ?   IS there a point where the world says the US prints money 24 hours a day 7 days a week whether it be to buy their own debt, buy their own stock markets, bail out financial catastrophes or whatever and the world says enough already on the value of the dollar ?  Oh look bad news capitulated and they are taking the stock market up again. Remember this Summer when World War III was quoted on TV by a politician and shortly after the 20% run up began ? The markets are an SEC regulated government funded casino . . . The house never loses.  The absolute best thing for any true bear in the media to do would be to go on television or write articles saying all clear – everything is just fine. As soon as everyone stopped buying puts and 100% of the people were long maybe just maybe there would be a chance of the market going down. Until then, the invincible equity fantasy lives on . . .   

HellasiousMarch 19th, 2007 at 10:13 am

Dear Nouriel,  I have an idea, or two…  a) Make all new CDO issues full recourse to the original mortgage or debt originator (the party approving the loan).  b) Limit Credit Default Swaps issued against a single name only up to that name’s outstanding debt.  Those two should immediately limit future problems. As to the current mess:  c) If you do (a) and (b) then all existing mortgage CDO’s will immediately be marked down to reflect their lower value vs. the new and better collateralized CDO’s – maybe a 25% haircut from par. Freeze trading in the old CDO’s: whoever has them, has them to maturity, except that another institution can buy them (at the lower price) if it agrees to assume recourse AND provide the same discount to the original mortgage’s principal amount, resulting in lower homeowner payments.   

CMCMarch 19th, 2007 at 10:17 am

Professor:  Your government aid proposal sounds sensible, but the problem is that government bail-out usually winds up being abused, and how they carry out your plan is the central issue — execution is often the problem. In the old days when banks and credit unions keep the underlying mortgages on their own book, they can work with borrowers to restructure the loan and that would also make it easier to manage government assistance. But now with securitization, banks have already sold the loans and mortgages are handled by a servicing company who has no incentive to spend the time and efforts to restructure these debts. So the issue is the abuse in the system when large sum of government money is involved. There are no easy answers. CMC

BrianMarch 19th, 2007 at 10:18 am

So the government will bail out the subprime borrowers using taxpayer dollars. What do those of us who borrowed responsibly and lived within our means get besides the bill?

ErnstMarch 19th, 2007 at 10:27 am

I believe in free trade and free markets. However, free markets do not mean unregulated markets. At least where I come from, banks and other financial institutions are not allowed to sell a mortgage without a 20% down payment and strict rules to verify the borrower’s income and assets. And that is a very sensible thing since it prevents, to a great extent, losses for banks and financial institutions as well as defaults from borrowers, and keeps the finance sector well oiled. Mortgage buyers can also request a consumer credit loan to pay their down payment. But this is subject to interest rates similar to credit card rates (very high) and are short term loans. And the bank has to verify net assets and income again before being authorized to give the loan. I think this is a reasonable regulation, helping both lenders (by trying to make sure they’ll get their money back) and borrowers (by making sure they’re able to repay the loan). I frankly never understood how regulators allowed such lax lending practices in the US. I believe the system I just described is a reasonable system to be put in practice. This does not mean that bad loans won’t happen. But they are contained in a reasonable range.  Ernst

ErnstMarch 19th, 2007 at 10:34 am

And I wholly agree with Brian. Whatever bailout there might be is absolutely unfair. If Government had regulations that imposed restrictions on certain types of loans and lenders broke them, they are felons and should be condemned. And the borrowers who falled into an illegal trap should be compensated. But if regulations allowed all the loose lending standards that you had, it is absolutely unfair to use taxpayer’s money to bail anybody out.  Ernst

ErnstMarch 19th, 2007 at 10:39 am

The only problem with the system I described above is that, where I come from, there is a significantly lower amount of homeowners. Most people rent, since they have to demonstrate the ability to pay before being granted a mortgage. This is changing now as regulators have extended the mortgage terms for a first home from 20 to 40 years.  Ernst

AnonymousMarch 19th, 2007 at 10:52 am

Just a question for the group. Any idea what impact the subprime fallout will have on the multifamily market? My sense is that the foreclosures and tightening of credit on the low end will force more people into traditional multifamily units driving up vacancy rates.

Jason BMarch 19th, 2007 at 11:42 am

Nouriel – I respectfully disagree that the cause of the problem is blind adherence to the dogma of free market, but instead to a deliberate lobbying campaign of the major financial institutions (Goldman, Morgan, et al) to have standards loosened for their benefit. This process began with the Depository Institutions Deregulatory and Monetary Control Act of 1980. They have benefited greatly, and will now probably escape with a bailout.  For the legal options of borrowers, I direct you to section 608 of the Depository Institutions Deregulatory and Monetary Control Act and Section 108 of the Truth in Lending Act. Not much there, really.

GuestMarch 19th, 2007 at 11:44 am

I will add another idea to the mix. Require that all real estate based derivatives are marked to market monthly. This will stop the big banks from sitting on losses while they attempt to manipulate the markets.

Jason BMarch 19th, 2007 at 11:56 am

I would like to point out that since Geo HW Bush presided over the S&L bailout (from which his sons Jeb and Neil profited nicely), and Geo W Bush over this subprime disaster, Bushes will have presided over the two biggest financial scandals in the history of the world.

SamMarch 19th, 2007 at 12:22 pm

Dr. Roubini,  A very thorough analysis of the upcoming scandal indeed. It is pathetic that mainstream media keeps driving with blinders on: the recent BusinessWeek touts how families are taking advantage of 30 year fixed which are going lower… All prime lenders like Wells Fargo do have a substantial sub-prime component, and they will try to transfer losses from sub-prime and Alt-A’s to the rest of their mortgage business by charging higher rates to those who can afford to pay, IMHO. So, rates can’t go lower for 30-yr fixed, in the medium-run…Anyway, what is your take on Fed’s interest rate moves in the next couple of years in the backdrop of outright recession / growth recession that you have been propounding for a while??  Meanwhile, I analyzed the red-hot housing market in the SFO Bay Area where I live: the real-estate value (or lack thereof) chain keeps pushing homes to gullible buyers, even though sub-prime numbers are eearily similar to the national average in a couple of counties here. Among other things, agents tout that demand will keep the house prices going up, since unemployment in Silicon Valley is 4%. It is a bunch of hogwash, because the valley never really recovered from the tech winter of 2001/2002, real unemployment is more like 15% to 20% (if one includes wives who are looking but can’t find jobs) and double-income families are rare here, which a family needs to afford the $700,000 home (median-price in SFO Bay Area). I did some preliminary analysis and am recommending that people rent and not buy, since renting is half of mortgage. My complete article on the Bay Area housing (more to come in the next few weeks) can be found below, for those interested in California real-estate (I also am urging my readers to read your blog, as one of my recommendations….)  http://economy.franteractive.com/real-estate/bay-area1.html  Best regards, Sam

PaterTenebrarumMarch 19th, 2007 at 12:35 pm

i find it quite astonishing that the mess is now blamed by Mr. Roubini on ‘free markets’ and/or ‘free market zealotry’. in reality, most of the blame lies with the central bank administered money price fixing scheme – in which the CB brings interest rates to levels below natural market rates (which is exactly what ignited the housing bubble and its wild outgrowths in financial engineering).  furthermore, the congressionally chartered GSE’s represent another state-directed market intervention that likewise contributed to the mess.  in other words, it is NOT a failure of the ‘free markets’ or the bureaucracy’s alleged ‘zeal’ to adopt free, unregulated markets (that’ll be the day). it is a failure of central economic planning, and little else.   if Congress now proceeds to ‘bail out’ borrowers who went in over their heads , it will make an even bigger mess – it will reward irresponsibility and prevent a market clearing of the malinvested capital. mistake would be heaped upon mistake.  this is actually the typical reaction to failures of central economic planning – once the failure becomes evident, cries for MORE state intervention immediately arise – to fix the mess made by the previous intervention. note also that it is highly doubtful that borrowers are going to be the foremost beneficiaries of Congress’ largesse – it is the lenders who need to be ‘bailed out’ – and inter alia because they all knew beforehand that they could rely on taxpayer handouts if push came to shove , they had an additional incentive to take such enormous risks.  besides, nobody put a gun to the heads of borrowers and said ‘borrow more than you can afford’.  what ever happened to personal responsibility? are all those borrowers akin to underage children? how can one borrow hundreds of thousands of dollars and not THINK for a moment if one can actually afford to do so?   why would lenders not scrutinize the credit risk their clients represented more carefully before handing over these vast amounts?  obviously none of this would have been even remotely possible without Messrs. Greenspan and co. dropping the FF rate to one measly percentage point, and implicitly condoning the development of the bubble by denying that it even existed, while lauding the risky lending practices that developed in its wake.  meanhile, when Mr. Bernanke asserts that the GSEs are NOT deemed ‘too big to fail’ the whole world has a good belly-laugh; everybody knows they will be bailed out – it’s an absolute certainty, more certain than gravity.  this allows them to indulge in risks no rational economic agent in a truly free market would likely ever take on.  so please, let’s for a change not blame the ‘free markets’ , but instead put blame where it belongs, with interventionist monetary and fiscal policy.  in this context note that the very foundation of the financial system – the currency system itself – is NOT a free market. if it were, there would not be a ‘central bank’, and there would not be any ‘fiat money’ either. these are features of central economic planning, which of course doesn’t work (never has, never will).  why people would believe – and by and large unthinkingly accept – that money should be excepted from the rules of the market is a bit of a mystery, but no discussion of a financial boom/bust situation such as this one makes sense without considering this central root cause of booms and busts.

