Well, the final nail is being hammered into the coffin. The Savings and Loan industry is going to be “legacy”…and, rightfully so.
The New York Times writes the obituary: “Financial Bill to Close Regulator of Fading Industry,” http://www.nytimes.com/2010/07/14/business/14thrift.html?_r=1&hp. “The most remarkable piece of the financial regulation bill that Democrats hope to send the president this week is the directive to dismember and close the Office of Thrift Supervision. The decision is all the more remarkable because it cuts against the grain of a bill devoted to expanding federal regulation, and because it has had virtually no opposition, save for the obligatory protests of the agency’s senior management.”
The original Savings and Loan Association was created to help Americans own their own homes. The S&Ls deposits were time and savings accounts, no transaction accounts, and the assets of an association were mortgages. An S&L could hold 80% of its assets of more in mortgages…not mortgage-backed securities or any other type of synthetic concoction of mortgage instruments or derivatives. These were the single family mortgages of individual families, most of them known personally by the people who ran the association.
Furthermore, these financial organizations were mutual institutions. That is, they were owned by their depositors. No stock holders, no maximizing shareholder value, no gimmicks, no nothing. By law they took time and savings deposits and, by law, they originated mortgages to hold on their balance sheets.
How did they make money? Well, for much of their history they paid 1 ½% to 2% interest on their deposits and collected 4% or so on their mortgages. Their expenses were extremely low. In a typical institution there were only one or possibly two managers (men) and a clerk and maybe two or three tellers or a receptionist (all women). They were mutual institutions so that they did not have to earn anything like 15% on paid-in equity. A 1% return on assets was really good and it just went into the surplus account anyway. Remember George Bailey (Jimmy Stewart), the Bailey Building and Loan Association and the movie “It’s A Wonderful Life.”
The demise of the industry is just another example of how much inflation can be the “stealth” destroyer of stability. The health of the industry was dependent upon the interest rate spread presented above. And, in non-inflationary times when interest rates remained relatively stable, the S&Ls could prosper because the interest rate spread they earned paid for expenses and added to the association’s surplus.
There were cyclical problems, but regulators, specifically using Regulation Q (Reg Q), put a lid on the rate that these institutions could pay depositors so that a positive interest rate spread could be maintained although this “lid” caused something called “dis-intermediation”, an outflow of deposits, that put pressure on the liquidity of associations. This disintermediation was just a time period these institutions had to go through until interest rates stabilized once again.
However, this disintermediation problem points up the underlying weakness of the Savings and Loan Industry. The industry was built on the foundation of interest rate risk: the assets of the typical Savings and Loan Association had an effective average maturity of twelve or thirteen years. The deposits had a maturity of…well, they were very short term deposits.
The periodic problem of disintermediation pointed up the underlying risk that existed within the industry. However, the inflation of the 1960s basically killed the industry. As inflation rose toward the end of the decade, interest rates rose as inflationary expectations got built into the term structure. That is, interest rates, both long-term and short-term, rose.
Well, the typical S&L saw the cost of deposits rise by a substantial amount almost across the board while the return they earned on their assets rose only modestly. All of a sudden, thrift institutions were faced with negative interest rates spreads and they could not exist in such an environment.
This is when deregulation started and accelerated dramatically through the 1970s. Basically, the idea of a thrift institution was dead by then. Not only did regulators allow balance sheets to become more like commercial banks, bank executives were drawn into the industry to run the thrifts. And, of course, thrift institutions were allowed to shed their “mutual” charter and become stock institutions. I took one thrift institution public in 1985 and ran another thrift that had just gone public in 1987.
I have spent a lot of time over the past two years writing about how inflation in the United States over the past 50 years or so basically undermined the financial system as it was known, created a tremendous environment for financial innovation, and helped to change the makeup of American society, where employment in financial services reached 40% or more of the workforce when, before 1980, employment in financial services had never exceeded 15% of the workforce.
The inflation created by the federal government since January 1961 forced the collapse of the post-World War II international financial system as the United States took itself off the gold standard on August 15, 1971 and floated the United States dollar. The inflation of the 1960s resulted in the rise in interest rates that destroyed the foundation of the thrift industry in the United States and created the conditions that led to the Savings and Loan crisis of the late 1980s and early 1990s. The continued inflation of the late 20th century led to the stock market bubble in the 1990s (the dot.com boom), the demise of the Glass-Steagall Act, and the asset bubble (both in the stock market and housing) of the 2000s.
The difficulties we have been experiencing in the last few years can also be traced back to the inflation of the past fifty years. Yet, inflation is sneaky and people tend to forget it in pointing their fingers at the “bastards” that “caused” the financial collapse.
