Courtesy of Calculated Risk, a fantastic example of the government’s inability to grasp the root cause of our economic woes:
The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress…”They’re probably going to need a bailout at some point because they’re making loans in a riskier environment,” says Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae. “…I’ve never seen an entity successfully outrun a situation like this.”
In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.
When you find yourself in a hole, stop digging. Except the Bernanke/Summers/Geithner team, who seem to believe you try to dig your way through to the other side of the earth. Call it the Martingale Strategy of government finance.
At this point, even folks in Washington seem able to acknowledge that prices for housing in the middle of the decade, especially in coastal regions and the desert southwest, were so high that families could afford no missteps in servicing the debt. Illness, job loss, divorce – any minor hiccup and there was no room in personal budgets to cushion the blow before delinquency.
To some extent, this problem should solve itself as all bubbles do: at a point in time, the hiccups occur, the houses begin to get foreclosed, and as more houses come available from ever more distressed sellers, people begin to reassess the value of housing. They start to shrink the amount of household income they would like to dedicate to housing, and integrated over the market, that reduces housing prices.
Despite being able to recognize the problem of high housing prices, Serious People in Washington appear unable to understand the necessity of lower housing prices. It is tough to tell if this challenge stems from fear of the difficulty of explaining the concept to the great unwashed or lack of comprehension of the key concept. Or, I suppose, the view that in no circumstances can the money center banks be allowed to fail or get nationalized, enough foreclosures will make their failure evident, therefore housing prices need to be propped up against the economy’s interest because it is in the banks’ interest.
I cannot quite tell, and the economic team has taken Churchill’s advice that in war the truth is so precious it must at all times be accompanied by a bodyguard of lies, so there’s no relying on their statements. That leaves their actions.
Policymakers have used the FHA to stabilize the housing market by pushing it to offer credit with far easier terms than that offered by most private lenders. For example, it will back loans with down payments as low as 3.5%….Before the boom, the FHA wasn’t a big player in the housing business because it didn’t follow private lenders in loosening its standards. Borrowers had to fully document incomes and insured loans were capped at $362,000. Congress increased those limits last year to as high as $729,750 in the most expensive markets.
Would someone explain to me why it is in the economy’s interest to “stabilize” the housing market by encouraging a practice that has proven itself rather harmful? If you get taken to the hospital with a fever of 108F, and after urgent measures are taken begin to cool, they don’t throw you in a sauna when you hit 105F in the name of minimizing the change from the original unsustainable level. They try to get you to a healthy temperature as quickly as possible, and in fact will likely err a bit on the side of overdoing it to make sure there is space to treat any condition that is contributing to the temperature.
While most private lenders have raised lending standards and now require minimum 20% down payments, the share of borrowers who are able to make down payments of less than 10% hasn’t changed in the last two years, largely because of the FHA, says Mr. Pinto, the former credit officer at Fannie Mae.
As I have often mentioned, the 80/20 fixed-rate 30-year mortgage is not the Eleventh Commandment, or even the Twelfth if you are Ronald Reagan. It is simply a postwar American convention. Other developed countries have different standard leverage levels, different duration, different incidence of rate risk – for that matter, different approaches to the tax deductibility of mortgage interest and residential rent – and they do not have greater incidence of homelessness or plagues or any other signs of the Apocalypse. In some cases – many parts of Florida or Las Vegas, for example – a 20% downpayment is probably quite an accommodating lender posture today; a prudent bank would look to something closer to a 30-40% downpayment to absorb future house price losses. In others – the Great Plains, for example – 10-15% down is probably not a big deal.
What should seem ridiculous, however, is spending the better part of two years lecturing bankers about the need to get their balance sheets in order and then counteracting the effect by encouraging a government agency to pick up the role of drunk guy at the craps table. It is profoundly irresponsible to keep inflating new bubbles to cushion the effects of previous bubbles, and simply distressing that none of the many distinguished economists in orbit around the government – Bernanke and Summers, Romer and Goolsbee – feels the obligation to stand up and say enough already, let’s take our losses and move on. I expect Rahm Emanuel to be a scumbag; I keep hoping for better from the grownups.
Mr Taunter: It is profoundly irresponsible to keep inflating new bubbles to cushion the effects of previous bubbles, and simply distressing that none of the many distinguished economists in orbit around the government – Bernanke and Summers, Romer and Goolsbee – feels the obligation to stand up and say enough already, let’s take our losses and move on.
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Absalutamente. I think the Summers/Bernanke/Geithner position of bailing out bondholders is so incompetent, that it is basically corrupt. I think that is why, looking at Congress votes on TARP, the pols voting in favor received on average significantly more money from the FIRE industries than those who voted against them.
I am Republican, historically straight ticket. But I started maxing out contributions to the progressive/socialist democrats fighting the bank bondholder bailouts (Bernie Sanders, Russ Feingold, etc), as well as the republicans fighting the bondholder bailouts, and cut off all donations to parties at large or any candidate that is supporting bank bailouts. I think campaign contributions and protests are the only way to stop the Summers/Bernanke/Geithner cabal.
The only hope I have to come from all this is that there is a populist backlash against crony capitalism, as manifested in one-sided free trade deals with mercantilists, bailouts, tax breaks, etc. We need to be as mercantilist as the French, Germans, and Japanese.
What could be more crony capitalist than mercantilism, which is essentially deciding upon favored industries and taxing the rest of society to support those industries? When the government of Japan decides not to allow rice imports, it is sending money from Japanese rice eaters to Japanese rice farmers. The process of deducing which industries will be favored is necessarily an opaque exercise in cronyism; folks behind closed doors need to implicitly decide who is naughty and who is nice. It is a very stealthy method of taxation.