Anonymous ibid.March 19th, 2007 at 12:42 pm

Brian asks, “What do those of us who borrowed responsibly and lived within our means get besides the bill?”  A sense of relief that you were spared months of wondering whether you would be homeless? Freedom from having the government ransack your financial life to decide whether you are worthy or not? The ability to face the world with the confidence that you’ve gauged things accurately? Maybe even a sense of gratitude to be secure while others must live by your good grace?   Those who reduce everything to money are truly the poorest of all.   One aspect that has not been adequately discussed is the role of fraud, including from organized crime in some of the more ridiculous mortgages. CNBC carried an interesting segment with the Atlanta US Attorney describing how poor people’s names were used fraudulently to get mortgages– used, by lawyers and appraisers and mortgage brokers who would never dream of having a subprime themselves.

GuestMarch 19th, 2007 at 12:57 pm

So how will millions of homeowners be thrown homeless when rental rates are far less expensive than mortgage cost right now. Actually this would save these homowners going into forclosures money. Nobody is going to be out on the streets unless they can’t find a job. The US has plenty of jobs to go around if we just make illegal workers illegal. If a bailout were to happen it would be only for the bagholders of these mortgages. The only thing a homeowner would lose is some pride because they now would have to live within their means.

wetzelMarch 19th, 2007 at 1:14 pm

PaterTenebrarum,   You end up making Dr. Roubini’s arguments for him.   Greenspan’s Fed is the result of having a free market zealot as Chairman. No more objectivist libertarians at the Fed.   We need another sour utilitarian like Volcker.

PaterTenebrarumMarch 19th, 2007 at 1:28 pm

also, lots of fraud has been going on at the height of the bubble, as detailed here:  http://bubbletracking.blogspot.com/  Congress may well end up bailing out a bunch of fraudsters in the process, who would of course relish the opportunity to make coin a second time! this would be hilarious, but not totally unexpected – when government hand-outs are to be had, fraud is never too far away after all.

Ryan DarwishMarch 19th, 2007 at 1:39 pm

I suspect that the current discourse on government intervention is little more than a thinly veiled attempt at creating a political plus on the side of its promoters. I think we must ask just what would a “bailout” distressed homeowners accomplish, and whom would it really help? The chances are good that many of the distrssed homeowners have little equity in their homes, and some of those that do only have it by virtue of its appreciation during the bubble phase. Other distressed homeowners have sucked the equity out and transformed it into current consumption. For many of these of these situations, the real loss would be the idea of home ownership as opposed to a loss of material net worth. If these homes were foreclosed, there would be a greater demand for rentals. It appears to me that the real beneficiaries of any kind of bailout, or government intervention would be the insitutional beneficiaries who have already profited so handsomely during the inflation of the real estate bubble. There has been ample discussion in this blog of the potential adverse systemwide financial effects of this sub-prime/alt-a meltdown. When the demogogic rhetoric is pierced, it is these institutions that will be given forebearance. If a sub-prime mortgagee is currently in trouble, why would they be less in trouble in the future? Better job, better consumption and credit management, lower health care costs? I don’t think so.  As to who is to blame, in a complex socio-economic system such as ours there is such implicit and explicit complicity that there is usually enoough blame to go around. The question of free market idealogues or a more regulated environment serves to more polarize positions. In reality free markets are more of a hypothetcial construct than anything which exists in reality. By the same token  “Booms and busts are regular features of market economies that do not have sensible government supervision and regulation of financial and credit markets.” leaves open the question as to what is sensible, and even if sensible in conception, does the corruptable human element of implementation hold within it the seed of its own demise? There does not appear to be a party monopoly on malfeasance and less than ethical behavior. Both the democrats and republicans seem to have ample skill in this regard.  The real question crux of the matter seems to come down to human behavior and character.  Ryan Darwish www.investmentmegatends.com Author of The Emperor’s Clothes: A Look at the Megatrends Affecting Your Financial and Investment Decisions

artichokeMarch 19th, 2007 at 1:40 pm

Fully agree with JMa and Brian. I don’t want to subsidize those who allowed themselves to be given the American Dream, on terms they should have known were baloney. It’s their responsibility not mine.  The guy who said “Those who reduce everything to money are truly the poorest of all.” is the most dishonest of all, because this is inevitably about money. This casino-like mortgage mania has indeed cheapened and embittered the house-buying process into an investment competition, but I didn’t cause that and indeed did not participate in it. I should not have to pay a nickel for it.

NourielMarch 19th, 2007 at 1:44 pm

PaterTenebrarum, it seems you did not read my blog. I spent endless ink in this blog explaining why low Fed Funds rate were not the main source of the housing bubble and why the GSEs – who may be blamed for a lot – were not at the center of the subprime securitization as they left that business to free private markets for the last few years. And i explained in detail how supporters of true victims (not all borrowers) can be provided without bailing out reckless lenders. So you make the usual fundamentalist arguments blaming government policies for this mess without bringing a shred of analysis and evidence for it. Try harder next time around. 

ErnstMarch 19th, 2007 at 1:48 pm

Pater Tenebrarum  As I mentioned before, I believe that the cause of all this is that the financial markets lack reasonable regulations. The main one in this case is that lenders should verify if their borrowers will be able to repay. And there are many ways to regulate this without becoming a serious impediment to a free market. The Central Bank uses interest rates to smoothen the extremes of a cyclical market. Or that’s what it should do. Obviously lenders did not put a gun to the head on borrowers. Borrowers were either stupid or malicious. There always will be bad loans since checking that borrowers are able to repay does not mean they are willing to repay. There is a certain percentage of crooks in every society. And banks and businesses know roughly that percentage amount and annualy or quarterly make a provision for uncollectible receivables against profits.  But the Fed rates have nothing to do with people being forced to enter unpayable debts. Interest rates normally rise and fall in the US. They may not be so variable in Switzerland, but they are in the US. So US consumers are perfectly aware of this fact since they have been experiencing this for tens of years in their credit cards. So don’t, please, put so much blame on the Fed. Why the heck would a sane person enter a contract he will not be able to repay instead of renting a home, which he can afford? I am at a loss to understand.   Ernst

paddingtonMarch 19th, 2007 at 1:49 pm

Brian “What do those of us who borrowed responsibly and lived within our means get besides the bill?”   Ibid “Those who reduce everything to money are truly the poorest of all.”  One can see that this is going to become a messy situation!   Here’s my take on it  – some (many) people took on loans that they knew were beyond their means in the expectation of making an easy buck through price appreciation – a very few people may have been talked into this (and I’m thinking elderly vulnerable people here) without understanding the risks – the general public (taxpayer) were not involved in these cases, and took no profit from the other side – the finance industry were involved and have taken lots of profit  For the majority of speculators or people who took on a stretch mortgage tough. Had the market gone the other way and produced 30%/ 40% gains over the next year or so would anyone be suggesting that those priced out of the mkt in that case should have a large subsidy to make up for the fact that they didn’t buy earlier? Of course not. If the government bails people out of this mess then that is a green light that propoerty investment and speculation has little downside and the bubble will become scarily large.  I do think that in the relatively small number of cases where it can be shown that products were so mis-sold it’s obvious that they shouldn’t have some redress should be considered. I strongly feel though that this should be the responsibilty of the finance companies and their parents who made these loans and profited hfrom the repackaging and reselling. It should not be down to the general taxpayer who was not complicit in this arrangement.  Overall I believe that we are all responsible for our actions and the conequences of them and do not believe that being bailed out by an already bankrupt taxpayer is relevant.  Ibid I think that this was an unfair comment to Brian. It was indeed greed for money which has put people in stretched situations that have caused problems, either their own or the greed of the industry that sold to them. My understanding is that this risk taking is part of the american way, and if people guess correctly they do well, if not they don’t. It’s not appropriate to have a one sided subsidy, nor in my opinion to change the rules once the game has started. Holistically I agree with your comment, but the way in which we live and in which our society operates is so far from the way in which it should that it is a different debate and not one for an economic blog I feel.   

artichokeMarch 19th, 2007 at 1:49 pm

We voted for Democrats because they are against the war, not because we wanted their social programs. But they made a deal with Bush that he gets his war and they get their social programs. Now we might be stuck with a social program for the mortgage market. Ain’t politics wonderful.

PaterTenebrarumMarch 19th, 2007 at 1:49 pm

Wetzel,  i don’t think it matters much WHO is doing the central economic planning – it is bound to be bad anyhow. a bureaucracy simply can not possibly know better than the market, even if we were to assume (a big assumption) that it was made up entirely of persons with nothing but the best intentions. the result will always be sub-optimal.  besides, i don’t think that Greenspan’s distant libertarian past had any bearing on his job as a monetary bureaucrat. he was the biggest inflationist of all time (money supply growth under Greenspan was certainly in a league of its own).  if he truly had been such a champion of the free market he would never have taken such a job – instead he would have recommended to abolish the job and return to honest money.  the central bank’s real ‘job’ is to inflate, while managing inflation expectations at the same time. it is basically a scam, an ingenious one admittedly, but nevertheless, at its core a fraudulent enterprise.  note in this context that investors willingness to take risk in the financial markets is a direct result of monetary inflation as well. how else can one protect one’s savings? irresponsible behavior is rewarded – while prudence is punished.  the misdirection of capital is a major effect of inflation – one can only wonder sometimes how much further we might have progressed economically if we had a sound free market system.  it is of course testament to the ingenuity of producers that as much progress as has taken place has done so in spite of the interventionist roadblocks put up by the statists.

artichokeMarch 19th, 2007 at 1:57 pm

I think I agree philosophically with PaterTenebrarum, but would add that economic progress is not all that is important. Without the inflationary push for economic growth, we might not have as much growth. But we would have better lives.  In growth economics, welfare is calculated as a function of wealth only, if it is calculated at all. In the older days, welfare was a function of both wealth and leisure as I recall. We’ve forgotten about leisure, i.e. the good life (or the closest approximation thereto within economics).