The economist Irving Fisher captured this situation in his book titled “Inflation”: “If it is inflation and the one who profits is the business man, the workman calls the profiter a ‘profiteer.’ The underdog reasons as follows: ‘How did I get poor while you got rich? You did it, you dirty thief. I don’t know just how you did it; your ways are too subtle, sinister, dark and underground for simple me; but you did it all the same’
But, none of us—neither the farmer, nor the workman, nor the bondholder, nor the stockholder—thinks of blaming the dollar. So the real culprit stands on the curbstone watching us poor mortals as we beat out each other’s brains, and has the last laugh.” (This was written in 1933.)
So, good-bye to the Savings and Loan Industry. You did America well. But, your time is past. Rest In Peace (RIP).
Showing posts with label default on mortgages. Show all posts
Showing posts with label default on mortgages. Show all posts
Tuesday, July 13, 2010
Wednesday, June 16, 2010
Unfortunately, Debt Must Be Repaid
Fitch Ratings Ltd. is releasing a report today that points up the problems of having too much debt. Restructuring the debt of a person or a family (or a business), even when government programs help to formalize and regularize loan modifications, is not a “magic wand” that resolves the issue of debt overload.
Using data from the Obama administration’s Home Affordable Modification Program, Fitch reports that “the redefault rate within a year”, of the loans that are modified, “is likely to be 65% to 75%”. This information comes from the Wall Street Journal article, “High Default Rate Seen for Modified Mortgages,” http://online.wsj.com/article/SB10001424052748703280004575308992258809442.html?KEYWORDS=james+hagerty. “Almost all of those who got loan modifications have already defaulted once.”
The failure rate is likely to be high because “most of these borrowers were mired in credit-card debt, car loans and other obligations.” That is, when a person or family (or business) goes into debt they go into debt “across the board” and do not just limit themselves to one kind of debt or one type of lender.
And, the Treasury Department says, that those given loan modifications under this program have a “median ratio of total debt payments to pretax income” that is around 64%. “That often means little money is left over for food, clothing or such emergency expenses as medical care and car repairs.”
The good news is that the results of the program indicate that around one-third of the loan modifications make it through the first year. This is looked on as “good” by the Treasury Department and by a Fitch representative.
This is the reality of debt creation during a period that can be referred to as a period of credit inflation. At times like these, more and more people, families, businesses, and governments take on more and more debt until it gets to the point that the debt loads become unsustainable in some sectors of the economy.
Thus, to the first point, people and families take on mortgages, as well as “credit-card debt, car loans and other obligations” until, the second point, their “ratio of total debt payments to pretax income” becomes too large. Then, any increase in total debt payments, like a re-setting of the interest rate on a mortgage, or a reduction in pretax income, due to being laid off a job, puts the borrower into a situation in which debt payments cannot be made. Defaults occur, and a foreclosure…followed by a bankruptcy…may follow.
The “macro” government response is to provide fiscal and monetary stimulus to make sure people stay employed and to inflate incomes so that debt loads (debt payments relative to pretax income) decline. This is the Keynesian prescription!
The problem with this solution is that in a period of credit inflation, as incomes and prices continue to increase, debt loads continue to increase. If the government buys people out of their debt burdens by fiscal stimulus and monetary inflation, people (and families and businesses) don’t adjust their behavior to become more financially prudent. They just keep on, keeping on. This is another case of moral hazard.
Even worse, given the belief that government will continue to “bail out” those who have taken on too much debt, we find that those that have taken on too much debt generally go even further into debt. Take a look at what has happened over the last fifty years of credit inflation and this type of behavior is observed everywhere.
The Keynesian prescription of fiscal and monetary stimulus to keep unemployment low and debt burdens manageable only exacerbates the problem over time. That is, governmental efforts to sustain prosperity over time just postpone the consequences of dealing with the debt loads that are built up during these time periods.
Keynesian economic models, with the exception of the maverick Keynesians like Hy Minsky, don’t include the credit or debt aspects of economic activity. As a consequence, they ignore how people (and families and businesses) manage their balance sheets over time. In essence, these models ignore the very real fact that ultimately, debt must be repaid and cannot just increase without limit!
Over the past fifty years we have seen people and families and businesses and banks and governments take on more and more debt. Inflation has risen at an average compound rate of about 4% from 1961 through 2008 so that it has paid people to increase financial leverage, take on more risky assets, and finance long term assets with short term debt. And the federal government has underwritten this inflation by increasing its gross debt by around 7.7% per year for this period of time and the Federal Reserve has caused the base money in the economy to rise by 6.2% per year. The M2 money stock measure rose at a compound rate of 7.0% per year. All roughly in line with one another.
The Fitch report is presenting us with a picture of what happens when debt loads get “out-of-hand”…when there is just too much debt around.
