Summary: The first in a long series of posts about one of our most serious problems, one that results from other and deeper problems — which makes it difficult to fix. Links to other chapters in the series appear at the end.
Something is wrong with America, rendering our society incapable of connecting effectively to reality. The late USAF Colonel John Boyd described this as a process: Observe, Orient, Decide, and Act. For a description of the OODA loop see this; for a discussion of Orientation see this article by Chet Richards. Who can tell what has caused this social illness, a form of cultural Alzheimer’s? The symptoms appear in many aspects of our national public policy — collective action in critical areas such as energy, geopolitics, and management of our economy.
We find it difficult to recognize large problems until they are upon us, and to discern causes and effects. Worse, often we cannot weigh the various short- and long-term factors to rationally decide how to respond, so we choose seemingly easy and fast solutions without bothering to perform the necessary research and analysis. And, perhaps as a result of this flawed process, we frequently find ourselves unable to competently implement whatever course of action we choose.
Rather than provide a theoretical analysis, I’ll show a few case studies. In Chapter I we will look at the housing cycle. Just a normal business cycle, although driven to amazing heights by a combination of factors — all noted at the time, with these warnings ignored by both our ruling elites and the citizenry:
- artificially low interest rates (Fed policy),
- ambitious public policy seeking to increase homeownership (esp among minority and lower income households),
- irresponsibly slack regulation of lenders, and
- ill-considered financial innovations.
Now we face the downcycle, inevitably long and hard proportionate to the extraordinary upcycle. Rather than take the time to assemble experts to do the necessary research and prepare recommendations, our activists and politicians immediately reach for quack nostrums — which almost certainly will have unpleasant long-term effects. Rather than rehash all this, here are a few links so you can read and decide for yourself.
As usual in America,the important initiatives are bipartisan.
- Actions Taken and Actions Needed in U.S. Mortgage Markets, remarks by Secretary of Treasury Paulson at the Office of Thrift Supervision National Housing Forum (3 December 2007)
- Hillary Clinton’s Statement about Treasury Secretary Paulson’s Comments (3 December 2007)
- Edwards Unveils Bold New Proposals To Restore The American Dream Of Homeownership (5 December 2007)
The criticism by experts has come quickly and fluently
From “Subprime Bailout II” by the Institutional Risk Analyst, 6 December 2007 — a comment from a client:
“The Paulson proposal will paralyze the US housing market for years. Who in their right mind will lend money for home ownership ever again if the contract can become null and void the second the hoi polloi start screaming to their elected officials? Fannie? Freddie? {Profanity}, they’re bankrupt as it is and will only lend up to $417k which does nothing for either coast of the United States. Everyone in a protected [guaranteed by the government or a government-sponsored enterprise] mortgage won’t ever leave ’cause they’ll never get a better deal. Home prices will not reset to more sane levels. The Paulson proposal is a {obscenity} for generations X, Y and Z. Thank you very much. If this continues, the US is going to be just like Japan in the ’90s.”
From Dennis Gartman, author of The Gartman Letter — one of the top sages on Wall Street (5 December 2007):
Are contracts no longer to be viewed as law, but rather are to be viewed as nothing other than mere whim? If we are to allow mortgagees who are in trouble to stand down and have their problems taken up by taxpayers, what then of contracts anywhere? Can we demand foreign governments, or foreign companies, or foreign individuals to stand by their commitments to Americans if Americans will not stand by their commitments to one another?
No one wants to see people put out from their homes. No one wants to see the television photo-op of poor people pushed from their homes at Christmastime, or in the depths of winter. No bank wants to take delivery of a foreclosed-upon home when it could be left in the hands of the former home owner, with the mortgage shortage to be worked out over time. But to have the government step in and mandate that homeowners be allowed, under penalty of law, to remain in their homes and for banks to be forced to accommodate is legal and philosophical madness.
This is a country of law, which believes in the sanctity of contract agreed upon by those who’ve consented to the binding nature of that contract. If the parties involved wish to change the contract, and if agreement can be reached to do so, then it can and should be done. But to have government force the issue — and worse, to mandate the taxpayer funds be used to do so — is morally wrong, with implications that shall redound into any and all other economic concerns.