wetzelMarch 19th, 2007 at 2:50 pm

PaterTenebrarum,  Currency stability is a necessary condition for business investment. For a bank to loan money, it needs to be reasonably secure in being paid back in currency that has inflated at a slower rate than the interest rate.  Business would have difficulty investing in capital if they did not have any way to discount the value of future earnings.  The absolutely number one priority of the Fed is to provide stability to the currency. Compared to this imperative, its mission to promote growth is not nearly as significant.  Let me see if I understand. You believe that market mechanisms, all by themselves, will guarantee a reasonably stable currency? Seems kind of nuts to me. Who has the market incentive to preserve a stable currency? (Debtors want inflation. Creditors want deflation).

jgMarch 19th, 2007 at 2:56 pm

Professor, you’ve been great on your analysis to-date, but you’re wrong on your proposed solutions. And, the good news is, that as confidence in the U.S. economy falls, foreigners won’t fund our Federal deficits, and we won’t be able to offer widespread relief to ‘deserving’ recipients.  It will be great for state and Federal governments to have their hands tied by falling tax revenues and sky high interest rates, minimizing further borrowing. Time to get back to basics, people.

wetzelMarch 19th, 2007 at 2:59 pm

Additionally, supposing that you might be able to argue that the market can spontaneously hold to a monetary equilibrium, would anybody have faith in that?  And if people did not have faith in it, wouldn’t that in itself destroy the currency?

moldbugMarch 19th, 2007 at 2:59 pm

Dr. Roubini,  I think that if you took the time to read the Austrians, you would find that their views on the Chicago School differ very little from your own. Perhaps there is some disagreement on the appropriate prison terms or method of execution. But if you are under the impression that anyone who is a “libertarian” must believe Milton Friedman made useful contributions to economics, it is not difficult to disabuse yourself.  It is certainly an error to assume that refuting the latter, which is easy, refutes the former.  The proposition that inadequate regulation can be responsible for financial disasters is not at all inconsistent with Austrian “praxeology.” In fact, Austrians will tell you that this is exactly how intrinsically unstable systems which include a regulatory central point of failure fail. The political power of the regulator is overcome by corrupt interests – precisely as you document. The obvious near-term solution is making the regulator bigger and stronger. In the short term this works. In the long term it provides more points of access by which corrupt interests can capture the system.  Austrians think the world works better without bandaids, but that doesn’t mean that if you have a spouting artery you shouldn’t throw some duct tape on it. It means that a financial system should be designed in such a way that it does not end up as a giant sphere of incrementally applied adhesives with a continually spreading pool of blood at the bottom.  Yet I can think of no better way to describe the place to which the indefinitely sustainable tension of Keynesian mandarin dirigisme and Friedmanite mathemolatrous “free-market dogmatism” has brought us. If the history of the last 50 years has taught us anything, it is that neither of these forces can inflict a final defeat on the other. This does not prove that both are pseudosciences, but it hardly contradicts the hypothesis.

DocBergMarch 19th, 2007 at 3:09 pm

Somehow I doubt that this fine essay by Professor Roubini is going to be popular at places like Lewrockwell.com… But, it makes a great deal of sense. I drive through all the new subdivisions currently destroying agricultural land in my area and it amazes me that none of the capital or credit used in their construction is being put to productive use. I am glad to see that I have some support in this belief. I think that much error is generated by thinking that people make rational choices in things like house purchases. I have been attempting to sell a small split level house in a small town with some severe economic challenges. I had a person try for 5 months to buy it last year who was handicapped and who could not navigate the stairs nor use the upstairs bathroom. She was strung along by a variety of mortgage scam artists for 5 months. Her only documented income was Socialist Security Disability, and was being paid in cash for some sort of a job. Her reported income was far too low to support the mortgage payments for even a cheap house like mine. There was no way that she should even have been considered for a mortgage. She could not even afford a down payment. But, she was told that if she had only applied for a certain mortgage before December 15, 2006 she would have qualified for a mortgage! So, here was a person seeking to buy a house that was totally ill suited for her needs, with no money, and not enough income to support the deal. And, was planning on doing extensive renovations to boot. Not much rationality involved there. My realtor went to a continuing education course and they spent an afternoon on mortgage fraud. Virtually all of what they covered had happened during this abortive process. If this sort of sad case is common, and it sure seems that it is, then Professor Roubini’s stark predictions are probably even a bit optimistic. There is a need for some sort of sub prime market for people starting out. But first time buyers are not the only ones to inflate assets and income to buy more house than they can really afford. I suspect that fraud is equally present in the more expensive mortgage realms as well. The difficulty lies in coming up with some ways of fixing what can be fixed in this disaster, without subsidizing moral hazard or fraud.

moldbugMarch 19th, 2007 at 3:16 pm

wetzel,  By implicitly evoking Irving Fisher’s hypothesis that lending is dependent on “price stability,” you are assuming what you’re trying to prove.  Price stability in the Fisherine sense can only be defined relative to an index of goods, which may have no relevance at all to either lender or borrower.  From the perspective of the lender, lending decisions are made at the margin, and are relative to other possible uses of the money, such as just keeping it in a box. If there is any borrower who can offer better interest rates than the slightly negative performance of simple storage, lending will occur. Lenders, in other words, are comparing apples to apples – money to money. No oranges need appear in the equation.  From the perspective of the borrower, his ability to offer a return does not depend on any generalized price index. It depends on the specific prices that the borrower pays for the factors of production, and the prices that the consumers will pay the borrower.  I believe you’ll find that in many industries, very profitable financial investment occurs despite exponentially falling consumer prices. The classic example is semiconductors.  Fisherine price stabilization was simply a new suit of clothes for the traditional mercantilist strategy of diluting the money supply. It was accepted in the 20s because it was convenient to the desires of the power centers of that day. It since has been taken into the canon as a revealed truth. But it cannot withstand any intelligent scrutiny.  Austrians would be happiest with a fixed supply of money, which would not “stabilize” prices but eliminate exogenous political effects on them, making it as easy as possible to forecast price changes (but, as Einstein put it, no easier). In theory a fixed money supply could be implemented in a fiat currency, but in practice the temptation to dilute has always proved irresistible. This is why Austrians, in general, favor the gold standard.

BrianMarch 19th, 2007 at 3:22 pm

Paddington, what I find hard to comprehend is those who seem to be intelligent that do not understand how they got to the point of not being able to afford their payments. I saw a news piece this weekend about a couple who had been remodeling their home and now they must put the remodel on hold because they are strapped for cash because their adjustable rate mortgage has reset and their payments are now $300 per month higher  One quote I found disturbing from the couple was “Somewhere between point A, B and C, our mortgage turned into an adjustable rate mortgage and now we are having trouble affording the payments.”  I’m not sure how a mortgage would “turn into an adjustable rate” without the homeowners knowledge.   These are not new home buyers either. They have lived in their house for 36 years! 

wetzelMarch 19th, 2007 at 3:29 pm

If there is any borrower who can offer better interest rates than the slightly negative performance of simple storage, lending will occur.  I have heard these arguments before, but I have never been able to grasp it. How is the “slightly negative performance of simple storage” accomplished? Why not the “catastrophically negative performance of hyperinflation”?   And what does gold have to do with anything? Why not vanadium, pretty beads or the color blue?

ErnstMarch 19th, 2007 at 4:08 pm

Dr. Roubini, I think that in the case of the US, a severe drop in the Fed funds rate, say to zero, would tend to create overspending (or overinvesting) somewhere. Because US people have a marked tendency to spend (or keep up with the Jones’, as was the old saying). In Japan, and other Eastern countries, where their people have a marked tendency to save, reducing interest rates would have very little if any effect. I believe the Fed has misjudged the psychology of the American consumer, just like the BOJ misjudged theirs’ some years ago. Probably, the American tendency to spend will be severely corrected in the following months, or years. But I believe it will inevitably come back and woe to those who witness very low rates in years to come, unless reasonable regulations are in place.  Ernst

moldbugMarch 19th, 2007 at 4:14 pm

wetzel,  Your comments in quotes are using the word “performance” in two separate senses.   The “slightly negative performance of simple storage” is an interest rate. The numerator and denominator are both in money – the good being stored. The rate is negative because of the cost of secure storage.  In the “catastrophically negative performance of hyperinflation,” the numerator is money and the denominator is something else. Even in a hyperinflation, the laws of logic are not bent and a dollar is still a dollar. Thus these two situations can coexist.  Various terms such as “inflation,” “real,” etc, have Fisher’s assumption built in. Ie, they are only meaningful relative to some price index. If you have any interest in reconsidering Fisher’s assumption, you may want to temporarily suspend your usage of these terms.  Pretty beads and the color blue are unlikely to be competitive currencies, because the latter is not scarce and the former is not inelastically supplied. Vanadium would make a perfectly good currency, especially in an age where electronic cash can denote a warehouse receipt and not require direct coinage, although because of the novelty of this usage any large, correlated increase in the price of vanadium relative to other goods would probably result in a very large increase in global stocks of mined vanadium, making the stuff relatively uncompetitive relative to other candidate currencies. Gold is the leader both because 5000 years of aggressive gold mining have created an extremely inelastic supply curve, and because only one good needs to have currency status for a stable equilibrium, and gold tends to be chosen because others will choose it (Schelling effect).

