Rocky Road Ahead for US Taxpayer

Posted by D.D.Grant at 10:53 PM

An object lesson for the US taxpayer is being played out in the subprime crisis fallout in the UK. The naive among us can still be found, on blogs and elsewhere, insisting that the measures being put in place by Governments and Central Banks will not cost the ordinary citizen. Developments in Britain are now showing the utter fallacy of this position.

It appears that Northern Rock, the British bank which suffered a run earlier this year in fallout from the funny money routine may saddle the UK government with "a bill in excess of £25bn" and calls are being made for the bank to be taken into public ownership. Since the latter action is unthinkable in the US, the alternative is easy enough to figure out.

"But now plans to sell the bank are running into a wall of opposition from politicians who are outraged that a sale could involve an open-ended commitment to provide government support to a buyer. 'Why should taxpayers' money be used to help Richard Branson, or whoever eventually acquires Northern Rock?' asked Vince Cable, shadow chancellor for the Liberal Democrats [a UK political Party]."

An insight into prospects for the easing up of credit pipelines worldwide can be gleaned from the comments of a City [of London] analyst: "No one will touch Northern Rock unless the Treasury continues to stand behind it; on its own, the Rock is not viable." Substitute the names of certain major US institutions and there you have it.

The full article is available at the Guardian website.

The End of the Beginning

Posted by D.D.Grant at 10:46 PM

"Defaulting middle-class U.S. homeowners are blamed, but they are merely a pawn in the game. Those loans were invented so that hedge funds would have high-yield debt to buy." Satyajit Das in an interview with Jon D. Markman, The Credit Crisis Could Be Just Beginning

In what follows I revisit the theme I touched on recently, namely the way in which all the focus of the current credit crisis is being laid at the door of the subprime bubble and by implication on those Americans who entered into one or other of the less than prime mortgages. Let's not forget the hoopla around the spread of home ownership in recent years and the signal it gave that anyone who struggled to get a foot on the home ownership ladder was being a model American. Now there is a definite atmosphere being created that those unfortunate enough to have been on the lowest rung of the ladder are the ones whose 'irresponsibility' has been the cause of tipping the ladder. Let there be no doubt about it that this is a smokescreen, and one made all the easier by the shroud of hocus pocus that has been built around the technical aspects of the finance world.

Everyday life has a pretty good idea of how cause works and despite all the verbal alchemy things are no different in the case of the credit crisis. If anyone approached an auto collision by focusing on how the innocent party had invited the offending vehicle to bring it on we would rightly consider it silly. Similarly, the growth of the subprime mortgage market wasn't a result of some smart idea dreamed up by the homebuying public. It resulted from a premeditated strategy to extend the market for mortgage credit. It wasn't the ordinary homebuyer who invented this mind boggling range of products. On the contrary the various players in the market vied to outdo each other in the next esoteric product they could come up with. All of this went on with the blessings, some would say encouragement, of the FED. Listen for example to Alan Greenspan speaking at the Community Affairs Research Conference in April 2005:

“Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country. With these advance in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers.”

The question then arises of the driver for these marketing innovations. We hear lots about the world having been swimming in liquidity. Note however that not many speak of this as being awash in cash. The truth is that the creation of 'liquidity' stemmed from the development of a range of financial products by the investment community, products massively built on leverage and the off-loading of risk through instruments that to all intents are one or another variety of insurance policy. The problem is that whereas insurers have a long experience of the statistical possibility of the risks they cover actually occurring and know full well that 'runaway' risks are absolutely rare - even mass auto pile-ups or 'out of control' forest fires have a limit as to how far they will go - no such predictability comes with the markets. No one ever heard of 'unwinding' in the case of the ordinary business carried by insurers.

Everyone in the financial markets however had better have heard of the great crashes that have been a recurrent feature in the history of that world. If not they have no business being in business. In practice of course what happens is that every generation cooks up one or another 'theory' that they've got things under control and it won't happen again, "the business cycle has been mastered" and so on, only to be proven wrong each time. These theories are invariably nothing but rationalization of the foolhardy risk taking, what has become known as 'exuberance'.

When in mid-August Goldman Sachs announced that a “25 standard deviation event” had caused the value of its quantitative fund to drop 30%, the implication was that the subprime mortgage crisis had caused the market to behave in some wholly unexpected pathological manner, normally to be anticipated only two or three times in the history of the universe. In reality such “25 standard deviation events” happen two or three times a decade and are perfectly normal. The abnormality, in which the market lost its mind, was in Goldman basing its reputation and its investors’ wealth on such obviously inadequate mathematical techniques. When markets lose their mind, Martin Hutchinson

Given this it is truly outrageous that those who will suffer most in real practical terms from the operations of the credit freewheelers are now being set up as the first link in the chain of cause of the crisis. The truth is that this line is being pushed more as a move to justify the rescue of the speculators by public funds than as a real explanation. It is hoped that gushing of crocodile tears for suffering homeowners will garnish enough sympathy so that the financial world can be pulled from the fire of its own creation, while at the same time it keeps the spotlight pointed elsewhere. And make no mistake about it, it is the financial industry that will benefit from any of the measures contemplated so far. Who after all will benefit from the publicly funded rescue of the debts owed to the mortgage lenders, (even if it's only through the 'liquidity enhancing' measures of the FED or through tax breaks)?

