Editore"s Note
Tilting at Windmills

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August 8, 2007
By: Kevin Drum

BUBBLES....Brad DeLong recommends this Wall Street Journal article about the origins of the current credit bubble, and it was indeed interesting. And yet, I can't help but think that in the search for specific causes of the current subprime mortgage mess we miss the forest for the trees — again. Sure, the current housing bubble is pretty obviously credit driven, but really, aren't all bubbles? And they come along with some frequency these days, always with some shiny new reason for bankers to become irrationally exhuberant. Just in the last couple of decades we've seen bubbles in S&Ls (safe as houses!), South American countries (sovereign states never default!), junk bonds (greed is good!), dotcoms (eyeball, not profits!), and now housing (safe as houses!). Every time, it turns out that there's nothing new at all. The economy has not been fundamentally changed, risk and reward are still roughly proportional, profit still drives stock prices, and supply and demand still function about the same way they always have.

And there's one other thing that always stays the same: the object of the particular bubble that's just burst comes under increasing scrutiny, but nothing is ever done to try to address the underlying issues in the finance industry which, left to its own devices, will simply move along and create a new bubble somewhere else in a few years. Maybe there's nothing that can be done. I don't know. But I imagine that this time around home mortgages will come under some kind of mild additional scrutiny, reminding one of fables about horses and barn doors, and the titans of the finance industry will shrug, lay low for a few years, and then become mesmerized by yet another shiny new toy. If we're lucky, it will be a bubble in green technology, and maybe we'll all actually get something good out of it while it lasts. Cross your fingers.

Kevin Drum 12:37 PM Permalink | Trackbacks | Comments (55)

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Comments

Same as it ever was. Same as it ever was.

Same as it everrr waaaas...

Posted by: c4logic on August 8, 2007 at 12:37 PM | PERMALINK

Dunno... finance isn't my thing, but my layperson's take is that banking & finance are no longer fundamentally conservative (meaning stable, prudent, etc.) fields, if they ever really were, and the safest bet is to stay away from whatever they're pushing hardest unless you're savvy enough to get in & out early.

Posted by: latts on August 8, 2007 at 12:41 PM | PERMALINK

Personally I'm investing in tulip bulbs. It's going to be HOT! My bank is giving a great variable rate to finance my tulip bulb investments. I can't loose!

Same as it everr wasss... indeed.

Posted by: Adventuregeek on August 8, 2007 at 12:41 PM | PERMALINK

Nope, there isn't anything to be done about it, and anything substantial which is attempted to wholly prevent bubbles is likely to make things worse.

Posted by: Will Allen on August 8, 2007 at 12:43 PM | PERMALINK

Everthing old is new again. It's amazing that no one, say Charles Mackay in 1841 (second ed. 1852) discovered this in Memoirs of Extraordinary Popular Delusions and the Madness of Crowds.

Americans are every bit as foolish as anyone else.

Posted by: freelunch on August 8, 2007 at 12:46 PM | PERMALINK

I think there also has to be some blame placed on the lack of mathematical and financial literacy in this country, since a huge chunk of the problems in the mortgage industry can be traced to people signing up for mortgages that they didn't understand, and people not having the mathematical skills needed to calculate the true financial costs of their mortgages.

Posted by: mfw13 on August 8, 2007 at 12:46 PM | PERMALINK

"Nope, there isn't anything to be done about it, and anything substantial which is attempted to wholly prevent bubbles is likely to make things worse."

Cue fiat money diatribes in 1, 2, 3...

Posted by: Walker on August 8, 2007 at 12:47 PM | PERMALINK

Maybe there's nothing that can be done.

Kevin, here are some things I learned from Economics 101. The market is cyclical. There are good times. There are bad times. But everything evens out in the end. For example during the beginning of the Bush Administration in 2001, it was reported "President Bush inherited an economy on the brink of recession." The recession then peaked and was fixed by Bush's tax cuts.
Same things is happening with credits. People borrowed too much, created a bubble, and interest rates went up because of it. The rise in interest rates resulted in people borrowing much less and the bubble is burst. Things will even out once supply and demand of credit are in sync again. No big deal.

Posted by: Al on August 8, 2007 at 12:50 PM | PERMALINK

Get rid of easy money, and promote a savings economy rather than a credit economy.

Posted by: gfw on August 8, 2007 at 12:52 PM | PERMALINK

Fiat money didn't exist when the first bubbles happened.

