Minor Thoughts from me to you

Archives for Mortgage Crash (page 1 / 1)

The economists' alternative to bailouts

The economists' alternative to bailouts →

Garett Jones on an alternative to either bailing out the banks or letting them fail spectacularly.

But all corporate bankruptcy means (again, to an economist, not a lawyer) is that some of the bondholders get turned into shareholders: Instead of getting the $10,000 you were owed, you get shares that will probably be worth much less.  In the simplest case, the shareholders get nothing (they had their chance to run the firm and blew it), the bondholders become the new shareholders, and the firm keeps right on running.  Seems like something you could do over a weekend.  

This entry was tagged. Mortgage Crash

A Fine for Doing Good

A Fine for Doing Good →

The Department of Justice is interested in racial quotas. It doesn't really care if meeting those quotas requires banks to blow up the economy.

In a complaint filed Wednesday and settled the same day, Justice claimed that California-based Luther Burbank Savings violated the 1968 Fair Housing Act and 1974 Equal Credit Opportunity Act by setting a policy that had a "disparate impact" on minorities. Between 2006 and mid-2011, 5.2% of Luther's single-family residential mortgage loans went to African-Americans and Hispanics, compared to an average of 41.7% for other lenders in the area. The complaint doesn't cite evidence of intentional discrimination because there wasn't any.

Luther Burbank wasn't a fly-by-night operator that marketed those loans to any and all. The bank insisted on a minimum $400,000 loan amount and made loans with an average 680 FICO score and 67% loan-to-value. Over the period that Justice examined, Luther Burbank foreclosed on a mere 11 borrowers out of 629 loans outstanding—a loss ratio of 1.75%. In a normal world, Luther Burbank would get a medal from regulators for its risk management, having chosen borrowers even at the height of the housing mania who could meet their monthly payments.

But Assistant Attorney General for Civil Rights Thomas Perez has a different priority: He wants banks to meet lending quotas to minorities—regardless of whether those borrowers can afford the loans. Many minority borrowers have low incomes that make them riskier lending bets. Is that a bank's fault?

To be fair, Congress passed the laws that the DoJ is enforcing. Is there any chance, at all, that we can repeal those laws without having the entirety of the liberal and progressive world scream "racist!"?

‘Trickle down’ & the 2008 meltdown

‘Trickle down’ & the 2008 meltdown →

Jonah Goldberg, talking about the President's incessant Bush blaming, on the 2008 financial mess.

The question of what caused the crisis is obviously still controversial, but a consensus seems to be forming around the following narrative: The federal government, out of an abundance of concern for the plight of the poor and middle class, made it too easy to buy a home. Congress, on a bipartisan basis, set unrealistic affordable-housing goals for Fannie Mae and Freddie Mac.

President Clinton used those goals to expand access to mortgages to low-income borrowers. Then President George W. Bush, with the approval of Congress, expanded the practice, until way too many low-income or otherwise underqualified Americans owned mortgages they couldn’t afford.

A mixture of greed, idealism, cynicism and stupidity led to the practice of bundling those iffy mortgages into financial instruments that Wall Street didn’t know how to handle and regulators didn’t know how to regulate. As Rep. Barney Frank (D-Mass.) put it in 2003, he wanted to “roll the dice a bit” on regulating subprime mortgages.

When the Washington-abetted housing boom went bust, regulators demanded immediate markdowns of mortgage-backed securities, which required financial institutions to sell them, creating a fire-sale atmosphere that fueled the panic even more.

My Mortgage Plan

The Obama administration is working on a mortgage bailout plan. Supposedly, they only want to help the people who are responsible home owners. That's a good aim. Given that 41% of modified mortgages end in default, we shouldn't send good taxpayer money after bad results. If the administration is sincere about their desires, I have a proposal.

We should only help homeonwers who have either made a significant investment or spent a significant amount on their house. Here's how I define those terms.

A significant investor is someone who has equity equal to at least 20% of the purchase price of their house. For example, someone who took out a loan for $200,000 would need to have already paid off $40,000 in order to qualify for assistance. Anyone who owns less than that, isn't really a home owner -- they're more like renters with extra privileges. We should only help those who have invested a significant amount in their homes. They've already proven that they can meet payments and put considerable resources into their homes. They're likely to continue doing so, given a little help.