The current response of the Federal government? Official federal government forecasts of the cumulative fiscal deficits for the next ten years runs around $9 to $10 trillion. Some of us believe that the deficits will run more in the neighborhood of $15 trillion. In terms of monetary policy, the Federal Reserve has placed $1.1 trillion in excess reserves in the commercial banking system. The leadership of the Federal Reserve expects us to believe that they will be able to reduce the amount of these excess reserves to more normal levels without the reserves being turned into loans that will expand the money stock measures by excessive amounts. (Just a reminder: excess reserves totaled less than $2 billion…note, billion and not trillion…in August 2008 before the big injection of reserves into the banking system took place.)
For one more time, the federal government is betting that by stimulating the economy and putting people back to work in the “legacy jobs” they were laid off from and by re-inflating prices and incomes that debt burdens will be reduced and we can get back to “spending as usual”. If the federal government is successful, the day in which debt loads are reduced will be postponed…once again!
However, the credit inflation causes other things to change. Over the last fifty years we have seen that in every employment cycle, fewer and fewer people are re-hired in the “legacy jobs” from which they were released. Under-employment, not just un-employment, rises and this puts more and more pressure on incomes. The ratio of debt payments to pretax incomes rise for these people. Right now, I estimate that roughly one out of every four or five potential works is under-employed, the highest level since the early 1950s.
Second, the steady inflation of the past fifty years has resulted in a larger proportion of the capital stock being un-productive. As a consequence, capacity utilization in industry has fallen to post-World War II lows. As we have seen in each business cycle during this last fifty years, less and less of this capacity is used in each recovery. This results in a drag on employment and income.
Eventually, debt must be repaid and debt loads must be reduced. The Fitch report highlights this problem. It is something that all of us should keep in mind in the upcoming months. If the situation with respect to under-employment and capacity utilization don’t change the debt loads will get even heavier.
Using data from the Obama administration’s Home Affordable Modification Program, Fitch reports that “the redefault rate within a year”, of the loans that are modified, “is likely to be 65% to 75%”. This information comes from the Wall Street Journal article, “High Default Rate Seen for Modified Mortgages,” http://online.wsj.com/article/SB10001424052748703280004575308992258809442.html?KEYWORDS=james+hagerty. “Almost all of those who got loan modifications have already defaulted once.”
The failure rate is likely to be high because “most of these borrowers were mired in credit-card debt, car loans and other obligations.” That is, when a person or family (or business) goes into debt they go into debt “across the board” and do not just limit themselves to one kind of debt or one type of lender.
And, the Treasury Department says, that those given loan modifications under this program have a “median ratio of total debt payments to pretax income” that is around 64%. “That often means little money is left over for food, clothing or such emergency expenses as medical care and car repairs.”
The good news is that the results of the program indicate that around one-third of the loan modifications make it through the first year. This is looked on as “good” by the Treasury Department and by a Fitch representative.
This is the reality of debt creation during a period that can be referred to as a period of credit inflation. At times like these, more and more people, families, businesses, and governments take on more and more debt until it gets to the point that the debt loads become unsustainable in some sectors of the economy.
Thus, to the first point, people and families take on mortgages, as well as “credit-card debt, car loans and other obligations” until, the second point, their “ratio of total debt payments to pretax income” becomes too large. Then, any increase in total debt payments, like a re-setting of the interest rate on a mortgage, or a reduction in pretax income, due to being laid off a job, puts the borrower into a situation in which debt payments cannot be made. Defaults occur, and a foreclosure…followed by a bankruptcy…may follow.
The “macro” government response is to provide fiscal and monetary stimulus to make sure people stay employed and to inflate incomes so that debt loads (debt payments relative to pretax income) decline. This is the Keynesian prescription!
The problem with this solution is that in a period of credit inflation, as incomes and prices continue to increase, debt loads continue to increase. If the government buys people out of their debt burdens by fiscal stimulus and monetary inflation, people (and families and businesses) don’t adjust their behavior to become more financially prudent. They just keep on, keeping on. This is another case of moral hazard.
Even worse, given the belief that government will continue to “bail out” those who have taken on too much debt, we find that those that have taken on too much debt generally go even further into debt. Take a look at what has happened over the last fifty years of credit inflation and this type of behavior is observed everywhere.
The Keynesian prescription of fiscal and monetary stimulus to keep unemployment low and debt burdens manageable only exacerbates the problem over time. That is, governmental efforts to sustain prosperity over time just postpone the consequences of dealing with the debt loads that are built up during these time periods.
Keynesian economic models, with the exception of the maverick Keynesians like Hy Minsky, don’t include the credit or debt aspects of economic activity. As a consequence, they ignore how people (and families and businesses) manage their balance sheets over time. In essence, these models ignore the very real fact that ultimately, debt must be repaid and cannot just increase without limit!
Over the past fifty years we have seen people and families and businesses and banks and governments take on more and more debt. Inflation has risen at an average compound rate of about 4% from 1961 through 2008 so that it has paid people to increase financial leverage, take on more risky assets, and finance long term assets with short term debt. And the federal government has underwritten this inflation by increasing its gross debt by around 7.7% per year for this period of time and the Federal Reserve has caused the base money in the economy to rise by 6.2% per year. The M2 money stock measure rose at a compound rate of 7.0% per year. All roughly in line with one another.