Banks used to have lending standards. That meant that some people who wanted to borrow money could not. New types of lenders came in with lower to nonexistent standards, relying on the tulipmania continuing unabated. Many of the people who got loans would not have been underwritten ten years ago. They didn't have enough income. They didn't have any documentation of their income. They were really bad risks. If the lender had to keep the risk, they would have never lent.

There have always been fiscally irresponsible people. Usually, those around them don't throw money at them.

Posted by: freelunch on August 8, 2007 at 12:52 PM | PERMALINK

Every one of these bubbles is a great example of free enterprise at it's best...and worst.

Part of what government can do is to assist those who are hurt by the crashes and another part is to regulate the particular industry to ensure they are playing within the lines and then a third part is to change the playing field in some small way to try and prevent future bubbles from becoming too large.

Already Hillary Clinton has suggested a fund to help people who are at risk with mortgages.

We also need probably to help some people who have already lost their homes.

We can't force Bush's hand to look at the regulators, but a Democratic president would do that.

Last, what new regulation or counter-pressure can be brought into the playing field to avoid the future bubbles from growing so large, collapsing so fast or hurting so many people AND businesses?

Don't count on a Republican freeper to do any of those things.

Posted by: MarkH on August 8, 2007 at 12:59 PM | PERMALINK

One of the primary effects of the last two bubbles has been the transfer of much of the newly created wealth from the people in the middle and the lower economic classes to the investors in the financial services companies.

If I was one of those investors, I would welcome the creation of more bubbles in the future.

Posted by: gregor on August 8, 2007 at 1:06 PM | PERMALINK

Republicans whine and do away with regulations.
After unregulated messes are created, they want a bailout.
SInce we usually opt for bailing out, we should impose adequate regulations to mimize the damage.

Posted by: bakho on August 8, 2007 at 1:09 PM | PERMALINK

risk and reward are still inversely proportional

That would be nice if the world worked that way (the higher the reward, the lower the risk), wouldn't it?

I think Kevin meant "directly", not "inversely" ...

Posted by: Foo Bar on August 8, 2007 at 1:14 PM | PERMALINK

My father in law watches a lot of TV news. He will insert into any conversation, multiple times, that the best place for your money is the (insert current hot investment item here). From the TV's mouth to his mouth. Always. Incessantly.

For some odd reason, people think that the bandwagon is going somewhere great. No one wants to miss the boat. And for some reason, they believe that the first place to hear about next best things is the news. And that CNN/MSNBC/Fox/blah, blah, blah are the quickest, sharpest news around.

So once it gets on the TV that a few 25 year olds have become billionaires because of internet startups, *bang* a nation of fathers-in-law opens its checkbook. This is called "buzz" and for some reason every knows it's illusiory and transitory, but everyone believes it's awesome.

The odd corrolary of this is that he will also happily parrot the reasons why the previous next big thing was just a mirage. And the cycle continues.

Stop watching TV news.

Posted by: brent on August 8, 2007 at 1:18 PM | PERMALINK

There was a time -- back in the era of laissez faire capitalism that still makes supply side hearts go pitter pat -- when credit bubbles could and did collapse with catastrophic results: cascading chains of defaults ending in bank failures, deflation and depression. These were called "panics" for good reason. The resulting financial scars tended to innoculate lenders and investors against reckless speculative behavior -- for a time, although human nature being what it is, only for a time.

These days, however, thanks to the miracle of elastic currencies and accommodative central banks, it takes an exceptional string of policy mistakes (like the Bank of Japan's mishandling of the 1990 Tokyo stock market crash) to turn the popping of a bubble into a major economic debacle. No debacles, no scars. No scars, no sea change in speculative behavior -- not even in the short run.

And so we have bubbles, one after the other. And from Wall Street's point of view, the more the merrier. The profits, of course, are privatized. The costs are largely socialized, either directly or indirectly. And so the financial sector grows like Topsy, while debt ratios and derivative trading volume chase each other ever higher.

Maybe there's a long-term economic price to be paid -- at least relative to some abstract model of free market economic efficiency. But who cares about that? Certainly not the free markets. Old fashioned hard money types grumble about moral hazard and warn it will all end in an ocean of tears -- but they've been grumbling about doomsday for decades. And yet Armaggedon never seems to arrive.