A significant spender is someone who spent at least 6 months gross salary on a downpayment. They're someone who has demonstrated an ability to scrimp, save, and plan for the future. They've locked up a considerable amount of capital in their house and made sacrifices to do so. They've already demonstrated an ability to manage their money and defer spending. They're likely to continue doing so, given a little help.

Both of these criteria would apply no matter what the current value of the house is. Those who are prepared to stay in their house long-term shouldn't be worried about whether or not their mortgage is currently underwater. It may yet rise back above water. And if it doesn't, the government shouldn't be worried about helping them earn a profit on their investment. Rather, our sole focus should be on keeping responsible homeowners in their homes, if at all possible.

These two criteria can help us identify who the responsible homeowners truly are. What happens after they've been helped over their current financial short fall is up to them.

What do you think?

(Updated on Feb 25, to reflect James' suggestion.)

Bad Theology and Bad Mortgages

How important is good theology? Pretty important. Not only can bad theology give people a wrong picture of God, it can also cause them to do some pretty stupid things in the here and now. Take the "prosperity gospel" and the recent mortgage crash, for example. Time recently reported on the intersection between bad theology and bad economic decisions.

Has the so-called Prosperity gospel turned its followers into some of the most willing participants -- and hence, victims -- of the current financial crisis? That's what a scholar of the fast-growing brand of Pentecostal Christianity believes. While researching a book on black televangelism, says Jonathan Walton, a religion professor at the University of California at Riverside, he realized that Prosperity's central promise -- that God will "make a way" for poor people to enjoy the better things in life -- had developed an additional, dangerous expression during the subprime-lending boom. Walton says that this encouraged congregants who got dicey mortgages to believe "God caused the bank to ignore my credit score and blessed me with my first house." The results, he says, "were disastrous, because they pretty much turned parishioners into prey for greedy brokers."

... Although a type of Pentecostalism, Prosperity theology adds a distinctive layer of supernatural positive thinking. Adherents will reap rewards if they prove their faith to God by contributing heavily to their churches, remaining mentally and verbally upbeat and concentrating on divine promises of worldly bounty supposedly strewn throughout the Bible. Critics call it a thinly disguised pastor-enrichment scam. Other experts, like Walton, note that for all its faults, the theology can empower people who have been taught to see themselves as financially or even culturally useless to feel they are "worthy of having more and doing more and being more." In some cases the philosophy has matured with its practitioners, encouraging good financial habits and entrepreneurship.

But Walton suggests that a decade's worth of ever easier credit acted like a drug in Prosperity's bloodstream. "The economic boom '90s and financial overextensions of the new millennium contributed to the success of the Prosperity message," he wrote recently on his personal blog as well as on the website Religion Dispatches. And not positively. "Narratives of how 'God blessed me with my first house despite my credit' were common. Sermons declaring 'It's your season to overflow' supplanted messages of economic sobriety," and "little attention was paid to ... the dangers of using one's home equity as an ATM to subsidize cars, clothes and vacations."

It's sad. Americans have been richly blessed by God. America is the richest country in the world and our poor are wealthy than most of the "rich" in Africa. Our poor are fantastically well off compared to the poor in Asia, South America, or Central America. The Bible also has much to say about contentment. Rather than teaching their congregations to be both thankful for what they have and content with what they have, these pastors have been encouraging people's natural greed, covetousness, and discontent. As a result, many of these people have been directly hurt by the mortgage crash.

Not that these pastors need to be worried about my opinion. Ultimately, they will answer to God for how they've led His people. That's enough for me.

This entry was tagged. Mortgage Crash

Blame the Fed?

I always like a story that points out how supposedly wise government employees manage to destroy the very thing they're trying to protect. Today, the Wall Street Journal fingered the Federal Reserve for much of the turmoil of the last year.

But the larger story is that the global economy is fast popping its latest monetary bubble, the one over the last 14 months in commodity prices and non-dollar currencies.

The original bubble was in housing prices and mortgage-related assets, which the Federal Reserve helped to create with its negative real interest rates from 2002 into 2005. This was Alan Greenspan's tragic mistake, not that the former Fed chief will acknowledge it.

As for the second bubble, this one began in August 2007 with the onset of the credit panic. This is Ben Bernanke's creation. The Fed chose to confront the credit crunch as if it were mainly a problem of too little liquidity, not fear of insolvency. To that end it flooded the economy with money, while taking short-term interest rates down to 2% from 5.25% in seven months. The panic only got worse, and this September's stampede finally led the Treasury and Fed to address the solvency problem by supplying public capital and numerous guarantees to the financial system.