The Fitch report is presenting us with a picture of what happens when debt loads get “out-of-hand”…when there is just too much debt around.
The current response of the Federal government? Official federal government forecasts of the cumulative fiscal deficits for the next ten years runs around $9 to $10 trillion. Some of us believe that the deficits will run more in the neighborhood of $15 trillion. In terms of monetary policy, the Federal Reserve has placed $1.1 trillion in excess reserves in the commercial banking system. The leadership of the Federal Reserve expects us to believe that they will be able to reduce the amount of these excess reserves to more normal levels without the reserves being turned into loans that will expand the money stock measures by excessive amounts. (Just a reminder: excess reserves totaled less than $2 billion…note, billion and not trillion…in August 2008 before the big injection of reserves into the banking system took place.)
For one more time, the federal government is betting that by stimulating the economy and putting people back to work in the “legacy jobs” they were laid off from and by re-inflating prices and incomes that debt burdens will be reduced and we can get back to “spending as usual”. If the federal government is successful, the day in which debt loads are reduced will be postponed…once again!
However, the credit inflation causes other things to change. Over the last fifty years we have seen that in every employment cycle, fewer and fewer people are re-hired in the “legacy jobs” from which they were released. Under-employment, not just un-employment, rises and this puts more and more pressure on incomes. The ratio of debt payments to pretax incomes rise for these people. Right now, I estimate that roughly one out of every four or five potential works is under-employed, the highest level since the early 1950s.
Second, the steady inflation of the past fifty years has resulted in a larger proportion of the capital stock being un-productive. As a consequence, capacity utilization in industry has fallen to post-World War II lows. As we have seen in each business cycle during this last fifty years, less and less of this capacity is used in each recovery. This results in a drag on employment and income.
Eventually, debt must be repaid and debt loads must be reduced. The Fitch report highlights this problem. It is something that all of us should keep in mind in the upcoming months. If the situation with respect to under-employment and capacity utilization don’t change the debt loads will get even heavier.
Friday, March 26, 2010
The Mortgage Market and More Plans to Aid Homeowners
There is still no better place to observe the consequences of the credit inflation of the last fifty years than the housing market.
Politically, this is democracy at work. Every wave of political change in the post-World War II period has focused on the housing market and putting “Americans” in their own homes in order that the new majority in Congress can get re-elected.
I was in Washington, D. C. during the time period that the mortgage-backed securities were being designed. The rationale for this innovation? Almost all mortgages were made in local depository institutions at that time. But, insurance companies and pension funds had lots of money to invest in longer term securities. If an instrument could be constructed that would allow local depository institutions to sell their mortgages to these companies that wanted long term investment vehicles then the local depository institutions would still have funds available to make more mortgages and put more “Americans” into their own home. And, the incumbent politicians could show their constituents the role they played in not only helping people acquire a home, but also how this effort helped to stimulate the local economy through additional home building. This surely would help the incumbents to get re-elected.
Economically this effort seemed to be sound because it would provide for an almost continued stimulus to the economy, spurring on economic growth and raising employment. A little “inflationary bias” along with this was not bad because almost all the economic models used at this time period showed a positive relationship between inflation and higher levels of employment. Inflation was good for the country!
And, these basic efforts were supplemented by the activities at the Department of Housing and Urban Development, the Federal National Mortgage Association (Fannie Mae) along with the creation of Freddie Mac and Ginny Mae and the work of the Federal Housing Authority, the Federal Home Loan Bank System, and other initiatives forthcoming from both presidential administrations and the Congress. Who could be opposed to such a worthwhile idea?
What we see is that maybe inflation was not all it was said to be. Maybe inflation, in the longer run, can actually be harmful to many of the people it was supposed to help. Maybe one of the “lessons learned” from application of the economic philosophy that dominated Washington in the last fifty years is that you can’t artificially “force” people into situations that are not fundamentally sound on an economic basis.
The efforts of the federal government over the last fifty years or so culminated in the Greenspan/Bernanke credit inflation of the 2000s. The United States experienced a housing bubble during this time period that really capped off the government’s effort to promote homeownership. Asset prices were artificially “forced” to rise further and further. And, as we saw, in the longer run the run-up in housing prices was unsustainable. So the bubble popped!
The consequence? The New York Times reports that “About 11 million households, or a fifth of those with mortgages” are underwater (http://www.nytimes.com/2010/03/26/business/26housing.html?hp). One in five homeowners with a mortgage faces a mortgage that is larger in value than the market price of their home! In addition, many of these homeowners have lots and lots of other debts which they assumed in the Greenspan/Bernanke period of credit inflation. Thus, the default or bankruptcy problem does not exist just in the mortgage area.