To paraphrase Dr. Strangelove, maybe it's time we stopped worrying and learned how to love the bubble.

Posted by: Peter Principle on August 8, 2007 at 1:23 PM | PERMALINK

I can't help but think that in the search for specific causes of the current subprime mortgage mess we miss the forest for the trees — again.—Kevin Drum

What the hell is to miss? The problem that will arise after qualifying people at a low interest rate with the knowledge that the rate increases to a much higher rate that even people with decent incomes couldn't manage is no mystery.

Posted by: JeffII on August 8, 2007 at 1:26 PM | PERMALINK

freelunch,

Fiat monies have been with us since the formation of banks, which means they have been with us for centuries. In the past, when a bank lent more in it's banknotes than it had gold reserves, it was creating a certain amount of fiat money.

The central banks, and their direct subordinates, are the primary cause of bubbles. They make credit artificially cheap, and when credit is cheap, it is in high demand, and the strictures for extending it become lax for the same reason- it is cheap. The population, through our collective actions, decide what assets get relatively frothy. In the late 90s we suffered stock mania, in the late 70s we were commodity crazy, in the 00s we have been land/house loony. And now, it looks like commodities are the bubble of choice.

Isn't this were I came in?

Posted by: Yancey Ward on August 8, 2007 at 1:32 PM | PERMALINK

The tie between domestic bubbles is deregulation. From the S&L crisis to the dot-com bust to the housing bust, it was a loosening of de jure or de facto regulation. First, it was exemption from the banking requirements that allowed the S&Ls to overextend, then it was the lowering of barriers to entry that caused the dot-com boom (financed on margin through low-cost online brokerages) followed up by the unregulated mortgage brokers throwing cash around for houses.

Deregulation followed by boom and crash. Lather, rinse, repeat!

Posted by: Adam on August 8, 2007 at 1:33 PM | PERMALINK

We will never get rid of manias and panics because they stem from human nature. We should attempt to slow them down by taxing capital gains the same as wages. The lowering of the capital gains tax in 1997 and the introduction of the $250,000 exemption for capital gains on primary residences were important cause of the recent bubbles.

Not appointing liquidity-loving hacks like Greenspan to the Fed would help as well.

Posted by: F. Frederson on August 8, 2007 at 1:36 PM | PERMALINK

Kevin, here are some things I learned from Economics 101. The market is cyclical. There are good times. There are bad times. But everything evens out in the end.

Take it from someone who actually majored in Economics, referencing Economics 101 to prove your point is excellent evidence of not having any clue what you are talking about. Everything one learns after that class is about how perfect supply and demand is a myth, a fiction, a convenient model that never matches reality.

There are market failures, distortions of incentives and most importantly, externalities. To gloss over boom/bust events as simply "cyclical" is not only disingenuous, but a misinterpretation born out of ignorance.

Posted by: uri on August 8, 2007 at 1:40 PM | PERMALINK

Banks used to have lending standards. That meant that some people who wanted to borrow money could not. New types of lenders came in with lower to nonexistent standards, Posted by: freelunch

This is really only a small part of the issue.

Very few "institutions" or companies that make mortgage loans retain the loans as part of a portfolio. This has been true for about 20 years, and is part of the reason Americans have one of the highest percentage of homeownership. Loans were first sold to servicing companies giving banks new cash to loan (most loan funding hasn't come from saving deposits for decades because Americans don't save).

Now loans are sold and packaged as "financial instruments," securitized,to provide new funds for new loans. These "instruments are considered low risk though usually low return.

Whatever the case, the initial lending institution no longer has any real liability or responsibility for the loans it initiated. In fact, it's double-plus good as they can still foreclose in some cases and sell the property!

Posted by: JeffII on August 8, 2007 at 1:42 PM | PERMALINK

The more I watch the deflation of the housing bubble the more convinced I am that the proper action is: Nothing. Those that took the risk of lending money to poor credit risks need to reap the fruits of that harvest. Those that bought dodgy loan packages from the lenders need to face the music and those that got themselves into mortgages far in excess of what their income would support need to be accountable for their foolishness. Sorry, I don't have any sympathy for someone who signed loan papers for big bucks that they didn't understand. Somebody who got themselves into a $500,000 loan at the top of the market when they only way the could afford the house was an ARM with a teaser rate and no money down deserves to lose the house. If that same person took out that much money and blew it at a table in Las Vegas because they didn't understand how gambling works, there would be no offers of bail-outs. Actions have consequences and bailing people out because they are stupid/greedy is not the job of the taxpayers.

