Let me suggest a conceptual distinction to make things clearer.
Economically, we face two related but distinguishable problems.
First, due to post-modern financial engineering, Wall Street has created vast upside down pyramids of leverage that are so intricate that nobody is sure what financial instruments are worth anymore, with frightening implications for the whole system, which could cause a lock-up of all lending.
Second, we have a fundamental problem, which is that a lot of those highly leveraged complex instruments really aren't worth much because the basic assets they balance on top of have declined sharply in value. Essentially, in this decade home prices (primarily in a small number of states, most notably California, Nevada, Arizona, and Florida) inflated to absurd levels, generating trillions in new wealth on paper. Those gains are now gone and won't come back for decades because they were always stupid: there was never enough human capital in California to earn enough money to pay for those houses.
My published articles are archived at iSteve.com -- Steve Sailer
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I agree with Auster here while I disagree with his nihilism. Ask your center-Right and Left pundits to address the fact that whatever we may think of a "rescue", as long as the crux of the problem is not addressed, that C.R.A. must be repealed, it is useless and cannot inspire any confidence:
I was about to say, if they want to make a deal that will get more Republicans on board to pass the bailout, how about repealing the 1977 Community Reinvestment Act and its various amendments and regulations and offshoots that push or require or help banks to give mortgages to uncreditworthy persons?
That would surely get some additional Republicans to vote for the package. But it would surely push a lot of Democrats away. For Democrats to give up the CRA and subprime mortgages would be the equivalent of giving up Brown v. Board, giving up the 1964 Civil Rights Act, giving up the Equal Opportunity Commission, giving up affirmative action, giving up Title IX, giving up any major piece of the infrastructure of modern liberal society. And the liberals will never do that, until, perhaps, the society literally crashes as a result of liberalism.
And all this time I thought we had discovered 'money for nothing'...
Regarding e.g. mortgage backed securities (MBS), and probably similar instruments, I think the mathematical models/principles used to put this paper together can yield a pretty good idea of its current worth. The problem is that up until now projections about default rates have been consistently wrong -- i.e. too low -- and so no one is willing to pay today's price for something that will likely be worth less in one month when the latest delinquency and default rates are available. Then throw in a likely longer rather than shorter recession and you have massive illiquidity because the risk is just too high.
I think the pyramid might have held together a little longer were it not for the dollar slide and $100+ oil. That is why this thing happened in September 2008, rather than September 2007.
Let me suggest a conceptual distinction to make things clearer.
Economically, we face two related but distinguishable problems.
Assorted posters have boiled down the crisis into two main problems as well: (a) evil minororeetees who tipped the US economy into bankruptcy by their bad mortgages or (b) stressed white people who "overbought" real estate and drove themselves to bankruptcy cuz they feared some Mexicans would move in next door.
Your explanation seems to be an improvement on what we've seen so far..
First, due to post-modern financial engineering, Wall Street has created vast upside down pyramids of leverage that are so intricate that nobody is sure what financial instruments are worth anymore, with frightening implications for the whole system, which could cause a lock-up of all lending.
OK fair enough, agreed, but I would add not only Wall Street. Its a global financial system with technical analysts manipulating the levers worldwide. Quote fromt he Weekly Strandard:
As the government's power recedes, new forces emerge. Global hedge funds, oil-producing nations, and sovereign wealth funds (pools of capital associated with and often controlled by foreign governments) wield considerable leverage over the international markets. These new actors do not necessarily have the interests of the American citizen in mind. Nor do the individuals empowered by the market or by governments who increasingly make decisions affecting the livelihoods of hundreds of millions of people.
Smick writes that the "industrialized world has surrendered control of its financial system to a tiny group of five thousand or so technical market specialists spread throughout investment banks, hedge funds, and other financial institutions."
http://www.weeklystandard.com/Content/Public/Articles/000/000/015/633hgasz.asp?pg=2
Second, we have a fundamental problem, which is that a lot of those highly leveraged complex instruments really aren't worth much because the basic assets they balance on top of have declined sharply in value. Essentially, in this decade home prices (primarily in a small number of states, most notably California, Nevada, Arizona, and Florida) inflated to absurd levels, generating trillions in new wealth on paper.
And according to assorted posters, this has happened because the white people in these states were "fleeing" Mexicans and blacks, eh?
Now, that doesn't sound so bad: easy come, easy go. And now the economy and standards of living are going to have to contract as this orgy of real world spending of paper profits is slowly paid off.
Sounds like common sense.. But it seems common sense gets lost by those who attribute it all to "minorities"....
We have three generations now of "me-first" narcissists. It's getting worse. These witless focques can't adjust when things change. They never took Problem Solving 101 because it ain't taught anymore. They teach "America is a racist, sexist, homophobic country" courses instead.
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Regarding e.g. mortgage backed securities (MBS), and probably similar instruments, I think the mathematical models/principles used to put this paper together can yield a pretty good idea of its current worth.
No, they cannot. That, in a nutshell, gets at the heart of this problem.
The banking cartel has set up a sweet game for themselves, where by borrowing short-term, and then lending long-term at higher rates, they cash in on the always large delta between interest rates short vs long. This delta would be larger in a free market. (In a free market, maturity mismatching is either illegal as a fraud, or else it will be punished via bank runs and collapses to the point where it ceases to be a good business practice.) How much larger, I don't know -- I tend to think not that much, maybe a percentage point or two. (A lot of crazier libertarians than I am think more than that.) But in any case, clearly by creating artificial long-term savings where there really aren't any, the rate must be depressed somewhat.