Taggert Murphy’s The Weight of the Yen (a very pro-Japan book) points out that Japan has fairly low nominal personal taxation, because most of what would be transfer payments through taxation in the West are handled through quiet subsidies and regulations to keep unproductive businesses operating. In a country with great social consensus as to what is “worthy”, it probably builds some cohesion to have everyone perceived as gainfully employed as opposed to living off the dole (essentially what we do with our farmers – we have them produce product at a loss and then subsidize the product so they think they are working for a living, as opposed to running them off the land and then cutting a welfare check). Unfortunately, it also stifles innovation, because all economic life has to take place within the construct of the regulatory system.
Japan’s problems in the twenty years since the book was written largely stem from the difficulty the nation has had breaking the feedback loop between a specific set of regulations and the economic activity that becomes reliant on the regulations. The country still behaves as if its national well-being depends entirely on selling advanced manufactured products to the West.
For an example closer to home, look at how our medical industry has grown to embody the bias of reimbursement regulations, with its emphasis on massive technological intervention in advanced medical conditions as opposed to preventive care and nutrition/lifestyle modification.
Mr T,
I support protectionist policies for the same reasons that Adam Smith did.
Smith believed in free trade where there the participants benefit from comparative advantage, not the absolute advantage that is the argument for globalization. Refer to pages 420-40 of Wealth of Nations, Modern Library. In dealing with protectionists, Smith advocated retaliatory tarrifs and quotas. Smith would have advocated such retalization against protectionist policies, such as violations of GATT, currency manipulation, and dumping, which have been engaged in by China, India, Mexico, and other countries.
Trade based on absolute advantage means one country wins and the other loses. If you are on the losing side because the other country’s “advantage” is lower wages, then trade on that basis is unacceptable. Unless there is a side agenda, like corporate statists wanting to unwind new deal protections for labor, like progressives wanting to give foreign aid to developing world workers, like military hawks wanting to give sweatheart trade deals to help them fight communism, terrorism, or some other cause du jour.
The logic of comparative advantage is that it is the Nash equilibrium of classical economics; there is no way for either side to improve its position. By contrast, absolute advantage is unstable, for the country with the lowest costs in all areas can still improve its outcome by focusing on the area where its advantage is greatest and importing where its advantage is least.
The logic of only exporting is flawed; when China sends us TVs, we send them pictures of George Washington on green paper. Those pictures of George Washington are only worth something to the extent they can be exchanged for goods or services, and if the Chinese refuse to consume either American goods or American services, the pictures will pile up. You will note that China has quite the problem today finding a mechanism to dispose of its excess dollars.
When countries follow protectionist policies they hurt themselves, by receiving less value than their labors could otherwise deliver. There may be some negotiating angle to making threats of cutting off trade, but ultimately it makes no more sense to follow someone down the path of subsidizing exports than it does to blow up our harbors because other countries have rocky coastlines. A system that does not subsidize or protect particular economic sectors is a blessing, not a curse.
Mr Taunter,
I disagree with your application of game theory. I assume a world with scarce natural resources and limited technological advancement for a period of time. I see this as a world where countries best obtain prosperity for their people through hoarding natural resources, intellectual property, and high value jobs. This was the case in the 17th century. The economist Thomas Munn spells out the case for mercantilism in such an environment.
In a world of wide open natural resources and rapid technological advancement, unilateral elimination of trade barriers can lead to prosperity. In a world of scarcity, it leads to you being abused, and ultimately, colonized.
Just a thought.
Could a country choose to subsidize (in the short-term) an industry or product that has some type of increasing returns style lock-in? Forcing out competitors, having the market come to a sub-optimal path that is this product, and thus capturing “excess” returns?
I mean, who would want to start a Boeing or Microsoft from scratch to compete with them? Too much fixed costs. Yuck.
Anyway, it seems like focusing on exporting in this way could be a good strategy. Not that this is anything related to what China has been doing.
I’ve found the handling of the banking sector in relation to the general economy to be quite brilliant, in the criminal mastermind sense of the word. The complexity, legality, and political convenience of the operation ensures it can’t be opposed by the only bodies which could, in theory, threaten it.
In my view, no sort of public uprising has the force to effect change in the short term, due the general lack of awareness, organization, and capital. Long-term, the crisis will be largely forgotten, then repeated.
I don’t think we will have to wait that long.
Taunter nails it again.
The saddest part of Obama’s administration so far is hiring the idiots that brought us here. Where in the world is Volcker?
Or Stiglitz?
In a weird way, the Obama Administration seemed from the very beginning of the transition to believe the argument of the Hillary Clinton campaign: OK, fine, you like him better than me, he is more inspirational, but I’m the serious one with the serious team and the serious ability to govern. The folks who lined up early with Obama – Volcker and Stiglitz on economics, Dean on health care and electoral strategy – were quite ostentatiously purged in favor of Summers and Geithner on economics, Tom Daschle on health care, and Rahm Emanuel on electoral strategy, despite the inconvenient truth that Obama’s team was not only loyal but also correct.
It’s too late for “fancy” speeches…. Forget about reasonable or hysterical dialogue….. it’s time to pick sides…..
I got my money on the fat kid….
Best regards,
Econolicious
To Joe and WiscoDude:
You are correct that strategic trade theory exists, and to the extent that there is (or will be) natural global monopolies, it makes sense. But the evidence is mixed at best. Boeing does have a competitor, Airbus; indeed, in smaller passenger jets, it has several (Bombardier, BAe, Embraer), with more germinating in Japan and China. Google is trying hard to compete with Microsoft, as is Apple from the opposite direction.
Occasionally countries get it right and defend industries that turn out to be Airbus. But far more often they merely continue to be Peugot, and drain the state trying to protect them.
[...] 13, 2009 by Taunter If I may quote myself, from September 4: When you find yourself in a hole, stop digging. Except the [...]