Posted by: arteclectic on August 8, 2007 at 2:12 PM | PERMALINK

Arteclectic touches on a key issue that relates to the question that Kevin asked about what could be done to prevent bubbles. One reason you see serial bubbles is that the central banks and the governments behind them stand ready to socialize the inevitable losses for each one. The whole system creates ever more moral hazard. Eventually, the system will collapse upon itself. And we, or our descendents, will start over.

Posted by: Yancey Ward on August 8, 2007 at 2:36 PM | PERMALINK

The more I watch the deflation of the housing bubble the more convinced I am that the proper action is: Nothing. Those that took the risk of lending money to poor credit risks need to reap the fruits of that harvest. Those that bought dodgy loan packages from the lenders need to face the music and those that got themselves into mortgages far in excess of what their income would support need to be accountable for their foolishness. Posted by: arteclectic

I agree except that the sum of money is so great that when it all falls apart we members of the hoi poloi will feel the pain. Unlike China, they aren't going to arrest guys like Allen Greenspan or other "banker types" and execute them. They might hold hearings six-months after the fact, as they did with the S&L fleecing, that, in the end, will change nothing.

Isn't interesting how financial crisis almost always happen during or result from Rethug administrations' mismanagement.

Posted by: JeffII on August 8, 2007 at 2:36 PM | PERMALINK

Kevin writes: Maybe there's nothing that can be done.

And maybe there's nothing that should be done -- at least with respect to home financing.

I mean, the people who are going to lose their homes -- those less creditworthy, often lower middle class folks who took out subprime mortgages -- are they really being hurt (I'm not talking about home equity lending and second mortgages, but rather, the exotic products enabling otherwise non-mortgage worthy people to buy property)? After all, without these aggressive debt products, they wouldn't have become homeowners in the first place, but would have remained renters. Now they'll just return to being renters. And it's not like all such people are being foreclosed on. Some of them will remain homeowners. And again, these people in most cases couldn't have become homeowners in the first place without the same exotic mortgage products that are now louddly being inveighed against.

The builders and the mortgage bankers themselves -- they're the fat cats, and I don't give a rat's ass if they're hurt. Indeed, pain ought to be the outcome of foolhardy lending and speculation prompted by greed.

I think more robust disclosure on fees and rates is in order to protect the little guy. But what I'm afraid is going to happen is that, in a zealous drive to "protect" against the "evils" of aggressive lending practices, it's going to become permanently more difficult for just plain folks to buy a home in this country.

Posted by: Jasper on August 8, 2007 at 2:50 PM | PERMALINK

"Now they'll just return to being renters."

Minus their life savings.

Posted by: jefff on August 8, 2007 at 2:55 PM | PERMALINK

Kevin, here are some things I learned from Economics 101. The market is cyclical. There are good times. There are bad times. But everything evens out in the end. For example during the beginning of the Bush Administration in 2001, it was reported "President Bush inherited an economy on the brink of recession." The recession then peaked and was fixed by Bush's tax cuts.
Same things is happening with credits. People borrowed too much, created a bubble, and interest rates went up because of it. The rise in interest rates resulted in people borrowing much less and the bubble is burst. Things will even out once supply and demand of credit are in sync again. No big deal.

Now you're just making shit up. We all know you never took an economics class.

Posted by: Joshua on August 8, 2007 at 3:07 PM | PERMALINK

"Now they'll just return to being renters."

Minus their life savings. Posted by: jefff

In many cases, not, and that's a big part of the problem. Many of these sub-prime loans were made for next to nothing down or as interest only loans.

As harsh as it may seem to some of you Bolshies, not everyone "deserves" to own a home. If you can't put even 5% down on a house you are trying to buy too young, are profligate to begin with, or may never have the income to afford to be anything more than a renter. We can't all be rich or even all be middle income. Even workers paradises like Sweden or, Sweden have the poor who, probably, don't own their own homes.

Posted by: JeffII on August 8, 2007 at 3:10 PM | PERMALINK

uri >"...and most importantly, externalities..."

*DING*, *DING*, *DING*

which will, of course, be ignored (and made external to the discussion etc...)