wetzelMarch 19th, 2007 at 4:28 pm

Okay moldbug, that is very interesting. I will try not to be flip.   Please explain how a ‘fixed supply of money’ would not (if I should avoid ‘deflation’) encourage hoarding and punish debtors. If the supply of goods and services is increasing (economic growth) then it must become harder and harder to get dollars in a fixed money supply environment. The best strategy would seem then to be to hoard dollars and never go into debt. This doesn’t seem to be a good set of incentives to design an economy around. What am I missing?  I am sorry if this seems like it is going off the topic of the thread, but the discussion of ‘what to do next?’ seems to get quickly to fundamental ideas of Friedmanism vs. Austrian libertarianism vs. Keynsian monetarism vs. Rawls vs. utilitarianism. At least it is naturally going to lead to questioning the role of the Fed, which goes toward the fundamental monetary policy.

ursel doranMarch 19th, 2007 at 4:36 pm

Dr. R., et al Your analysis of this horrifically complex issue is excellent as usual.  However with the FED as the primal creator in this brave new world of Ponzi finance, I think you are letting them off way to light. Recalling Greenspan told Ron Paul in 02 that he could not control the money supply as he did not know what it was.  Do you recall Mr. Raines neat little business generator of putting touch screen computers in the MacDonalds stores in the Southeast so folks could get a mortgage on their dwellings while having a super size Big Mac. Mania chronicles for history.   As the FED is private, and not responsible to anyone, then we should either put them out of business, or make them a cabinet post under control of Goldman Sachs. Kidding of course. Two serious views here and some comic relief of the Tragic Comic Opera now playing for the next several years.  One Honest congressman puts the blame on the FED.  http://www.house.gov/paul/tst/tst2007/tst031907.htm Janazen has good comments on the fallout. http://www.itulip.com/forums/showthread.php?t=1087 Poster boys of stealing from banks by invitation, without a gun. Gotta love it.  http://bubbletracking.blogspot.com/2007/03/mr-senator-dodd-subprime-victims-right.html  

Anonymous ibid.March 19th, 2007 at 4:49 pm

Paddington, I don’t believe that the comment directed to Brian was unfair at all.   Free market fundamentalism asserts that there is no role for government except the army (and other very limited functions). *Every* industrialized nation has rejected that idea, except the United States where the issue has been fought out in elections over the last generation.  Brian asks what he gets out of helping people who have bought a mortgage they could not pay. But what does he get out of educating another family’s child? What does he get out of paving Interstates he may never use? What does he get out of treating the tuberculosis of a prison inmate?   He gets a *society*, instead of a bunch of animals trying to grab everything they can for themselves.   No, the comment was not unfair. We can discuss whether speculators should be excluded from help with mortgages, whether there should be a cap on property size covered by relief, and so on. But to fail to see that we all have a stake in keeping people from homelessness deserves rebuttal. Free market fundamentalism is extremism, and Nouriel was exactly right to slam it.   As for the doubts expressed by various posters that being evicted will lead to homelessness, they have failed to consider transaction costs. Once you have exhausted your savings and piled debt onto credit cards in an attempt to avoid eviction, you don’t have enough to pay a mover, your credit is shot, and you are emotionally at the end of things. The odds of ending up homeless, if not worse, are very high.   One other point that jg’s post reminds me of: foreigners bought a lot, probably 25%, of the securitized mortgages. The US market as a whole will lose credibility if we fail to deal with this problem fairly.

Jason BMarch 19th, 2007 at 5:35 pm

Anonymous ibid:  It is a false choice between bailout and homelessness. Those foreclosed upon can always rent. Don’t define the problem so you can conveniently answer.  If people were the victim of fraud, then a crime was committed and they won’t be foreclosed. Otherwise, they went into the agreement well educated about the terms. The signed their names more than 2 dozen times. They saw the monthly payment schedule.

artichokeMarch 19th, 2007 at 6:21 pm

If people need help, there are some programs like section 8 subsidized rent, and AFDC if they have dependent children. They could move in with friends or relatives. They can find a way to get along, the same as everyone else does.  These are people who have had a share in doing it to themselves, specifically by handling money at least somewhat irresponsibly, or gambling on price appreciation when they could not afford to make such a gamble. Some other poor people are totally blameless. Should we treat the first better than the second by giving them more money or better subsidized housing? I say it would be immoral to do so.

Octavio RochettaMarch 19th, 2007 at 6:46 pm

We are living in the age of TV, the age of Hollywood, the age of short cuts, the age of getting rich via reality TV shows. The age of trying to come by easy money. Forget about hard work, saving, getting value an education.  People have lost the sense of reality; e.g., if you work in the post office you cannot afford to drive a Hummer/live in a million dollar house. People in the US are consuming beyond their means. If you do not produce you are not entitled to consume.  The Professor says:  “The analysis above suggests some principles for the coming financial support that will be given with public funds to clean up the unfolding mortgage disaster. First, distinguish between true victims of predatory lending and deadbeat borrowers who were into early strategic default. Early payments default is a clear way to distinguish between inability to pay and unwillingness to pay. Also, means testing for financial support is crucial: low income and low asset households who were pursuing the American Dream and were deceived by lenders may deserve support. But subprime borrowers with higher incomes and/or assets do not deserve support and should be pushed into foreclosure if they are unable or unwilling to service their mortgages.”  IMO, coming up with any kind of objective/fair scheme to decide who gets help is virtually impossible. The harder I think about it the more I believe that the “optimal solution” (my background is optimization) is the “do nothing approach”. Let the chips fall where they should. Anyone who believes they were cheated/forced to take a loan (writing this feels ridiculous) theyy could not afford can take legal action.   Let the bubble burst. Trying to help people stay in houses they cannot afford is ridiculous. Perhaps, once prices correct they can start from zero: bust their behinds working hard to save 20% for a down payment on a piece of property they can afford. Or just pay rent which may even be a smarter alternative.

ErnstMarch 19th, 2007 at 6:53 pm

ursel doran,  The Honest congressman does not blame the Fed for doing something wrong. The congressman says the Fed should never have existed in the first place. And those are two different views. And maybe if the Fed did not exist we would be leading different types of lives. Better or worse?  It’s up to the economic theorists of different schools to wrangle that out and come with a logic and reasonable explanation.   Ernst

ErnstMarch 19th, 2007 at 6:59 pm

I believe that a Central Bank should exist with limited powers. How limited? I think that should depend to a great extent of the type of people living in that country. Maybe a country with 100% well educated people, with a high cultural level, who never indulge in reckless behaviour, are 100% honest and look after what is really better for them, don’t need a Central Bank.  Ernst

ErnstMarch 19th, 2007 at 7:09 pm

But then, of course, there is reality. One has to be able to wake up. And economists must make realistic assumptions.   Ernst

wetzelMarch 19th, 2007 at 8:33 pm

Our society is facing huge challenges. We are bogged down in the Iraq fiasco. The climate is changing. . .  We don’t have time to change our monetary system. This is absurd. Maybe it would work. But it seems like a kind of irrelevant mental exercise.   Maybe our economic system is not Plato’s ideal Austrian super economy, but it has proven to deliver a pretty good quality of life over the years. My instinct is towards conservatism. In a crisis, conserve what has practical value.   We all can remember. Not so long ago there were much more prudent underwriting practices in residential mortgages, so it does not follow that we have to eliminate the Federal Reserve to get prudent underwriting because we can all remember having a Federal Reserve system coexist with prudent underwriting.   Something else is wrong today, and Nouriel is close to the mark.  It is idiotic to talk about abolishing the Fed. We have much more important things to worry about.   