Inflation, in the longer run, does not help the lower income brackets and it does not help the middle class. Most people cannot protect themselves against inflation, as can the wealthier classes in society, and the tendency is for those that are not of the wealthy classes to “stretch” their budgets, especially during periods of inflation, to acquire more than they can comfortably carry, financially. Furthermore, as we have seen, inflation tends to increase those that are underemployed in the economy as well as those that are unemployed. When the music stops, the family budget problems extend beyond just paying a mortgage.
This is the dilemma faced by the government in attempting to create a program that will prevent or slowdown defaults and foreclosures. It is not just the fact that the homeowner is underwater. The problem is that the mortgagee is over-extended in other areas and has a real cash flow problem.
The initial effort to provide relief to these troubled borrowers was to reduce interest payments that would reduce monthly mortgage payments. Over the past 12 months over 50% of all mortgages modified in this way defaulted, according to a report just released by the Comptroller of the Currency and the Office of Thrift Supervision. Mortgages that are at least 30 days late climbed to about 58% over the last twelve months. This seems to be evidence that the problem is more than just one of meeting mortgage payments. (See http://www.bloomberg.com/apps/news?pid=20601010&sid=aVYxPZ56vjys.)
The next effort, promised to be released by the White House today, will focus more on writing down the value of mortgages. It is expected that this will prove to be more beneficial to homeowners because it will result in a greater reduction in monthly payments and will reduce the psychological effect of having to pay off something that is larger than the underlying value of the asset it is financing. Another portion of the effort will be to have the F. H. A. insure mortgages that are re-written with lower loan balances, a risky effort for a tax-payer supported institution that is already facing financial difficulties.
There are several problems associated with such a program. First, if financial institutions re-write or re-finance underwater mortgages, the issue becomes one of the solvency of the underwriter. Almost one in eight banks in the United States is either on the problem list of the FDIC or near to being on this list. Can these banks afford to be forced to write off these losses in the near term?
Analysts argue that one of the things the initial effort did (the effort to reduce interest rates) is that it just “spread out” the banks having to deal with foreclosures and capital write-downs over several years. This, at least, allowed the banks to slow down the write-off process allowing them to continue to “stay alive” while they worked out their loan problems. This new program threatens these banks: the losses on these loans would have to be written-off sooner rather than later. Could this accelerate the closing of banks?
Another issue relates to whether or not these problems of “underwater” mortgages are connected to bigger issues than just the foreclosure on houses. It is the case that many of the people that purchased these houses were “stepping up” to a higher living standard and doing so created other payment obligations connected with the higher living standards. Many of the people that are underwater now re-financed in the years before the financial “collapse” and took out a lot of the equity built up in their homes to finance other purchases, perhaps a second home or an addition on the home or some other expenditure that allowed them to “step up.” Without the credit built up through the inflation in their home price they would not have been able to afford the purchases out of their cash flow, even if they continued to remain employed. In these cases the cash flow problem is more than just the difficulty in covering the monthly mortgage payment.
The point is that when a person, a business, or a society attempts to live beyond their means, events will, sooner or later, catch up with them. Inflation incents people to live beyond their means. We are observing the consequences of such behavior in the problems being experienced in the housing market.
Politically, this is democracy at work. Every wave of political change in the post-World War II period has focused on the housing market and putting “Americans” in their own homes in order that the new majority in Congress can get re-elected.
I was in Washington, D. C. during the time period that the mortgage-backed securities were being designed. The rationale for this innovation? Almost all mortgages were made in local depository institutions at that time. But, insurance companies and pension funds had lots of money to invest in longer term securities. If an instrument could be constructed that would allow local depository institutions to sell their mortgages to these companies that wanted long term investment vehicles then the local depository institutions would still have funds available to make more mortgages and put more “Americans” into their own home. And, the incumbent politicians could show their constituents the role they played in not only helping people acquire a home, but also how this effort helped to stimulate the local economy through additional home building. This surely would help the incumbents to get re-elected.
Economically this effort seemed to be sound because it would provide for an almost continued stimulus to the economy, spurring on economic growth and raising employment. A little “inflationary bias” along with this was not bad because almost all the economic models used at this time period showed a positive relationship between inflation and higher levels of employment. Inflation was good for the country!
And, these basic efforts were supplemented by the activities at the Department of Housing and Urban Development, the Federal National Mortgage Association (Fannie Mae) along with the creation of Freddie Mac and Ginny Mae and the work of the Federal Housing Authority, the Federal Home Loan Bank System, and other initiatives forthcoming from both presidential administrations and the Congress. Who could be opposed to such a worthwhile idea?
What we see is that maybe inflation was not all it was said to be. Maybe inflation, in the longer run, can actually be harmful to many of the people it was supposed to help. Maybe one of the “lessons learned” from application of the economic philosophy that dominated Washington in the last fifty years is that you can’t artificially “force” people into situations that are not fundamentally sound on an economic basis.