"There is nothing worse than a sharp image of a fuzzy concept." - Ansel Adams

Posted by: daCascadian on August 8, 2007 at 3:14 PM | PERMALINK

"I mean, the people who are going to lose their homes -- those less creditworthy, often lower middle class folks who took out subprime mortgages"

This sounds like you believe that the subprime issue is "contained". No doc loans are the real problem and they extend way into prime. That is why Alt-A (which is not a less-creditworthy, lower middle class product) is crashing now.

The early foreclosures are the lower rungs of the housing ladder, but there are many wealthier people farther up the ladder that will follow them soon. They bought homes above their income and stayed in them through serial financing. The deflation of this bubble has barely started yet. Unlike stock unwinds, housing run-ups historically take 6-7 years to correct. And the run up this time is so extreme that this one may last even longer than that.

Posted by: Walker on August 8, 2007 at 3:17 PM | PERMALINK

This isn't rocket science.

When wealth becomes concentrated in too few hands, people start investing in really dumb stuff, because they've invested in all the smart stuff you can invest in.

We've got an economy where most people aren't actually earning enough to make ends meet--they're in negative savings. They're borrowing money to meet their basic needs.

And there's a handful of people at the top who have just way, way too much money. So much money that they literally can't figure out what to invest it in, so they're investing it in whacked-out stuff.

The mortgage thing is a perfect example. Take a bunch of working people that income inequality have left too poor to buy a house. Take a bunch of guys that income ineaquality has made too rich to know what to invest in. Have group B lend money to group A. And when there's any shock to the economy, watch group A get totally devastated, and the market that group B has created totally falls apart.

That's why severe income inequality, the kind we have, is economically unsustainable. These bubbles are inevitable, and they will continue to happen until we address the underlying cause and make sure that working people get what they earn, and stop having all this ridiculous money with no place to go except into schemes to earn money financing the basic consumption needs of people who are too poorly paid to meet their needs.

Posted by: anonymous on August 8, 2007 at 3:58 PM | PERMALINK

As harsh as it may seem to some of you Bolshies, not everyone "deserves" to own a home. If you can't put even 5% down on a house you are trying to buy too young, are profligate to begin with, or may never have the income to afford to be anything more than a renter. We can't all be rich or even all be middle income. Even workers paradises like Sweden or, Sweden have the poor who, probably, don't own their own homes.

I actually agree with this, and I generally dislike the fetish Americans have for home ownership. That said, Bush made home ownership a major priority of his Presidency, a key part of his "Ownership Society" rhetoric, and the economic policies of his Administration, including regulation of these mortgages, bear responsibility in our current situation. Yes, people shouldn't have been so dumb, but the companies didn't have to give out the loans. You can't even argue they had an obligation to in service of their shareholders, they are getting clobbered now.

Posted by: Joshua on August 8, 2007 at 4:17 PM | PERMALINK

What a load of shit. Where to start?

When wealth becomes concentrated in too few hands, people start investing in really dumb stuff, because they've invested in all the smart stuff you can invest in.

What the fuck do you mean by this? Are you saying that Warren Buffet is now investing in laetrile clinics in Nogales because Berkshire Hathaway can't find any worthwhile investment opportunities?

We've got an economy where most people aren't actually earning enough to make ends meet--they're in negative savings.

No we don't. We have a culture (the economy has nothing to do with personal spending habits) in which people spend more than they earn. The overwhelming majority of Americans earn their keep and then some. The problem is that a certain percentage of this overwhelming majority then spend their "and then some" on shit they probably don't need, and don't bother to save. We have one of the lowest is not lowest savings rate of all the "advanced industrialized nations."

They're borrowing money to meet their basic needs.

No they aren't. They are borrowing money to buy SUVs or 4WD pick-up trucks (though they live in SoCal or somewhere else below the Mason-Dixon) or take vacations to the Magic Kingdom or get a couple of season tickets to the Falcons. Yes. A small percentage are using their credit cards in emergencies to pay for health care. But if you can't afford to put food on the table to begin with because you aren't earning the proverbial living wage, so you probably haven't qualified for a credit card to begin with (you know, they don't qualify everyone, it just seems that way) or own a home with some equity that you've used as a cash machine sometime in the last decade.

And there's a handful of people at the top who have just way, way too much money. So much money that they literally can't figure out what to invest it in, so they're investing it in whacked-out stuff.