moldbugMarch 19th, 2007 at 8:41 pm

wetzel,  These are certainly the right questions to ask.  The idea that it would be “harder and harder” to get units of currency in a closed-loop financial system (fixed money supply) is certainly intuitively appealing. It is also generally accepted. But, like all intuitively appealing and generally accepted ideas, it needs to be looked at carefully.   To put the same proposition in slightly different terms, we are very used to thinking the money supply needs to grow as the economy “grows,” and if it doesn’t there will be some kind of “crunch.” In which debtors will, indeed, suffer. And all the historical evidence we have certainly appears to confirm this relationship.  But historical evidence is not empirical evidence.   Empirical evidence means a controlled experiment in which variables are isolated. Historical evidence gives us the results of a variety of uncontrolled situations whose consequences we know. Anyone doing empirical research who set up his or her experiments in the kinds of random patterns that history gives us would be shot. Feynman’s essay on cargo cult science is essential reading for anyone interested in the perils of uncontrolled experiment.  It is presently impractical to experiment with economic systems containing actual human actors. But, with the growth of virtual worlds, it’s starting to become at least conceivable. Suppose this trend continues, and granting agencies support the creation of a software framework for a virtual world which can actually attract real users, and which is designed so that its economic parameters can be tweaked.   If such controlled experiments then become practical, it is fairly easy to see that they represent altogether another order of science than the results of the uncontrolled experiments that history has presented us with. The latter can then be discarded – along with pretty much all of 20th-century positivist economics, which from the perspective of the 21st century will appear to be nothing more than a pseudoscience. Nor is it clear that we need to wait for the results of these experiments to appear. For if the word “science” has any meaning, pseudoscience is pseudoscience – it is invariably inferior to honest and acknowledged ignorance.  The problem with uncontrolled experiments is that they are subject to selection bias. In other words, they tend to tell you what you want (or at least expect) to hear.  So the historical evidence gives us some reason to believe that there is a relationship between policies that freeze or contract the supply of present money, and unpleasant economic effects. We can agree that these effects are not desirable.  But what we don’t know is the nature of this relationship. We don’t know the structure of cause and effect. All we have is a few simple mathematical models that are back-tested against history. These models (such as the quantity theory of money, the IS-LM curve, the Phillips curve, the Taylor rule, etc, etc) in general do not purport to describe any emergent behavior of real economic actors. They are a mix of tautologies (Murray Rothbard once compared the quantity theory of money to the hypothesis that the amount of water that hits the ground is the amount of rain that falls out of the sky) and historically validated rules of thumb.  The idea that any policy formed as a result of these kinds of models must be “scientific” is astounding. I suspect to our children it will appear comical, though ruefully so.  To understand this, let’s consider two different perspectives that are consistent with the historical relationship between monetary growth and macroeconomic stability that we’ve observed so far.  Perspective A tells us that monetary growth is like eating. You can injure yourself by eating too little, or too much. You can starve to death, or you can get fat and even burst your stomach, as in the Monty Python sketch. Perhaps deflation is like starving yourself, and hyperinflation is like bursting your stomach. Therefore the optimal policy must be a moderate and stable balance between these two extreme endpoints.  Perspective B tells us that monetary growth is like shooting heroin. When you stop shooting heroin, you are guaranteed to feel awful. In fact, for some drugs (like barbiturates) withdrawal can actually be fatal. Heroin addicts have to do heroin all the time just to feel normal, but (I assume) there’s still a little rush when you shoot up, then a crash later. And, of course, if you do too much, you can kill yourself. So deflation is like withdrawal and hyperinflation is like overdose. It is possible to coast along as a functional addict on a maintenance dose, with those little ups and downs, surviving indefinitely. But this certainly does not change the fact that the optimal amount of heroin for anyone to be shooting is none at all.  My point is that historical evidence does not give us any way to distinguish between these alternatives. If we are unable to run a controlled experiment and we want to decide which perspective is right, we need to resort to deductive logic – the Austrian specialty. (Sometimes you will hear people call it “praxeology” or “catallactics,” but these terms never really caught on.)  Deductive logic has gotten a bad rap because it is very easy to construct gigantic, intricate chains of deductive reasoning which have some little syllogistic screw loose, and thus are effectively a cathedral of lies. There is no way around this difficulty. One simply has to be careful. Compared to the risks of uncontrolled experiment, as I think I’ve demonstrated, these ancient, creaky castles of Teutonic logic are positively salubrious.   One notes, for example, that there is no math at all in Dr. Roubini’s post above. Deductive economics, which was the method not only of the 19th century but of all preceding ones, was widely mocked as “literary economics.” But those who laugh last laugh loudest.  So let’s apply the analytical method again to your question.  We see immediately that the analysis of lending given in my prior post above is correct – for new loans. Lending will occur when some method of production can produce any positive rate of interest (or even a negative rate which nonetheless exceeds the cost of secure monetary storage). Of course, this is an inherently speculative process and can only be predicted by the “wisdom of crowds,” but both historical and analytic methods agree on said wisdom.  However – contrary to the “free-market fundamentalists” – market projection of results is not magic. It is the result of a consensus about reality. The market will be wrong – and the borrowers, for example, default unexpectedly – if its projection about the results of the borrowers’ business activity is incorrect.  An exogenous change in price levels due to an unanticipated money supply shock is certainly a force that can result in such error. Again for both historical and analytic reasons, we would expect monetary contraction to lead, ceteris paribus, to falling prices. That is, prices fall relative to the borrower’s projections, and this causes his or her calculations of profitability to be incorrect, resulting in defaults, etc.  This analysis therefore corresponds to perspective B of the choice above. It says that “deflation” is like heroin withdrawal, not like starvation. And it suggests that the reason 20th-century attempts to return to the gold standard did not succeed is the same reason that most people don’t succeed in getting off heroin. Perhaps naive liquidation, Andrew Mellon style, simply doesn’t work, or at least is too stressful for our political system.  (Incidentally, there is hist
orical evidence to “support” this analysis: the Bank of Amsterdam period in the Dutch Golden Age, in which there was no fractional-reserve banking and all money supply increases were due to new gold production. Lending, even very risky lending, was by no means absent in this period. But I put “support” in quotes for a reason – I think a better word is “illustrate.” For reasons which I now hope are obvious.) 

gmdMarch 19th, 2007 at 9:21 pm

Nouriel, Great post! You’ve made many good points, but what caught my attention the most was the following:   “The rest of the world spent the last decade investing in factories that produce world class, high-quality and low costs goods; the US invested in McMansions that have zero productivity value and spillovers for the economy. Again thank the free market fundamentalist zealots who love no regulation and little taxation of capital for this sorry state.”   I couldn’t agree with you more! We, as a nation, have wasted so much time. As we continue to export manufacturing jobs, our reliance on imported energy only deepens. There are a number of organizations, that would like to see this nation embrace renewable energy. We’re talking about creating tens of thousands of jobs. Are “Financial Products” the best we can do? We used to be a nation of builders. And I’m not talking about houses. There are some great, small startup companies with great idea’s. Silicon valley is sprouting up a number of them. “Tesla” is one of them; they build electric sports cars.   Having an “Oil man” in the White House is the last thing we need right now. We need new ideas, not the same old tired cr*p! Iraq has the second largest oil reserves in the world. We all now this is the reason we’re in Iraq now. It’s a terrible waste of lives and money. We should be running away from oil, not toward it!   Bush likes to pretend he favors renewable energy. But don’t forget, a few months ago he had to restore funding in a hurry to the NREL lab in Boulder, CO because his trainers  had scheduled a PR stop shortly before layoffs were going to occur due to his funding cuts.   With the proper incentives, renewable energy products such as advanced batteries, solar cells, ocean power, advanced geothermal power and wind energy could increase production in this country. Also, electric cars, and plug-in hybrid cars, these could be the products worth building.   

AnonymousMarch 19th, 2007 at 9:55 pm

Dr. Roubini – stick to economics; politics is not what I (nor likely many others) come to your web site seeking your ideas and commentary. As a regular reader, I can say you make many thought-provoking points when you keep your comments to discussing the “free” markets and the economics principles that drive them.  Also, whatever happened to “greed”? Does not greed operate in both unregulated as well as regulated markets. In this sub-prime mortgage mess, borrowers were “greedy” for bigger homes than they could afford; lenders were “greedy” for loans and fees which drive profits. Greed is not new and will continue to perpetuate, regardless of the level of regulation. Let the chips fall where they may without using my taxes to bail-out those who have been greedy on either side of the equation.  Very truly,   Your “free-market, fundamentalist, supply-side, neo-con friend”.

BrianMarch 19th, 2007 at 10:06 pm

Anonymous ibid,  I do not believe your comments were unfair, but there are several things about a bailout that bother me.  It doesn’t bother me to help bail out those who may have been taken advantage of by the “so called” predatory lending (if such a thing really exists).   What bothers me is the bailing out of the lending companies themselves. Those who originated the loans knowing full well that those who were granted these loans would never be able to repay them. These companies were driven by greed knowing that they would sell the loan, where it would be repackaged and end up in some poor slobs 401k. (Probably mine). So I’m getting hit twice for these practices. Once in my retirement account, and again when the government uses money to bail them out that could be put to good use somewhere else.   What also bothers me are those who treated their homes like ATM machines and withdrew every last bit of equity and then some to finance their spending sprees. I would assume that in any sort of bailout that they would be included.  You said that by paying for these things, “He gets a *society*, instead of a bunch of animals trying to grab everything they can for themselves”. But it would appear to me that the loan originators ARE the animals trying to grab everything for themselves, and to hell with the rest of us. The greed displayed by these lenders is second only to the greed displayed by Wall Street on any given day.  I do not believe there would be a fair method in which to conduct such a bailout.  

GuestMarch 19th, 2007 at 11:38 pm

gmd, have you noticed that GW Bush has pushed the most ineffective solution to replacing oil, ethanol. Ethanol not only competes with our food supply but it also takes a lot of labor and energy to produce. One replacement for oil I think has been purposly looked over is coal gasification. We have at least 200 years worth of energy sitting in coal deposits in the United States. How much money is going into coal gasification research? Who has even heard of coal gassification in this country?

ErnstMarch 19th, 2007 at 11:51 pm

I think that if someone borrowed to buy his first home, did not use his home as an ATM, was given a loan that was illegal by the then regulatory standards and markets legislation, and is now not able to repay the installments because he was not given the full information, he deserves monetary assistance to pay what he really should pay. That monetary assistance must be provided by the lender chain, which includes the original lender and all institutions who may have repackaged his loan, securitized it or whatever, with the last person in the chain bearing the residual cost of that which is left after having extracted the proportional amount of the others in the lending chain.  Ernst

ErnstMarch 19th, 2007 at 11:56 pm

As a matter of fact, I think that anyone who was sincerely deceived by not receiving the full information of what he was getting in to should be bailed out. But not by Government using taxpayer money, but by the whole lending chain itself. Including banks, investment banks, brokers, etc.  Ernst

ErnstMarch 20th, 2007 at 12:03 am

Guest, About using coal. Progress Energy in the USA converts coal to fuel. In South Africa, when the problem of apartheid caused world sanctions that effectively would have cut their oil supply, they developed the coal to fuel technology which the South African big oil company, Sasol, currently has available.  Ernst 

Anonymous ibid.March 20th, 2007 at 1:26 am

Brian, I see nowhere that Nouriel (or I) has advocated bailing out *lenders.* He has said that they acted rapaciously because there is no proper regulation. He specifically cites a Bloomberg article in which Durbin and Dodd talk about helping *homeowners* by helping them obtain forebearance long enough to refinance. In a second Bloomberg article, Clinton says that lenders should be prevented from collecting pre-payment penalties. That’s hardly bailing them out!   I think you imagined what Nouriel was saying and didn’t bother to read or think about ithe issue. I propose you read and reconsider.   Jason B. says, “It is a false choice between bailout and homelessness. Those foreclosed upon can always rent.”  Jason, it is simply *not* true that people who get foreclosed can “always” rent. *Some* of them will end up on the street. Will it be thousands? Hundreds of thousands? Millions? A lot will depend on leadership by the national government.   You also claim that “If people were the victim of fraud, then a crime was committed and they won’t be foreclosed.”  So *you* say. The law takes a long time to act, and many people will face foreclosure before some of the criminal schemes that have been operating are prosecuted.   artichoke says, “If people need help, there are some programs like section 8 subsidized rent, and AFDC if they have dependent children. ”  Tried it lately, artichoke?   There’s virtually no safety net. What do you– and the many people who post stereotypes of people who get caught unable to pay a mortgage– really know about what it’s like to be poor and in a world of hurt?

