Tag: House-price bubble

John McCain’s housing-crisis speech is best described as a nothingburger.

McCain thinks that big mortgage lenders should provide loans to homeowners whose mortgages are in default. He doesn’t explain how that’s supposed to be profitable for the lenders, why if it is profitable for the lenders they’re not doing it now, or why if it’s not profitable for the lenders the people who run, but don’t own, those institutions should do it anyway.

It might be reasonable to ask banks to go easy on their own borrowers. But equally of course the slicing and dicing of risk means that the outfit that services a mortgage often is just an agent for others, and has no authority to renegotiate the terms of the loan.

So McCain’s message to the victims of predatory lending practices and the owners of homes in half-finished subdivisions is: Good luck, suckers! You’re on your own.

Equally deficient is McCain’s analysis of how we got where we are. Yes, there was folly by lending institutions, fraud by agents, and excessive optimism among buyers. But the folly wasn’t a purely psychological phenomenon; the executives of those outfits, driven by the demand to “make the numbers” and (over)compensated via incentive schemes that encouraged them to take big risks with other people’s money, did so with abandon. The notion that we could solve the underlying problem without addressing corporate governance and executive pay seems rather bizarre.

Update

Ryan Avent of The Bellows says of McCain:

If the American public finds out that he feels Bear deserved its bailout and homeowners deserve nothing, they’re going to be pissed.

h/t Matt Yglesias, who doubts that “eat your peas” is a winning political slogan:

Actual voters don’t much like that kind of thing; I think they’re skeptical as to how much different government policy makes in their lives, but they want policymakers to be at least trying to make their lives better.

Paul Krugman answers the question I raised yesterday: he says that the housing crunch is creating solvency problems, not just liquidity problems, for some large financial institutions. If so, it’s not just homeowners who are in for a rough ride.

But I’m not sure Krugman’s argument supports his conclusion. Yes, there are clearly lots and lots of bad loans out there; how many, and how bad, we won’t know until housing prices stabilize. But since not every home with negative equity will go into foreclosure, and the loss to the mortgage-holder in a foreclosure varies, the fact that a 20% drop in housing prices would put 13.7 million mortgages under water doesn’t tell me whether the banks that hold those mortgages are broke or not.

I read somewhere that Warren Buffet is buying bank stocks. That seems reassuring.

What, you ask, is an SIV? There are long-winded answers to that question, but I think Dr. Hypercube has the right short answer. An SIV is a financial matryoshka.

The outermost shell is the SIV, which looks like a fixed-income mutual fund. Inside the SIV there are CDOs (collateralized debt obligations), which are slices of mortgage pools, each slice carrying a different, but hard-to-determine, level of risk. Inside the CDOs there are mortgages, many of which are never going to pay off, because inside the mortgages are houses, some of which couldn’t be sold for what is currently owed on them.

Each layer increases the opacity of the system, worsening the lemons problem that leads to unsalable assets and thus a liquidity crunch, and makes it impossible to know whether the liquidity crunch is just a short-term glitch or whether instead it covers a solvency problem for some of the financial institutions involved.

And that’s why Citigroup has to pay several points above prime on its short-term debt.

Update Krugman says it’s a solvency problem, not just a liquidity problem. But I’m not sure how he thinks he knows that.

In Pohl and Kornbluth’s brilliant, dystopic Gladiator-at-Law, one of the consequences of losing your job is losing your housing. The protagonist and his family have to move to “Belly Rave,” a hideous, gang-ridden slum.*

That chapter begins with a flashback to the construction of a new suburban development called Belle Rêve (that’s “beautiful dream,” if you were sleeping that day in French class). In an economic downturn, some of the houses become neglected and then abandoned, leading to a downward spiral in both physical and social conditions.

Looks as if the future may be now:

Pushing up against almond groves and dirt-bike trails, the row of homes on St. Salazar Circle marks the furthest advance of Modesto’s housing boom - and the start of its scorched-earth retreat.

Brown, unwatered lawns of foreclosed homes compete with the green grass of neighbors still hanging on. Some of the structures, although new, are missing outdoor equipment like air conditioners, taken by metal thieves. One in 4 houses of the neighborhood stands empty, and mortgage defaults are certain to push even more residents, mostly Hispanic immigrants, out of their homes.

It’s a sign of the home-loan crisis’ uneven impact: light in some areas, heavy in others - often those populated by minorities or the lower-middle class.

Yes, the banks and mortgage companies and appraisers all deserve to take their lumps for the subprime and Alt-A messes, but let’s not forget the Bush Administration, relentlessly hawking the “Ownership Society” (with the clear implication that somehow non-owners were less than full members) and pointing to pride with increasing homeownership rates driven largely by purchases of overpriced homes on shaky mortgages by people who couldn’t afford them.

* My sister Kelly reminds me that “Belle Rêve” was the name of Blance Dubois’s lost home in A Streetcar Named Desire, which appeared several years before Gladiator-at-Law. That must have been a deliberate allusion on the part of Pohl and Kornbluth.