Again, cite an example. Fur-line sinks? Electric dog polishers? Politicians? Newspapers?

The mortgage thing is a perfect example. Take a bunch of working people that income inequality have left too poor to buy a house. Take a bunch of guys that income ineaquality has made too rich to know what to invest in. Have group B lend money to group A. Posted by: anonymous

Just which pay toilet, phone booth or comic book do you get your information on business and the economy? The fly-by-night mortgage companies or even major banks aren't to be confused with private equity funds.

Imanass, er, I mean anonymous, quit while you're ahead.

Posted by: JeffII on August 8, 2007 at 4:43 PM | PERMALINK

""Now they'll just return to being renters."

Minus their life savings. Posted by: jefff

In many cases, not"

Ahh the good old "in many cases" meaning "I have no idea if this even ever happens, but I'm willing to roll the dice that it has happened 'many' times given the huge number of times where it might possibly have happened".

There are significant costs involved in buying and getting kicked out of a house which are not usually or ever covered by mortgages, and I expect that most people burn through nearly all their savings in an attempt to pay the mortgage they never should have been offered or accepted even if they don't have a down payment or any bought equity to loose (by 'bought equity' I mean equity they paid for with mortgage payments above what they would have paid in rent). Your hypothesis about people loosing their homes and getting out of it without serious financial consequences strikes me as being a cousin to the welfare Cadillac myths of the 80's and in the general vein of "let them eat cake".

By the way I never made any of the ridiculous claims you think I would make. I find it quite obvious that lending needs to be tightly regulated to prevent people with poor financial skills from borrowing stupidly from evil people, and to prevent evil people from lending other people's money out knowing that their cut will be safely in the bank when the whole thing falls apart, and I think the American fetish for and subsidization of home ownership is stupid.

In fact I think it is the right who constantly go on and on about the utopia inducing properties of "ownership" and defending bizarre lending arrangements while reforming bankruptcy laws to insulate lenders from the consequences of making loans people will not be able to pay and adding more and more financial risk and responsibility to their lives whether or not they are competent to handle it. Then when their house is foreclosed on or their 'wealth building personal account' fails to even keep up with inflation people like you say that it is all their own fault for being unable to play the game effectively enough, and look at this guy who is one of the 5% who did far better under the new rules than he would have under the old!

The left's stupidity of housing policy is rent control and many low income housing projects, which I also disagree with.

Posted by: jefff on August 8, 2007 at 4:52 PM | PERMALINK

Let's get to the root of this problem. Where did all the money for this bubble come from?

China threatens to trigger US dollar crash.

No gun boat diplomacy for China - one sell order is worth a thousand gun boats. Not that I entirely blame China - they offered us a golden noose but we're the ones who put it around our necks.

P.S. Thanks to "Doc at the Radar Station" for that link on a previous thread.

Posted by: alex on August 8, 2007 at 4:53 PM | PERMALINK

Your hypothesis about people loosing their homes and getting out of it without serious financial consequences strikes me as being a cousin to the welfare Cadillac myths of the 80's and in the general vein of "let them eat cake". Posted by: jefff

No. I didn't say that. But many people who have or are in danger of losing their homes are not also losing a 5, 10 or even 20% down payment perhaps totaling tens of thousands of dollars. This is, in fact, why many of them never should have been "qualified" to buy a house of any kind.

Posted by: JeffII on August 8, 2007 at 5:00 PM | PERMALINK

alex >"...they offered us a golden noose but we're the ones who put it around our necks..."

ah yes, Comrade Lenin appears to have been correct - "...The Capitalists will sell us the rope with which we will hang them..."

Happy Reaganism folks !

"A conservative government is an organized hypocrisy" - Benjamin Disraeli

Posted by: daCascadian on August 8, 2007 at 7:40 PM | PERMALINK

I live in one of the hottest housing bubble parts of the country, and was damn lucky to buy a condo before the neighborhood became too hot. One of the realities that Jeff overlooks is that when housing prices were rising steeply, so were rents. So people were desperate to take any mortgage they could to escape sky's-the-limit rent increases. Most people - the average income folks - hope to refinance that adjustable rate mortgage before it kicks into a high rate. Reality dictates that many can't.

Posted by: Rugosa on August 8, 2007 at 8:38 PM | PERMALINK

The only way out of this debt crisis is massive inflation.We have a dollar that is worth 4% what it was worth when the Federal Reserve was created.China,it appears,is willing to help.