GuestMarch 20th, 2007 at 2:26 am

Fed and treasury pumped another $20 bln in short term loans into the system on Monday!!!  http://buttonwood1792.blogspot.com/  they’re going nuts. what are Bernanke and Paulson so afraid of? They must be reading Dr. Roubini’s blog… no, they know more than Roubini and are throwing down the gauntlet to prop things up.

GuestMarch 20th, 2007 at 3:09 am

Dear Sir,  I have read you for over a year now. Always with the sense that you were 100% right. I appreciate that your voice does not belong the so-called consensus.  Thank you for your detailed opinion on the subprime subject.I follow you on the fact that the US mortgage “industry” was over-engineered and not regulated enough.  As an outsider to the party (here in France the mortage is still highly regulated), I understand you’re turning a tad political now that the harm done is fully surfacing.   Since the subject is so touchy, I feel that the risk that this blog may lose a part of its utter value: delivering the view of a NY economist with no link to WS finance.  May we expect that whilst tackling the present situation, you do stop your independant investigations into the future of the american economy!  François 

wetzelMarch 20th, 2007 at 4:56 am

moldbug,  Thank you for a series of well expressed and thought-provoking posts.  My own tendency is to be conservative about fundamental structures. I think there is a tendency to take having a reasonably functioning society for granted, but history shows that this is by far the exception.  Still, in the sense that a radical critique can be an useful analytical tool and guide useful change, I think that questioning down to first principles can be extremely valuable.  Many are protesting that Dr. Roubini is veering into ‘politics’, but there will certainly be some forms of political response to what is happening in the marketplace. Judging from the comments, determining the best course of action involves fundamental ideas of economic justice which informs people’s view of how our current institutional framework may have failed.  On the one hand there is a strong influence of libertarian ideas of justice, that the just society is one in which the distribution of economic goods most closely adheres to the decisions of free individuals in the marketplace. On the other hand there is also a strong influence of utilitarian ideas of justice, in which the just society is one in which the distribution of economic goods produces the best outcome for the most people. Libertarians often accuse utilitarians of being ‘socialist’ but this isn’t true at all. Most libertarians are utilitarians on odd days of the week anyway. Besides, nearly all utilitarians view the free market as the best way to means to achieve material progress and prosperity for society.  Both the Friedmanist and Austrian flavors of libertarian economics aren’t really libertarian. They are utilitarian when convenient and libertarian when convenient. In one paragraph you have, ‘Don’t use my money to solve society’, which is libertarian, and in the next, ‘If the government would just get out of the way, we would all be better off,’ which is utilitarian.  I think that we are reaching a crisis point soon in which the libertarian arguments have a real possibility of preventing our society from acting to head off a deep economic collapse. This is why the politics are important, and why thoughtful people need to sharpen their arguments. I think there is a real complacency to the idea that ‘they will just become renters’, which conveniently ignores the possibility of a banking and monetary crisis which may just take ‘your money’ and ‘your opportunity’ whether you like it or not.  I am afraid that the quality of our current politics in Washington is too degraded to arrive at useful solutions. Quality discussion only seems to happen when there is big money on both sides of an issue ‘satellite vs. cable’ or ‘candy makers vs. sugar producers’. The idea that we are going to have a productive debate when it is ‘the people’ as a whole whose interests need representing has become laughable at best. As a life-long Democrat, I am really hoping for my party to step forward but not holding my breath.

gmdMarch 20th, 2007 at 5:31 am

My family and I moved to Humboldt County, CA in Jan. 2005, before the housing peak. The realtor’s words are still ringing in my ears, “You need to make your move now, or you’ll be priced out of the market”! I didn’t fall for it, but we know plenty of people that did. And, as many of you know, sub-prime loans are very popular in California, as are option-arms, interest only, etc. This is a poor county and a lot of people are going to get hurt. Their loans are beginning to reset.  I could easily take either side of this discussion. Why should I have to help homebuyers (via taxes) that decided to buy a house at such high, unsustainable prices? Then again, how many people were pulled into the “mania” that home prices will go up forever? Two years ago, I remember having doubts about my decision to continue renting. My wife thought I was wrong at the time.  The solution must involve prosecution of solicitors of predatory loans, and of appraisers, lenders and realtors involved in schemes to pump up the value of homes for 120% loans for quick profits.  The solutions will be many for the plight of those caught in the housing mania.   For my family, the solution is to move out of California. I’m currently trying to transfer to Colorado. Something that would not be an option if we were stuck in an upside down mortgage.  

Jason BMarch 20th, 2007 at 5:45 am

Anonymous ibid –  Again you are making a false choice. It is not a choice between bailing out irresponsible borrowers or not, it is a choice between bailing them out and doing something else with that money. Is bailing out irresponsible borrowers who could probably find a place to rent the best use of that money resource? I say let the free market operate.  I also agree that for one of the wealthiest countries in history, the way we take care of those of us who have fallen on hard times or are unable to take care of themselves is shameful. But that won’t be fixed with a one time bailout.  “It is a miserable arithmetic which makes any single privation whatever so painful as a total privation of everything which must necessarily follow the living so far beyond our income.” –Thomas Jefferson to William Hay, 1787. ME 6:223

Jason BMarch 20th, 2007 at 5:56 am

Interesting e-mail received by the author of the above mentioned blog:    * “Just FYI, i am sure the market as discounted part of this already… Next month, 3 year ARM holders will understand why that was a bad decision. There are 2 waves of ARM mortgage rate increases coming. The first wave will occur in April on 3 year ARMs. This is hard to believe, but if interest rates remain the same in the next few weeks, then these ARM mortgage holders will see a 100% increase in their interest rate. If they were to refinance today, they would see a 60% increase in their rate. The second wave of increases will begin this Summer on the 5 year ARMs, and will continue to run for the next few years unless homeowners refinance. The best hope these people have now, is for us to have a large enough slowdown in the economy that would cause Bernanke to lower interest rates.  While some market analyst were only worrying about defaults coming from sub-prime loans, they forgot to look at the mortgage defaults that will occur because of the 3 and 5 year ARMs. What this means is that we are likely to see these problems filter down to the banking industry, and that would put pressure on the market. Analyst are telling us that these problems are not affecting the banks. The reality is, that these problems take time to filter down to banking financials. Over the next few months, you will hear how banks will have to increase their default reserves, and how it will begin to affect their profits.”

wetzelMarch 20th, 2007 at 6:06 am

Two years ago, I remember having doubts about my decision to continue renting. My wife thought I was wrong at the time.  I think that the strongest marketing force in the world is the desire of mothers to have a secure comfortable home for the family.   How this became a mania for McMansions with granite countertops and flagstone floors will be a topic for future generations.  Of course they will blame the men. 

gmdMarch 20th, 2007 at 6:24 am

Guest, Ernst, others,   I have mixed emotions concerning ethanol. Corn is not a good feedstock for ethanol production. I believe to energy ratio is 1.2:1. While with sugar cane it is 7:1, that is seven times as much energy is obtained that that used to process the sugar cane. The one good thing about corn ethanol is that it’s helping to produce a need for flex-fuel vehicles. I strongly support cellulose ethanol production. Making ethanol from waste products makes a lot of sense. A few years ago, I got on the hydrogen bandwagon, as did many others. IMHO, with current technology, it just doesn’t make sense. If you use natural gas to produce hydrogen, you’re still using a finite fossil fuel. If you produce hydrogen via electrolysis of water, you’re losing energy in the conversion process. Better to use the electricity directly.  IMO, plug-in hybrids make the most sense. Battery development has reached an interesting level.  Coal gasification makes more sense than extracting energy from “oil sands”, though I worry about the CO2 release.  Another interesting fuel is Bio-Butanol, which doesn’t require any modification to an engine.  I realize that many on this blog probably feel that I’ve gotten way off topic. Please keep in mind that cheap energy helped kick start this nation in the first place. During WWII, the U.S. was the largest oil producer. Germany and Japan were envious. Oil prices in the $50-$60 range is a flat tax on all Americans. Those that can least afford the higher gas prices are the same folks that are in trouble with their subprime mortgages.  