It’s conventional to wring one’s hands about the deflation of the housing-market bubble. Kevin Drum refers to himself and the others who predicted a steep slide as “pessimists,” and caps a discussion of predictions of a 20-25% slide in SoCal housing prices from their peak with “This is really not going to be pretty.”

Surely, it would have been better had the bubble never inflated in the first place, and clearly lots of people are going to be hurt: by losing their homes to foreclosure, by not losing their homes to foreclosure but taking a big financial hit to hold on to them, by losing their housing-related jobs, and, if the housing crash and the credit crunch trigger a recession, by losing their non-housing-related jobs. I don’t want to minimize that suffering, and it’s rather shocking how little is being done in Washington to limit it.

But I submit that the collapse of inflated housing prices is, on balance, overwhelmingly A Good Thing. Right now, the high price of housing is the worst thing about living in LA: worse than traffic, worse than air pollution, worse than the Getty and the LA County Museum of Second-Rate Art, even (maybe) worse than the LA Mummified School District. UCLA is not stingy with salaries, by university standards, and the pension system is insanely generous, but my department lost a first-rate scholar to a university that isn’t nearly as good simply because at the same salary that left him on the fringes of the LA housing market he could afford a four-bedroom house in a good school district near his new employer.

If prices on the Westside of LA fall 30% from their peaks, they’d still be above the house-price-to-income ratio that prevailed from 1970-2000, and housing in LA wasn’t cheap then. High housing prices are the enemy of all things good and noble; I only wish I thought we’d seen the last of them.

Thanks to Peter Cohan, I finally understand what a Structured Investment Vehicle (SIV) is: it’s a leveraged investment fund sponsored by a big financial institution that trades on the parent company’s reputation but is off its balance sheet. The extent to which the parent is legally liable if the fund goes belly-up seems to vary from case to case, but as a matter of maintaining business reputation the pressure on the parent firms to bail out the SIVs is strong.

The leverage comes from the SIVs’ capacity (based on their parents’ credit and credibility) to sell asset-based commercial paper. In English, that means that they operate by borrowing short-term money to lend long-term money. Borrowing short and lending long was the basic source of the S&L crisis (though of course mismanagement, moral hazard, and outright theft all contributed to the debacle). That is to say, SIVs were in business to do something insanely risky and stupid. Now that the subprime mortgage meltdown, and the revelation that a AAA rating on an asset-backed security doesn’t actually mean that security is … well, secure … have made asset-backed commercial paper hard to sell, the SIVs are up the proverbial polluted estuary with no apparent means of propulsion. They can’t sell their assets for anything like their underlying value, because the opacity of the instruments and the uncertainties in the housing markets means that no one really knows what that value is, and every potential buyer has to worry that the potential seller is simply trying to offload toxic waste. With the financial institutions’ own solvency in question because no one knows how big the losses are or how big any single institution’s exposure is, their ability to borrow money on their own account is also compromised.

How to divide up the losses among the investors and the parent financial firms is going to be complicated, but I’m with Peter: the appropriate taxpayer share of the losses is zero, and the Treasury shouldn’t bully the financial institutions who in this instance were less stupid and greedy to help bail out those that were more stupid and greedy.

The temptation to “do something” is obvious: if the SIVs have to dump their holdings at fire-sale prices, other holders of similar assets, when they mark them to market, are going to show gigantic losses, further shaking confidence. But we pay Treasury Secretaries and central banks to resist that sort of temptation. Maybe if a Very Big Bank goes under that will help remind future bank CEOs that it’s not actually necessary to dance as long as the music is playing. There need to be some rewards for sitting down first.

Il est bon de tuer de temps en temps un amiral pour encourager les autres.*

Update Apparently something’s going to be unveiled tomorrow.

Continue reading “The SIV epidemic”

HOUSING BUBBLE WATCH….The housing meltdown continues apace

says Kevin Drum.

To nit-pick: bubbles pop if made of soap, sag if of gum; implode is a sound generic term. An igloo can melt, at a pinch a sandcastle.

Only resourceful Hollywood can unmix the metaphors. In one of the later Bond movies, Die Another Day, the villain’s essential palace-cum-death-ray-control-centre is a huge dome made of ice. In the finale this naturally both implodes and melts. So a bubble meltdown can fit crazed plans for world domination, not the mundane housing slump.

With all the skill and empathy of Lord John Russell devising a new twist on the Poor Law for the starving Irish peasantry, George Bush presents a package to aid and comfort the working-class Americans facing the loss of their homes. They should be particularly grateful for the $150 million for education in financial literacy. (Maxim 1: vote Democrat.)

Note this attempt at humour:

See, it’s easy for me to stand up here and talk about refinancing — some people don’t even know what I’m talking about.

That’s right. The poor are poor because they are stupid, not because they are unlucky, cheated, and abandoned by their elected government.

There’s a thread at Crooked Timber on the bizarre proposal to enrol “mortgage service companies” in preventing the foreclosures which it is their daytime job to carry out. Noting an expert view that this will not work, commenter doug hits the nail on the head:

“Feature, not bug”.