Posted by: seymour bling on August 8, 2007 at 9:39 PM | PERMALINK

Bankers have always - in modern US history, to create bubbles then sell off the bad assets before they crash. This is what prompted banking reforms in the early 1930's.

Nothing new. Make a loan - if it's good keep it, if it's bad, sell it off to some sucker.

Then when the last sucker spends his last dollar, the market bubble deflates and that market crashes.

You know that a lot of people have gotten very very rich on mortgages in the last decade.

In the old days, it was easier to identify who the bad guys were. They were bankers who sold off the loans they made that went bad. Now, the market is much more complex, with lots of buyers and sellers, many different kinds of securitization, stripping off financial "parts" of a portfolio and selling them, etc.

But the basic process hasn't changed in a very long time.

And, I say this as a former corporate banker. I've sold off loans I knew were bad to relatively sophisticated players (large insurance companies). It can still be done.

Cheers! Enjoy the bubble.

Posted by: rcc on August 9, 2007 at 12:37 AM | PERMALINK

Rugosa, I don't know where you live,but where I live in Washington DC rents did not increase at all. Since everyone was buying, existing landlords (ie not those who bought a property with the intent to rent it) were forced to keep rents low to keep the monthly payments below the monthly payments of the teaser rates.

Frankly I do not feel bad for people who lived beyond their means. Yes people need a house, but do they need a 3000 foot 4 bedroom house for their spouse and one kid? Further for someone who actually is responsible with their cash and are ready to buy their first place, their ability to buy is limited because of all of the people driving up real estate who can't actually afford it.

Posted by: nathaniel on August 9, 2007 at 12:53 AM | PERMALINK

One of the primary effects of the last two bubbles has been the transfer of much of the newly created wealth from the people in the middle and the lower economic classes to the investors in the financial services companies.
Posted by: gregor on August 8, 2007 at 1:06 PM
-------------

The "mechanics" of this transfer are manifold and work up the food chain:
1) The poorest people are preyed upon by car title loan companies, payday loan companies, easy to obtain credit cards for everybody at the worst loan shark rates. They might have managed a mortgage, but are now on the curb when the interest rates reset the 2nd time or they have lost their job.
2) Middle-class people are lured into mortgage equity loans to pay old credit card debt, buy cars, plasma TV's, the new rock garden, etc. When they lose their jobs part or all of their retirements may get cashed out to keep their house.
3) Upper middle-class people are lured into buying a 2nd vacation home that is now affordable that previously was not, or speculate in "flipping" 2nd homes as investments. They may now be stuck "upside down" in real estate they can't dump. Their white collar jobs are in danger of imminent "plug-in" outsourcing.
4) The top x% have got to do SOMETHING with all the money they have and invest heavily into high-performing hedge funds composed of debt created by the people in [1-3].

In effect, what you have is a crawling grass fire that is working its way up slowly but surely. Nobody has said shit when it first started, but as it moved further it affects more and more literate folks that start to whine a bit. Not only that but the grass gets much taller and more concentrated as it moves. This tends to accerate the fire.

When all this gets to a certain dimension-there aren't any more bubbles that you can easily create. This isn't just a problem on the scale of an "oil shock", or the "S&L crisis", or a "dotcom bust". This is something that is layered throughout the economy from top to bottom. It is systemic.

Posted by: Doc at the Radar Station on August 9, 2007 at 1:06 AM | PERMALINK

John Doe Pays for Excessive Financial Institution Risk Taking

When the new shiny bauble financial types go on a binge that entails red flag obvious 'excessive risk' taking, then massive losses occur, financial institution' equity hemorrhages and then ( Big Point) interest rates and margins on interest rates must increase until the financial institutions replace the lost capital.
John and Jane Doe have to pay a greed tax and pay more for their car loans, their mortgages, their credit cards until the financial system replaces the capital.
Meanwhile the financial types have stripped a tenth of a point here and a half a point there from these capital flows, enriching themselves until the speculative 'excessive risk' schemes meet their inevitable ( and I might add repetitive) denouement.
In 2006, a good year for speculation and mortgages, Wall Street stripped 25 billion dollars from capital flows in bonuses alone.
In a bad year, when capital and equity shrink the little guy has to pony up to replace the capital. It's a mugs game and trust me, if the only way to get the money out the door to consumers in order that the 'bankers' can put a piece of the action in their pocket is to ratchet up the risk, consider it done.
-cognitorex-