JohnFlemingMarch 20th, 2007 at 6:28 am

To François   “As an outsider to the party (here in France the mortage is still highly regulated)…”   Reveillez-vouz!  Wake up, please!   As it might seem that the old french banks are still keeping  up appearances, the market is flooded by new and foreign players who have played the market very aggressively. People  who didn’t qualify for traditional mortgage went in mass to ‘courtiers'(brokers), who kept searching among all possible providers until someone found, desperate to leverage and probably package and sell.  And the only answer the prime candidate to the French presidential elections, Nicolas Sarkozy, can come up with is  attacking the ECB(Trichet) for raising interest rates.  He’s saying:”Look at the US, they used and use their intrest rates policy to keep their economy going.”   (long term interest rates in Europe are in the low 4’s for now)  Keep dreaming…  

DecraenMarch 20th, 2007 at 7:41 am

To Francois  I think you are right that mortgage is more regulated in Europe than US. To me, the coming recession in the US will of course have an effect on the housing market of Europe, but indirect (people loosing their jobs etc). House prices also went up in Europe because the general lending period was extended from 20 years to 30-40 years.  Tom from Flanders Fields

russianMarch 20th, 2007 at 9:08 am

to NR  on your post : Subprime and nearprime and other risky mortgages (option ARMs and other reckless lending practices) were 50% of mortgage originations in 2005 and 2006 (see http://www.rgemonitor.com/blog/roubini/180573/). So the collapse of this segment of this significant fraction of the market is an important fact.    Written by Nouriel on 2007-03-19 08:09:47 This of course is nowhere near representative of the WHOLE S/P MORTGAGES OUTSTANDING. Please note that s/p fixed mortgages are about 4% of the total and most dangerous chunk is s/p adjustable – about 10%. I agree with the author above 10% * Del Rate – hurts but not that big deal. also, much better spread thru the use of derivatives so please be accurate with your data. russian

AnonymousMarch 20th, 2007 at 10:15 am

To John Fleming,  I stick to my point concerning regulations applying to mortgages here in France.  Despite some recent development in the field of innovative “financial industry”, most French mortgages are still pretty oldish by design.   Most are made via the bank system. Most are still fixed rate. Mortages are documented. All of them. Well.   I do not mean we did not have our part of market exhuberance. But I’ll stick to my say, John. The picture is not neat but nowhere near what I read on US blogs.  François

BrianMarch 20th, 2007 at 11:13 am

Anonymous ibid,  I don’t see anywhere in my comments where I indicated that I thought you or Professor Roubini advocated bailing out the subprime lenders. My original comment was “So the government will bail out the subprime borrowers using taxpayer dollars. What do those of us who borrowed responsibly and lived within our means get besides the bill? .  I know that Professor Roubini believes that a bailout would not be a good idea based on his comments contained in this link: http://money.cnn.com/blogs/generationrisk/2007/03/time-for-mortgage-bailout.html  “Don’t provide direct financial support to homeowners in trouble, urges Nouriel Roubini of Roubini Global Economics: Public funds to help borrowers should be used with care for several reasons. First, some forms of borrowers’ financial support end up bailing out also the culprits of this mess; thus, these specific forms of support of homeowners under financial distress should be avoided. For example, direct subsidies to households who cannot afford their now-reset and excessively high mortgage payments end up helping the victims as well as the culprits.”  If I understand his comments correctly, he is saying that it would be very difficult to bail out the borrowers without bailing out the lenders. I am simply agreeing with professor Roubini that we should not bail out the lending institutions.  

koteliMarch 20th, 2007 at 11:36 am

To François and Decraen,  I agree with both of you that mortgages are more regulated in Europe than in USA, but here in Spain, we have the bigest bubble in housing industry:  — 800.000 new houses a year in a country of 44 million people.  — Houses now are three times more expensive that the houses of 1997. Triple price in 10 years, while wages stagnating.  — Most mortgages are variable (MINOR + 0.5).  — Traditional mortgages were for 20 years, now the standard is 30 years, and you can find easily 50 year mortgages.  — 18,7% of the GDP is housing industry.  — When the US recession hits Europe, and the housing bubble suddenly pops, lots and lots of housing workers will be in the street without any job.  It won’t be funny!  Regards

ErnstMarch 20th, 2007 at 12:53 pm

gmd, Ethanol is certainly much more economically viable if produced from sugar cane, like it is in Brazil. Brazil even exports this cheap ethanol since they produce more than enough to satisfy their own needs. And most Brazilian cars run on pure ethanol. However the US has imposed a tariff of somewhere around 50 cents/gallon on imported ethanol from Brazil. This is interference in free trade, just like the agricultural subsidies, and makes fuel more expensive for US consumers. In order to protect some special interest group with some voting power I guess.  Ernst

moldbugMarch 20th, 2007 at 1:00 pm

wetzel,  Thanks – I agree with everything you say.  It is important and interesting to design alternatives to our present financial system which might work better. Perhaps at some point there will be the opportunity for what software engineers call a “flag day,” an instantaneous and precisely planned switchover.  But this is very far from the “free-market fundamentalism” that Dr. Roubini and you are so right to criticize. It is the difference between a doctor and a witch doctor.   We have plenty of evidence from both history and analysis that decentralized economic systems, when properly designed, work better and are more stable than centrally managed systems. But this does not allow us to conclude that going into the mainframe and pulling out random memory banks, like Dave in 2001, will result in some magical improvement. In fact, just the opposite might be the best policy – at least in the short term.

gmdMarch 20th, 2007 at 2:28 pm

Ernst,   I oppose the tariff on imported ethanol from Brazil. I also don’t support subsidizing corn ethanol production in the U.S. There needs to be a moratorium on corn ethanol production facilities in the U.S. I’ve recently learned that southern Mexico is also a good location to grow sugar cane for ethanol production. Since Mexico’s oil production is declining, I would like to see ethanol importation from Mexico and Brazil.  

Anonymous ibid.March 20th, 2007 at 3:26 pm

Jason, you begin from a false premise and arrive, unsurprisingly, at a ridiculous conclusion. You assume that people who aren’t ultimately able to pay their mortgage are irresponsible.   Well, I am sure some are. But there is absolutely no evidence that the typical individual buying a home and using a subprime or ARM or exotic mortgage is any less responsible than you or me.

AnonymousMarch 20th, 2007 at 4:08 pm

Hi koteli,  I am aware of the figures you gave. I basically had the same information.  I have called personal friends with family or relatives in Spain to get confirmation of the situation since I would not believe the figures I read.  Of course the outcome will be nightmarish. There is little doubt about it. I’m still wondering when will the authorities try to react and curve the whole thing.   It may of course be beyond control. What is your feeling ?  François

Jason BMarch 20th, 2007 at 4:25 pm

Anon ibid  “You assume that people who aren’t ultimately able to pay their mortgage are irresponsible”  Now instead of framing a question to create a convenient answer, you are attributing quotes to make a convenient point. I never said that.  You should be more attentive to logic and fact.

DougSMarch 20th, 2007 at 4:50 pm

Nothing with human nature is absolute. Most of what is said on this thread is reasonable considering that we all have different perspectives from our own life experiences.   Renting is not something that would suit me or most people given a choice. There are many factors besides the monetary issues. There is the ownership. That gives people a different outlook from a renter. Mowing your own lawn is a much different feeling than mowing the owner’s lawn. Some on this thread must never have been poor and had to rent. Let me tell you, it wasn’t hard to talk those people into a risky loan with the promise of ownership.   I have things that belonged to grand parents and things I have acquired over the years. I also have tools which at one point in my life were very important to me and I still use. Having a secure place to have them vs. a 30 day notice to move to me makes the issue of ownership a much bigger issue for me. How can a person travel for weeks and longer with out a place to have keepsakes and comfort to return to. It would be extremely uncomfortable for me to rent.   That said, I think I understand why people get in over their heads. Some are pure speculators and take risks but most others just get caught. They need a place and are offered a loan which on the surface they can afford. How many of you have been to a real estate closing involving a loan. Many times the package of papers is three quarters of an inch thick. People aren’t given the loan documents a week a head of time to read and ask questions about. The first time they see them is at the closing. The mortgage broker is on a commission and makes more money with more transactions. They really don’t want to be educators, they may not even understand all the language themselves. In most states, they don’t even have a license much less any real training about what they sell themselves. This part of the system is the wild west and totally unregulated. There are suppose to be checks and balances but the people responsible are often the same people who benefit from the volume. It is like the rating agencies which get paid by the people they rate.   So, people take the risky loans because the nice person wearing nice clothes told them that they could afford it. Then over the next year some unexpected thing happens, the car breaks down or the kid has to go to the emergency room or the heating system has to be repaired and the next thing they know they are behind on their payments. All the while the government makes deals with the corn growers to produce ethanol and food has been costing more almost each week and gasoline has gone up too. So at the end of the month do they pay their mortgage or the credit card which they can not live with out as they need it to buy gas and food.   This is the frog in the water syndrome. Inflation is the real killer and will continue to hurt. The fed says it is fighting inflation while all the figures I have seen show that the money supply continues to grow.   At this point, if the fed doesn’t fight inflation, they will put more and more people at risk of losing their homes but if they do fight it, they could cause stocks to drop and harm themselves and their friends. What do you think they will do tomorrow? What is best for the most people or what is best for their own peer group?  