For a brief but more technical analysis, see Max Fraad Wolff’s article here. There ar many sites with excellent coverage of the housing cycle, such as Calculated Risk. For a valuable overview see this article.
The pattern shows the problem
If this cycle is like the commercial real estate bust of the early 1990’s, is that a big deal? Fifteen years ago and now almost forgotten. We bailed out the banks, with the cost just another load added to the Federal debt.
The pattern shows the problem. We’re not talking here of 100 year floods, or even 50 year floods. It’s only 15 years and already face a broadly similar situation, perhaps worse. We cannot do this every 2 or 3 decades! Whatever fixes we implemented have proven inadequate. Worse, the responsible institutions — both commercial and governmental — did not recognize the problem as it grew or even as the bubble popped. Only months into the crisis have they responded. This demonstrates a flaw in our national ability to collectively see, think, and act (our OODA loop).
Solutions
We do not only have too many houses; we have too much debt incurred to buy the houses. Solutions to excess debt come in four flavors.
1. Growth: given time and rapid wage growth, the debt burden becomes manageable. We pay it off, ever more easily as incomes grow. That was the dream solution to America’s high levels of household debt and large long-term government obligations. It burst in 2000, and will not return in time to help us.
2. Inflation, reducing the real weight of our debt. This requires two things. First, real growth in wages. Second, either the cooperation or blindness of bond investors — they must either accept negative real after-tax yields, or remain oblivious to rising inflation. (Note the low reported numbers of the government’s inflation indexes.)
3. Debt can disappear the hard way, as debtors default on their loans. Both recessions and declining home prices drive defaults (involuntary and voluntary, respectively). This is surgery, resulting in bankruptcies, homelessness, decaying neighborhoods, bank failures, etc. Also, many states have single option laws making mortgages on primary residences (only first’s, not refi’s or seconds) non-recourse to the borrower, so the lender cannot collect a deficiency from the borrower (when the mortgage exceeds the home’s net sale price). This leads to “jingle mail” — keys mailed back to the lenders.
4. Socialization of the debt. The government can spread the burden of debt, in many different ways.
- They can legislate to direct change mortgage contracts: reducing interest rates and payment terms, preventing or slowing foreclosures. This spreads the debt burden from debtors to creditors.
- They can change the rules of the bankruptcy courts, with the same result as above — spreading the debt burden from debtors to creditors.
- They can directly intervene in the markets, extending loans (absorbing the resulting losses) or buying property from debtors or creditors (e.g., as the Resolution Trust Company did after the commercial real estate bust in the early 1990’s.)
- They can nationalize the problem, taking direct ownership of the sector.
Socialization is the seemingly easy path. Done well, we have reforms like those Solon instituted for Athens — laying the foundation for its future greatness. Done poorly, we have increased moral hazard leading to another cycle of rising debt and speculation — except that the next crash will imperil a larger part of the society, or even all of it. See this post for more about this solution.
It’s all about choice. Every downturn gives us the opportunity to determine what America will become. We weigh our fidelity to our principles, our history, our forebearers — vs. our ability to collectively withstand pain (financial, social, political). Interesting times, indeed.
Other posts about the housing crisis
- Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
- “Idiots Fiddle While Rome Burns” – comforting and facile rhetoric, 24 July 2008
- A must-read for every American citizen: “The Fannie Mae Gang”, 25 July 2008
- A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
- Knocking down houses in order to save the village, 20 October 2008
- Destroying houses in order to boost home prices, 16 December 2008
- The housing crisis allows America to look in the mirror. What do we see?, 9 March 2009
- Another step to solving the housing crisis: downsize cities by destroying neighborhoods, 2 April 2009
- Sparks of justice still live in America – cherish them and perhaps they’ll spread, 11 September 2009 — About foreclosures.
- Has the US financial system been nationalized?, 28 October 2009
- Who should we blame for the mortgage crisis?, 16 January 2010
- Cutting through the fog to clearly understand the housing crisis, 8 July 2010
- Housing Update – dynamite to blast us out of our lethargy?, 27 July 2010
To see the all posts on this subject, go to the archive for The End of the Post-WWII Geopolitical Regime.