The Fed's liquidity burst nonetheless sent markets for a 14-month loop, as the nearby charts indicate. The Fed created a commodity bubble of record proportions, with oil doing a round trip in a single year from $70 up to $147 and back down to $69 yesterday. The dollar also plunged along the way against most global currencies, notably the euro, as the bottom chart illustrates.

The dollar price of oil and the dollar-euro exchange rate are probably the two most important prices in the world. They represent a huge share of global commerce, sending signals that shape trade and capital flows. When those two prices move up and down so sharply in so short a time -- based more on fear and expectations than on economic realities -- they distort price signals and can lead to a misallocation of resources. Commodity prices have now fallen back to Earth, as the reality of global recession hits home and the Fed can't ease much further. Meanwhile, the euro has fallen from the stratosphere as Europe heads into recession and the dollar becomes a safer haven in a world of fear.

Did Deregulation Cause the Crash?

Many people are blaming the mortgage crash on the repeal of the Glass-Steagall Act -- the 1999 Gramm-Leach-Biley Act. But did Gramm-Leach-Bliley cause the crash? I don't think so.

First, Glass-Steagall created a "wall of separation" between investment banking and commercial banking. Investment banks create and sell securities in the investment markets. Commercial banks earn money by offering deposits and making loans (home, auto, business, etc). Glass-Steagall said that commercial banks couldn't offer securities in the investment markets and investment banks couldn't offer loans or deposit accounts.

The law had been steadily weakened before being repealed:

The 1933 Glass-Steagal Act that prohibited commercial banks from owning investment banks, and vice versa, had been steadily weakened since the 70s by an increasingly diverse and complex new financial reality. Waivers from regulators for merger became routine and the 1998 merger between Travelers and Citigroup functionally repealed the law. Gramm-Leach-Bliley only put a de jure stamp of approval on a de facto regulatory framework.

Second, how did allowing a merger between investment banks and commercial banks cause the crisis? Investment banks were primarily buying mortgages from commercial banks. Commercial banks weren't creating the mortgage backed securities, they were selling mortgages to investment banks who then created the securities.

The rest of the previous link offers more details:

In fact, the evidence so far shows that Gramm-Leach-Bliley has helped soften the blow to taxpayers by allowing commercial banks to take over trouble investment firms. Just look at which organization's have failed:

  • Bear Stearns was an investment bank before it was sold to JP Morgan Chase (which includes a commercial bank).
  • Fannie Mae and Freddie Mac were government sponsored entities before the government bought them.
  • Lehman Brothers was an investment bank before it want bankrupt.
  • Merrill Lynch was an investment bank befor it was sold to Bank of America (which is a commercial bank).
  • AIG is an insurance company with no commercial banking division.

Remember, Glass-Steagal was passed to protect commercial banks from failure by forbidding them from investment bank practices like trading in securities and underwriting stocks and bonds. As you can see above non of the failed institutions are commercial banks that got in trouble through risky investment banking. Instead, it is the commercial banks that are providing some stability to the system by purchasing troubled investment banks. Without Gramm-Leach-Bliley they would not even be allowed to technically do this.

Alex Tabarrok and Tyler Cowen say the same thing, but both include links to scholarly sources and papers to back up their point. Megan McArdle also dubunks this myth and includes these interesting notes:

They can't say it more directly because it's moronic. Even if you ignore the economic history indicating that Glass-Steagall didn't help the crisis it was meant to solve--even if you assume, arguendo, that the repeal was a bad idea--there's simply no logical reason to believe it had anything to do with the current mess.

Securitization was not introduced in the 1990s; it was invented in the 1970s and became popular in the 1980s, as chronicled in Liar's Poker. (As an aside, if you haven't read it, you really must. Especially now).

GLB had nothing to do with either lending standards at commercial banks, or leverage ratios at broker-dealers, the two most plausible candidates for regulatory failure here.

Most importantly, commercial banks are not the main problems. If Glass-Steagall's repeal had meaningfully contributed to this crisis, we should see the failures concentrated among megabanks where speculation put deposits at risk. Instead we see the exact opposite: the failures are among either commercial banks with no significant investment arm (Washington Mutual, Countrywide), or standalone investment banks. It is the diversified financial institutions that are riding to the rescue.