The efforts of the federal government over the last fifty years or so culminated in the Greenspan/Bernanke credit inflation of the 2000s. The United States experienced a housing bubble during this time period that really capped off the government’s effort to promote homeownership. Asset prices were artificially “forced” to rise further and further. And, as we saw, in the longer run the run-up in housing prices was unsustainable. So the bubble popped!
The consequence? The New York Times reports that “About 11 million households, or a fifth of those with mortgages” are underwater (http://www.nytimes.com/2010/03/26/business/26housing.html?hp). One in five homeowners with a mortgage faces a mortgage that is larger in value than the market price of their home! In addition, many of these homeowners have lots and lots of other debts which they assumed in the Greenspan/Bernanke period of credit inflation. Thus, the default or bankruptcy problem does not exist just in the mortgage area.
Inflation, in the longer run, does not help the lower income brackets and it does not help the middle class. Most people cannot protect themselves against inflation, as can the wealthier classes in society, and the tendency is for those that are not of the wealthy classes to “stretch” their budgets, especially during periods of inflation, to acquire more than they can comfortably carry, financially. Furthermore, as we have seen, inflation tends to increase those that are underemployed in the economy as well as those that are unemployed. When the music stops, the family budget problems extend beyond just paying a mortgage.
This is the dilemma faced by the government in attempting to create a program that will prevent or slowdown defaults and foreclosures. It is not just the fact that the homeowner is underwater. The problem is that the mortgagee is over-extended in other areas and has a real cash flow problem.
The initial effort to provide relief to these troubled borrowers was to reduce interest payments that would reduce monthly mortgage payments. Over the past 12 months over 50% of all mortgages modified in this way defaulted, according to a report just released by the Comptroller of the Currency and the Office of Thrift Supervision. Mortgages that are at least 30 days late climbed to about 58% over the last twelve months. This seems to be evidence that the problem is more than just one of meeting mortgage payments. (See http://www.bloomberg.com/apps/news?pid=20601010&sid=aVYxPZ56vjys.)
The next effort, promised to be released by the White House today, will focus more on writing down the value of mortgages. It is expected that this will prove to be more beneficial to homeowners because it will result in a greater reduction in monthly payments and will reduce the psychological effect of having to pay off something that is larger than the underlying value of the asset it is financing. Another portion of the effort will be to have the F. H. A. insure mortgages that are re-written with lower loan balances, a risky effort for a tax-payer supported institution that is already facing financial difficulties.
There are several problems associated with such a program. First, if financial institutions re-write or re-finance underwater mortgages, the issue becomes one of the solvency of the underwriter. Almost one in eight banks in the United States is either on the problem list of the FDIC or near to being on this list. Can these banks afford to be forced to write off these losses in the near term?
Analysts argue that one of the things the initial effort did (the effort to reduce interest rates) is that it just “spread out” the banks having to deal with foreclosures and capital write-downs over several years. This, at least, allowed the banks to slow down the write-off process allowing them to continue to “stay alive” while they worked out their loan problems. This new program threatens these banks: the losses on these loans would have to be written-off sooner rather than later. Could this accelerate the closing of banks?
Another issue relates to whether or not these problems of “underwater” mortgages are connected to bigger issues than just the foreclosure on houses. It is the case that many of the people that purchased these houses were “stepping up” to a higher living standard and doing so created other payment obligations connected with the higher living standards. Many of the people that are underwater now re-financed in the years before the financial “collapse” and took out a lot of the equity built up in their homes to finance other purchases, perhaps a second home or an addition on the home or some other expenditure that allowed them to “step up.” Without the credit built up through the inflation in their home price they would not have been able to afford the purchases out of their cash flow, even if they continued to remain employed. In these cases the cash flow problem is more than just the difficulty in covering the monthly mortgage payment.
The point is that when a person, a business, or a society attempts to live beyond their means, events will, sooner or later, catch up with them. Inflation incents people to live beyond their means. We are observing the consequences of such behavior in the problems being experienced in the housing market.
Friday, January 8, 2010
Something is Wrong!
A headline in the New York Times, “Walk Away From Your Mortgage!”
Why not?
The best remedy for the current economic malaise?
Since there is too much debt, let’s all just walk away from our debt.
And, if the New York Times is printing such material, then it must be OK! Right?
As we “recover” from the Great Recession we see pockets of problems all over the place. Things just don’t fit together the way they used to. And, what we are doing to combat these problems doesn’t seem to be relieving the suffering. The whole world seems to be dislocated.
There is too much debt outstanding. No one disagrees with that, but how do you get people and businesses and governments to start spending again when they are desperate to reduce their outstanding debt?