Them and Us: A Capital Tax Plan
.
(Wall Street firms are expected to pay out a record $23.9 billion in bonuses this year. 12/20/06 USA Today)

Place a one one hundreth of one percent Value Added Tax on all capital flows.
'Them' enrich themselves by taking a bite out of America's capital flows at every instance while 'Us', the creator's of this wealth, need Moms and Dads working multiple jobs to eat and provide the capital for this system.
As our capital washes around the globe for economic enterprises, both good and bad, and hedging and currency (and other asset) speculation, there is no reason Us couldn't charge a way tiny `rent' for this resource.
Social Security and Medicaid could thus be amply funded and capitalism would manifestly not miss a heart beat.
-cognitorex-

Posted by: cognitorex on August 9, 2007 at 12:26 PM | PERMALINK

"One of the realities that Jeff overlooks is that when housing prices were rising steeply, so were rents. "

I, until recently, lived in Seattle, and while the home buying prices were going up 20% a year in my neighborhood for a good five years my rent went up 20% over the entire five years. A year ago they were selling condo's in a nearly identical building to mine (with a plumbing/wiring/cabinetry type renovation) and the monthly payments would have been slightly over triple my rent.

Time will tell if my $2k in savings a month was the better investment than their $2k in housing costs, but rents were definitely not rising nearly as steeply as purchase prices where I lived. Over the long term those two numbers should be expected to converge, but over the past ten years they have rapidly diverged. Personally the only way I could see rents catching up to purchase prices in that area in the next five years is if an energy crisis dramatically shifts the relative value of suburban to urban housing (which would favor the very central area I lived in).

Posted by: jefff on August 9, 2007 at 12:28 PM | PERMALINK

"But many people who have or are in danger of losing their homes are not also losing a 5, 10 or even 20% down payment perhaps totaling tens of thousands of dollars."

Even people with no down payment are likely to be loosing tens of thousands of dollars in transaction costs, payments made above what rent would have been, and moving costs.

The case required to make your 'let them eat cake' true is a zero down mortgage covering all transaction and moving costs where the person has made no payments above what their rent would have been and let the bank foreclose without expending any of their savings trying to keep their house. I would be shocked if that was the situation in 1% of actual foreclosures.

No down payment != no costs.

Posted by: jefff on August 9, 2007 at 12:39 PM | PERMALINK

Even people with no down payment are likely to be loosing tens of thousands of dollars in transaction costs, payments made above what rent would have been, and moving costs. Posted by: jefff

Jesus. Where to do you get your information? You and anonymous tag-teaming for clueless postings? You write as a person who has never bought a house.

Many of the people now losing or in danger of losing their houses decided to purchase precisely because the mortgage payment wasn't much higher than renting due to ridiculously low interest rates, interest only payment options, zero-down financing or some combination thereof. The only people paying "tens of thousands of dollars in transaction costs, payments made above what rent would have been, and moving costs" might be the rare case of someone who went from renting a two-bedroom apartment to buying and furnishing (highly unlikely, new furnishings sufficient to fill the new manse purchased before moving in - everyone raise his hand who has done this) a 5,000SF house in a nice neighborhood.

If there were "tens of thousands of dollars," as you seem to believe in transaction costs, etc., not even people firmly in the middle income ranks with enough savings for a 10-20% down payment would be buying houses. If you believe that "transaction costs, etc." would exceed or even be close to down payment costs (for example $40K on a $400K house), then you haven't the slightest idea about real estate costs.

Posted by: JeffII on August 9, 2007 at 1:40 PM | PERMALINK

According to this congressional report:
http://jec.senate.gov/Documents/Reports/subprime11apr2007revised.pdf

The administrative costs alone to the homeowner average $7200 in a foreclosure. So it is approaching $10k assuming there was no down payment, there were no transactional costs of buying, they paid nothing more than they would have paid in rent, they made no improvements to the property, and assuming they don't expend any savings trying to avoid foreclosure.

If any of those rather ridiculously implausible statements are false tens of thousands is a blink of the eye away.

But I am sure that your extensive personal experience with being foreclosed upon means you know different.

Posted by: jefff on August 9, 2007 at 3:13 PM | PERMALINK

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