So, this results in a system that has two equilibria, not just one. The free-market equilibrium point is a truly stable one. The other one of those equilibria, the one we've known all our lives, is unstable, although it is only very slightly unstable. The government has created a lot of forces to keep it on track; only by a very large anomolous drop in the underlying asset values of long-term loans (due to the otherwise unrelated mortgage bubble) has the fundamental instability been exposed.
Thus, right now, all long-term loans have, essentially, two values. One is the value that they used to have (more or less): this is the value that they will have if the government manages to contain this crisis. The other value is a lower value, perhaps considerably lower, that will happen if the free market interest rates assert themselves.
You might think of the government bank cartel with its mismatched maturities as an SUV: most of the time, zipping down a nice straight economic road, it is perfectly stable. But if it hits a sharp enough turn at speed, it goes over. We've just hit a sharp enough turn that we're up on two wheels. We can still steer the thing down, or we might go over. Situation unclear: check again later.
If the thing collapses, then long-term rates go up (and short term rates down). Not just for a while, sustainably. In that scenario, the value of all mortgages currently written is ... well, lower. And the value of all assets based on cheap mortgages, also lower.
Consider an example with bonds (since they are a lot easier to compute). Consider a 10 year, $100 bond with 6% coupon. Clearly its internal rate of return is 6%; but what is its value, assuming no risk of default, in present dollars? That depends on the long-term interest rate. If we assume the long-term interest rate is zero, then we find that its net present value is $160: you get $6 in interest each of ten years, and $100 in repaid principle, and they are worth exactly as much later as now. Now assume that long-term real rates are higher -- say, 4%. Then we must devalue each coupon and the principle by their distance in time: so, net present value is just ~$116.
Thus, higher long-term rates == lower present value. The same is true of mortgages, or any other loan. When real interest rates increase, lenders suffer. Not just lenders stuck with crap debt, although they of course suffer too. All lenders.
Now, I think when a lot of people think about this stuff, they think in personal terms. Me, for example: I've got a bunch of money out earning various rates in various things (stocks, CDs, etc.). If the value of all of these investments was halved, well, ouch. That would hurt. I.e., if my $10000 in GLD shares dropped (because the value of gold halved -- unlikely just now), I would "lose" $5000 -- but only on paper. But I would not be bankrupt, because I don't have any debt.
But banks, they are not like that. Their profit model is, again, borrowing short and lending long. So, it's as if I had borrowed, say, $8000 from my brother to buy GLD, then it went up to $11000, and I am congratulating myself and selling $1000 of it to take a nice vacation, then this crisis hits and it goes to $5000 -- and I still owe $8000. This is not just financial ouch. This is, um, sorry brother, I can't pay you back. Could I maybe mow your lawn for a while?
To the extent which they have borrowed the money they are lending -- which, of course, all modern banks have -- they are bankrupt if asset prices drop.
To review: there are two states that the American financial system might have. One is the current state, with the federal government intervening in the credit markets to lower long-term rates. The other is a free-market state, with higher long-term rates and lower short-term rates. If we were to transition to such a state, practically every bank and many other credit institutions would go bankrupt. FDIC would get a workout, certainly.
That is what the bigwigs are fearing here. They are riding a tiger, and I think right now they are slipping a little, and they know it.
there was never enough human capital in California to earn enough money to pay for those houses.
There wouldn't be enough human capital in California even if they were all white or Asian: quite frankly, so many of the jobs Californians were getting paid 6 figures to do in the 90s are now being done in India for (barely) 5 figures. When I visited an MBA friend living outside LA 5 years ago, he told me the company he worked for wouldn't pay him any more to work at their office in California than to work at their office in Texas. They wouldn't pay the diffeential, and in California even he, MBA, fluent Chinese and all, couldn't afford a home (not in a decent area, anyway).
For so many talented and well educated Americans, the choice used to be between a job in San Francisco and a job in Topeka. Why not choose San Francisco? But today, it's a job in Topeka or no job at all, since you can't make it in SF on what the company pays. The result: home prices in expensive areas have to come down.
"there was never enough human capital in California to earn enough money to pay for those houses."
This is something I've been saying to everyone I know for years; now thanks to Steve (and Tim Berners-Lee) I can say it to a lot of people I don't know: there isn't enough income in London to buy all the houses in London at the prices they're supposed to be worth. This is only possible because houses aren't actually commodities for market. Most people just live in them and only a small fraction are for sale at any time. If everyone decided at the same time to sell up in London and live on the proceeds somewhere cheaper (Arizona's nice, I think) prices would collapse - not by 10% but to 1/10th.
There was always unfairness in rising house prices. Where did the increased value accruing to homeowners come from? Houses are not factories. It could only be a wealth transfer from renters to owners - generally from the rather poorer to the rather richer. That I believe is why so many people wanted to buy rather than rent.
If your house is only valuable so long as you and everyone else don't actually sell, you think your rich when you're not. Who benefits from that? I blame Thatcher (and her heirs like Blair).
if they want to make a deal that will get more Republicans on board to pass the bailout,
Who is that "they"? If they are Establishment Republicans, they ain't about to try to repeal the so-called CRA.
Why? Because the CRA has been a moneymaker for finance, insurance, real estate, and construction bizznezzez.
Your big mistake is to think that Establishment Republicans are conservatives. They are not.
Neither are voters in the aforesaid business sectors, many of whom are nominal Republicans, likely to vote against their pocketbook interests.
how about repealing the 1977 Community Reinvestment Act and its various amendments and regulations and offshoots that push or require or help banks to give mortgages to uncreditworthy persons?
That would surely get some additional Republicans to vote for the package. But it would surely push a lot of Democrats away.
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