Other headlines this morning point to the problems in commercial real estate. In “Delinquency Rate Rises for Mortgages” we read that “More than 6% of commercial-mortgage borrowers in the U. S. have fallen behind in their payments, a sign of potential troubles ahead as nearly $40 billion of commercial-mortgage-backed bonds come due this year.” (See http://online.wsj.com/article/SB20001424052748704130904574644042950937878.html#mod=todays_us_money_and_investing.) Also, “Further Slide Seen in N. Y. Commercial Real Estate” points to the fact that 180 buildings totaling $12.5 billion in value, are in trouble in Manhattan. (See http://www.nytimes.com/2010/01/08/nyregion/08commercial.html?hp.)
But, the problems don’t seem to be just in commercial real estate. The New York Times article cited above states that at least one quarter of all residential mortgages in the United States are underwater and that 10% of the mortgages outstanding are delinquent. Another round of foreclosures and bankruptcies seem to be on the way.
Which brings us to the banking system: here the difficulties bifurcate depending upon size. If you are really big you seem to be doing very, very well these days. In fact, it seems as if the “good ole daze” have returned for these bankers. Risk-taking and speculation in the carry trade abound. Simon Johnson, an economist at MIT issued a warning on CNBC yesterday morning that the next phase of the financial crisis could be just beginning and this gets back to the risk-taking of the six major banks in the US whose combined balance sheets exceed 60% of United States GDP.
If you are smaller, however, your problems are immense. The smaller banks are carrying the burden of the commercial real estate problems and consumer debt and mortgages still present these banks with problems because these loans represented “Main Street” and were not all packaged and sold to investors in Finland. Remember there are 552 banks, all small- and medium-sized banks that are on the FDICs list of problem banks and this is expected to grow this year before declining, generally do to actual failures.
There are more dislocations throughout the economy that point to persisting problems. For example, in manufacturing, since the 1960s the unused capacity of United States industry has continually declined from peak usage to peak usage of that capacity The latest peak utilization of capacity still saw that about 20% of the industrial capacity of the United States remained unused. Unused capacity for the past thirty years seems to average around 23% to 24%.
We see unused capacity in the labor force as well. Since the 1970s under-employment of labor has grown quite consistently. Attention is focused upon the unemployment rate, but this measure does not include those individuals that have left the labor force because they are discouraged and those that are only working part time but would like to work more. We have seen estimates that 17% to 20% of the employable people in the United States are under-employed. Another dislocation that is not comforting.
Then we hear about the problems in state and local governments. Reports indicate that there are more than 30 states that are currently experiencing fiscal difficulties. We hear most about California and New York, but there are many other states particularly in the west and southwest that are having real problems. One estimate is that the states will have a combined budget shortfall of at least $350 billion in the fiscal years of 2010 and 2011. And, this doesn’t even get to the difficulties that are being faced by local governmental bodies.
And, there are the dislocations being created by the federal government. Budget deficits for the next ten years have been placed in the range of $15 trillion. The United States is fighting in three wars throughout the world. The government is passing health care legislation that has been justified fiscally by postponing start dates of programs from three to five years. There is climate control efforts being considered along with regulations, like anti-pollution controls, that will just exacerbate the economic and fiscal problems of the country. Then there are other changes in the rules and regulations that apply to industry that will further change the playing field and create greater uncertainty about what management’s should do.
There is the problem of unemployment, the number one issue among the American voter. (And, you thought the number one issue was health care or pollution or terrorism or the war in Afghanistan.) But, there is a dislocation problem relating to federal government stimulus programs.
For fifty years or so, the federal government has attempted to stimulate the economy to put people back to work in the same jobs that they were released from. The government has sought to put unemployed people back to work in the steel industry, in the auto industry, and in other jobs that are the backbone of American industry (according to the labor unions and others). As a consequence, the steel industry lost competitiveness, the auto industry lost competitiveness, and so do many other industries.
This effort to stimulate the economy and put people back into the jobs that they had lost has contributed greatly to the increase in the unused industrial capacity and to the increase in the under-employed in this country. The effort to constantly maintain a low unemployment rate by putting people back into the jobs they have lost has resulted in a massive slide in the competitive position of the United States.
The point of this discussion is my concern with the huge dislocations that now exist within the country. Things are out-of-whack and it is going to take us quite a while for us to get things back together again. Yes, we can try and “force” the economy back into a position of higher employment and greater capacity utilization, of lower debt burdens and greater solvency. But, this would just postpone, once again, the need to realign the country to deal with the pressures of the 21st century.
Something has changed, however. The United States is now facing a more competitive and hostile world economy. The government may not be able to “force” the economy back into its old mold.
Why not?
The best remedy for the current economic malaise?
Since there is too much debt, let’s all just walk away from our debt.
And, if the New York Times is printing such material, then it must be OK! Right?
As we “recover” from the Great Recession we see pockets of problems all over the place. Things just don’t fit together the way they used to. And, what we are doing to combat these problems doesn’t seem to be relieving the suffering. The whole world seems to be dislocated.