Octavio RichettaMarch 20th, 2007 at 6:36 pm

Latest from Fleck  Warning: This mess will only get worse The inevitable demise of the subprime mortgage market leaves the entire housing market — and with it the economy — on the verge of collapse.   Bubbles have a way of masking what would otherwise be self-evident truths. And, as the credit bubble in real estate dies a dramatic, not-pretty death, a very simple truth has resurfaced: It’s not a viable business when you lend money to people you know can’t pay it back. If the late, “great” subprime sector had a tombstone, that would be a fitting epitaph for New Century Financial and others.  …   http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/WarningThisMessWillOnlyGetWorse.aspx

Ryan DarwishMarch 20th, 2007 at 8:25 pm

Wetzel  “I think there is a real complacency to the idea that ‘they will just become renters’, which conveniently ignores the possibility of a banking and monetary crisis which may just take ‘your money’ and ‘your opportunity’ whether you like it or not.”  I don’t know that its complacency or a “best of all evils” conclusion drawn from examining other suggested and contemplated alternatives. Yes, there certainly seems to be a strong possibility of a banking and monetary crisis. Day by day emerging evidence seems to suggest that it has even gone beyond possibility to emerging actuality.  The possibility that this crisis may take ‘your money’ and ‘your opportunity’ is all too real. There are at least two choices, to try the bandaid, or glue and duct tape, approach to keeping a financial and monetary system, which has served some well and some not so well, afloat, or alternatively allow the natural consequences of poor financial and economic choices to run their course by taking its own medicine. In all likelihood, the the first alternatives would probably be doing litle more than delaying the second alternative.  Moreover, since this seems to be a juncture we have not been to before in our global economic and monetary system, it is a speculative to believe that there are not some entities who have made wiser economic choices who will step into the picture and acquire assets at firesale prices. Good for them, not so good for those parting with the assets. It does appear, however, to be the way of human economic behavior.  Rather than the anguished hand wringing over the possible end of an established order, it might be more productive to try to identify where the shelters from the storm may lie and be ready to step in to help rebuild at the appropriate time, both for the greater good as well as in self-interest.

lmnopMarch 20th, 2007 at 8:34 pm

Dr. R.   moldbug and others are correct in tracing the current problem back to the roots of the monetary system. fractional reserve banking combined with central bank interest rate targeting begets vast swings in liquidity. where and how this liquidity flows is not the issue nor does post facto rule creation to make sure it doesn’t flow without regulation into a particular sector cure the problem. housing, tech stocks or baseball cards hardly matter. it is the ability of the system easily create credit excess that is the problem.  the following system would be far more stable and far more efficient than the current one:  1. only the federal government can create money.  2. the federal government should not issue debt.  3. the federal government should issue as much new money each year as is politically desirable.  4. government should remove itself from the business of regulating transactions except in so far as to require transparency rules.  5. parties engaging in transactions that were completed adhering to the rules of transparency would be indemnified against poor outcomes.  to the extent that the government’s creation of money was somewhat rule based and predictable the market would be in a position to set interest rates based upon its estimation of forward inflation/deflation. systemic credit bubbles such as the current one would be much less likely to form because market rates would respond quickly to increased credit demand because of the inelastic supply of money.  the ‘tax’ system would be a totally frictionless flat wealth tax with 100% compliance. it could be made progressive or regressive simply by deciding how much money to create and what to do with it. 

G. ChaltonMarch 20th, 2007 at 9:45 pm

Wow. This entry needs a lot of editing. You basically say the same thing over & over & over until you’ve run out of ways to describe “free market voodoo economic fundamentalist laissez-faire zealot extremsists” in the most reactionary & hyperbolic terms available.   All forms of regulation are pragmatic & sensible & carry zero consequences. People who support regulation for the sake of regulation are all right thinking, pragmatic & sensible people, and the only people who could oppose such regulation, or lobby for less of it is a hard-core free-market extremsist cowboy capitalist apparantly. For a reference point, since we know Mr. Roubini is the bench mark for right-thinking pragmatic & sensible economic thought(those economic commentators who disagree with him being extremist zealots), just how far are you allowed to diverge from this view without being labeled an extremist free market fundamentalist voodoo economics supply-side laissez-faire zealot?

GuestMarch 20th, 2007 at 10:32 pm

Nouriel:  Great post! I especially like your increasingly colorful language as this mess unfolds. I did not, however, understand your point about the U.S. investing in housing while the rest of the world has been investing in more productive assets. It seems that you are suggesting that the housing bubble is a uniquely American phenomenon. I don’t think this is accurate. Many parts of the world, such as many countries in Western Europe, Australia, South Korea, etc. have seen price runups even greater than our own. I believe that when we go into recession their housing bubbles will burst as well.

moldbugMarch 20th, 2007 at 11:29 pm

lmnop,  Sacre bleu! This is indeed an excellent description of a certain class of fix.  Please bounce me an email (moldbug dot gmail at com) if you wouldn’t mind…

gmdMarch 21st, 2007 at 7:51 am

Ernst, great link! Nothing like some good charts to put things in perspective.  http://www.safehaven.com/article-7181.htm  Here’s part of the story: “Even if March real retail sales increase 0.5% month-to-month, that would yield first quarter annualized growth in these sales of only 2.4% — a far cry from the 10.5% annualized growth of Q4:2006. It must be the weather, huh? It can’t be related to the sharp drop in mortgage equity withdrawal, the slowdown in job growth and already record high debt service burdens (see Chart 3) in the face of an onslaught of adjustable rate mortgage resets.”    

ursel doranMarch 21st, 2007 at 10:02 am

Dr. R, My earlier note on you being WAY to charitable regarding the FED’s role in all these serial bubbles, housing being just the latest, is eloquently laid out by Gary North.  The next guy sees much the same. Janszen at itulip has a great piece on whether the FED is incompetant, and or irrelavant. One must realize they serve their own masters, and exist to inflate. Perhaps when this is over we can do something about them.  http://www.lewrockwell.com/north/north519.html  Cause and effect from FED’s serial bubbles laid out here.  http://www.atlanticfreepress.com/content/view/1201/81/  

Rich HMarch 21st, 2007 at 10:52 am

Foreclose Away.  TOO BAD! I say. I’m sick of hearing stories about the “poor people” who got duped into bad loans. Call it schadenfreude. (My favorite word)   Let’s take a second to think about it. There are a few big decisions you have to make in life. Getting married, having children, buying a car and buying a house. (sure there are other big decisions, but I’ll keep this as short as I can.) Why would someone throw caution to the wind on any of these decisions? …and if and when something goes wrong with one of these decisions, it usually takes a great deal of time/work/effort to recover. That recovery usually builds character, and teaches us valuable lessons!  As I’ve stated on past posts, my wife and I do pretty well with income and savings. In addition, we are nearly debt free. (with our only exception being the remaining half of my wife’s student loan for law school.) We are still renting a 1 bedroom apartment and have been for almost 8 years now! (while trying to save up enough for a house.) We have 2 kids. (1 in our bedroom, and 1 in a makeshift bedroom)  Am I actually supposed to feel sympathy for the schlep that got themselves in over their head and didn’t make a RESPONSIBLE DECISION with what amounts to the most important fiancial decision most of us will ever make in our life? NO! Am I actually supposed to pay more in taxes so that the same schlep can keep their house that they didn’t deserve in the first place? NO!   Losing something you shouldn’t have had isn’t really “losing something”. It was borrowed, and now it’s time to return it!   I’m glad to say this! Put their house on the market! Flood the market. (8 years into renting and I can only now just afford a house in my Brooklyn neighborhood with 20% down payment.) Let’s see a devaluation of at least 10% on houses. So I don’t have to use my entire savings on that 20%. (I’ve been responsible for 8 years, and it’s time I get some reward!)  Foreclose away, and when that family of 4 needs a place to stay, I’ll hopefully have a 1 bedroom apartment available for them.  Rich H  p.s. I’m beginning to think this credit crunch / crash will never happen. Between the Gov’t pumping money into the system, and financial institutions being allowed to use loose accounting methods to mask losses, all we keep seeing is “record earnings” (MS today). If $millions/billions/trillions of dollars are really missing or overstated, and no institutions are forced to show these loses, then the bulls/gov’t/brokers/hedgefds/corrupt will never slow down. How does this cycle stop? Who stops it? 

artichokeMarch 21st, 2007 at 11:03 am

There are other housing bubbles in Spain, UK (that nation of shopkeepers), etc. But those aren’t the places that have been building factories either!  Nouriel is spot-on about our building McMansions for ourselves instead of productive infrastructure, and now I expect that somehow we’ll pay. I thought we would have paid a long time ago, but trends are persistent — but not eternal!  The only thing I disagree with — strongly — is that any of these borrowers should get a special bailout. As I said earlier, there is AFDC, section 8 rental, and other programs for poor people.  People who become poor because they were over-consuming housing don’t deserve better treatment (to say the least) than those who become poor because — say — they are not blessed with high intelligence or had bad family circumstances or other reasons.  The comment from Rich H is exactly right. He’s been responsible and saved and probably been looked down on by others who played the max-mortgage real estate game. Now he deserves at least some reward at their expense.

TedKMarch 21st, 2007 at 11:33 am

I too agree with Rich H that there should be no bailout for anyone. Not because I am a free market fundamentalist; far from it. Nor because I love schadenfreude.  But because the bubble priced out even many highly accomplished people who couldn’t do anything but wait, sometimes at great personal and social costs. There was no reason for a rational human being to jump in if he/she could not afford the mortgage. Those who did jump in, in the anticipation of prices continuing to rise, cannot expect to be rewarded now for their bad decisions. In cases where buyers were misled by lenders or brokers, it is for some NGO’s or the Fed Govt. to take legal action and make the offenders pay.   When there is a game of life all of us are expected (and forced for our own survival) to play, there cannot be a change in the rules of the game halfway, favoring some people selectively. One either changes the game entirely, or the players live with whatever outcome results from the game.

Scott RootMarch 24th, 2007 at 1:11 pm

Actually, we are all to blame for the “Mortgage Carnage and Coming Financial Disaster? Unregulated Free Market Fundamentalism Zealotry” By taking a step back in time and implementing the solutions offered by the economist, Henry George, in his economic literary classic – Progress and Poverty. If you’re interested in the solution, you may download a copy of the book here:  http://vitavero.com/henrygeorge  Very simple when you understand the “common” logic presented in this book.  Scott  

EricOctober 27th, 2007 at 7:06 pm

Rich H:  I agree with you that we should all have to live with the consequences of our decisions, provided no outright fraud was involved. Note that this would include your decision to continue to live in one of the most expensive housing markets in the world, when you could have probably put down 10-20% immediately on a nice house in many other wonderful cities in the US. So unless you are in NYC because of some noble cause, like caring for a sick parent, please don’t hold yourself up as the model for responsibility for having lived in an apt for 8 years, while at the same time you bemoan the fact that others are failing to accept the consequences of their own decisions.

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