There is too much debt outstanding. No one disagrees with that, but how do you get people and businesses and governments to start spending again when they are desperate to reduce their outstanding debt?
Other headlines this morning point to the problems in commercial real estate. In “Delinquency Rate Rises for Mortgages” we read that “More than 6% of commercial-mortgage borrowers in the U. S. have fallen behind in their payments, a sign of potential troubles ahead as nearly $40 billion of commercial-mortgage-backed bonds come due this year.” (See http://online.wsj.com/article/SB20001424052748704130904574644042950937878.html#mod=todays_us_money_and_investing.) Also, “Further Slide Seen in N. Y. Commercial Real Estate” points to the fact that 180 buildings totaling $12.5 billion in value, are in trouble in Manhattan. (See http://www.nytimes.com/2010/01/08/nyregion/08commercial.html?hp.)
But, the problems don’t seem to be just in commercial real estate. The New York Times article cited above states that at least one quarter of all residential mortgages in the United States are underwater and that 10% of the mortgages outstanding are delinquent. Another round of foreclosures and bankruptcies seem to be on the way.
Which brings us to the banking system: here the difficulties bifurcate depending upon size. If you are really big you seem to be doing very, very well these days. In fact, it seems as if the “good ole daze” have returned for these bankers. Risk-taking and speculation in the carry trade abound. Simon Johnson, an economist at MIT issued a warning on CNBC yesterday morning that the next phase of the financial crisis could be just beginning and this gets back to the risk-taking of the six major banks in the US whose combined balance sheets exceed 60% of United States GDP.
If you are smaller, however, your problems are immense. The smaller banks are carrying the burden of the commercial real estate problems and consumer debt and mortgages still present these banks with problems because these loans represented “Main Street” and were not all packaged and sold to investors in Finland. Remember there are 552 banks, all small- and medium-sized banks that are on the FDICs list of problem banks and this is expected to grow this year before declining, generally do to actual failures.
There are more dislocations throughout the economy that point to persisting problems. For example, in manufacturing, since the 1960s the unused capacity of United States industry has continually declined from peak usage to peak usage of that capacity The latest peak utilization of capacity still saw that about 20% of the industrial capacity of the United States remained unused. Unused capacity for the past thirty years seems to average around 23% to 24%.
We see unused capacity in the labor force as well. Since the 1970s under-employment of labor has grown quite consistently. Attention is focused upon the unemployment rate, but this measure does not include those individuals that have left the labor force because they are discouraged and those that are only working part time but would like to work more. We have seen estimates that 17% to 20% of the employable people in the United States are under-employed. Another dislocation that is not comforting.
Then we hear about the problems in state and local governments. Reports indicate that there are more than 30 states that are currently experiencing fiscal difficulties. We hear most about California and New York, but there are many other states particularly in the west and southwest that are having real problems. One estimate is that the states will have a combined budget shortfall of at least $350 billion in the fiscal years of 2010 and 2011. And, this doesn’t even get to the difficulties that are being faced by local governmental bodies.
And, there are the dislocations being created by the federal government. Budget deficits for the next ten years have been placed in the range of $15 trillion. The United States is fighting in three wars throughout the world. The government is passing health care legislation that has been justified fiscally by postponing start dates of programs from three to five years. There is climate control efforts being considered along with regulations, like anti-pollution controls, that will just exacerbate the economic and fiscal problems of the country. Then there are other changes in the rules and regulations that apply to industry that will further change the playing field and create greater uncertainty about what management’s should do.
There is the problem of unemployment, the number one issue among the American voter. (And, you thought the number one issue was health care or pollution or terrorism or the war in Afghanistan.) But, there is a dislocation problem relating to federal government stimulus programs.
For fifty years or so, the federal government has attempted to stimulate the economy to put people back to work in the same jobs that they were released from. The government has sought to put unemployed people back to work in the steel industry, in the auto industry, and in other jobs that are the backbone of American industry (according to the labor unions and others). As a consequence, the steel industry lost competitiveness, the auto industry lost competitiveness, and so do many other industries.
This effort to stimulate the economy and put people back into the jobs that they had lost has contributed greatly to the increase in the unused industrial capacity and to the increase in the under-employed in this country. The effort to constantly maintain a low unemployment rate by putting people back into the jobs they have lost has resulted in a massive slide in the competitive position of the United States.
The point of this discussion is my concern with the huge dislocations that now exist within the country. Things are out-of-whack and it is going to take us quite a while for us to get things back together again. Yes, we can try and “force” the economy back into a position of higher employment and greater capacity utilization, of lower debt burdens and greater solvency. But, this would just postpone, once again, the need to realign the country to deal with the pressures of the 21st century.
Something has changed, however. The United States is now facing a more competitive and hostile world economy. The government may not be able to “force” the economy back into its old mold.
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