The other aspect of this turn of events is that it acts as an impediment to the understanding of the real causes. Could it be that this is yet another convenient result for those who have gained most from the whole affair? After all, failure to unravel the system of real interconnections that have ended as this 'unwinding' leaves the door open for an equally profitable repeat in some future period.

Blame the Victim Rules the Subprime Debacle

Posted by D.D.Grant at 2:04 AM

Anyone get the impression as I do that the scene is being set for placing the blame for the economic crisis on those hapless people who were so inconsiderate as to put everyone at risk by actually taking advantage of what they saw as the opportunity to get their piece of the pie? Yes folks, the reason the wheels of high finance are now gumming up is you or your neighbours utter selfishness in wanting a decent roof over the heads of your families. How thoughtless and unpatriotic of you to throw caution to the wind.

Max Wolff notes the mindlessness that has become a feature of commentary on the financial crisis where mouthing "subprime" a sufficient number of times seems to absolve anyone from actual analysis. The following from Credit Backwash August 21, 2007

"Every day we watch people blame sub-prime. Sub-prime is neither contained nor, is it the essence of present trouble. Discussing sub-prime as the cause of asset re-pricing has become ubiquitous. I would liken this line of explanation to the way that American urban violence is often discussed as "gang related" or "drug related". In short, it is a lazy catch all employed to avoid scratching below the surface. ..."

The truth is it seems that it's not only in the housing mortgage sector that 'liar loans' have been the fashion.

"A huge credit bubble exists and extends far beyond sub prime mortgage distress. The global bubble is enormous and has many sub-component bubblettes. The internationalization, integration and expansion of finance extended and distributed the effects of overly cheap and easy credit. Innovation of new products, thin opaque markets in credit vehicles and voracious appetite for leveraged yield have transformed balance sheets and portfolios. This mountain of gas soaked rags was ignited by the credit concerns in sub prime. Now the credit bubble is burning. Years of euphoria, easy money and asset inflations built to dizzying heights. Massive, cheap and easy debt was taken on to buy houses, currencies, bonds, equities, mortgages, leveraged loans, credit default swaps, real goods and services. Credit burdens were taken lightly, rolled over, bundled and sold. As long as lenders, buyers, ratings agencies and faith held, bubbles formed and swelled. The size, volatility and interconnectedness of international asset inflation was unprecedented. The downturn has been similarly correlated. Sub-prime credits and the collateralized mortgage obligations comprised of them deflated- the match was struck. The fire is never really caused simply or exclusively by the match that lights it.

All these innovative new mortgages were written because there was great money to be made in bundling them into mortgage backed securities (MBS) and collateralized mortgage obligations (CMO). Lenders cashed in on a "originated to distribute" bonanza. All types of finance companies wrote mortgages- and many other types of credit contracts - only to sell them off. A popular final destination was in collateralized obligations. This industry swelled as trillions of dollars in mortgages were written over the past few years. Every obstacle to further lending was innovated around to allow profits to continue to flow. The risks of all this lending were less pressing as mortgages loans were made to be sold- not held. All the available credit bid up house prices and led to the false conclusion that houses were always safe, appreciating assets. Questionable loans and sub-prime mortgages were sold and reconfigured into AAA rated product. Risk vanished from consideration and discussion. Transformed mortgages became credit vehicles and were sold all over the world. Part of the mad dash now involves finding these hidden gems hiding on books and ascertaining their real value."

Meanwhile over at the Pundit's Blog Brent Budowsky tells it to America straight: Gilded Age Crime: Poor Go Homeless, Wealthy Get Bailouts

"Is it right that the new racket on Wall Street is that banks make bad loans, sell them to hedge funds and private equity firms, many of whom are virtually unregulated and untaxed, who then complain about their pain after they foreclose on average Americans for falling a little behind their payments?

It is good that today the Fed cut the prime by 50 points, but it is bad, and terribly wrong and unjust, that in the last week the Fed has essentially used Americans' money to bail out the wealthy who made the profits, while doing zero for the foreclosed and homeless.

When the banks, hedge funds and private equity firms make bad deals, they keep the personal profits, while the corporate profits are protected by bailouts. Meanwhile, when the average Americans in the middle class, or the poor, fall a little behind, they get the boot, they lose their jobs, they are thrown into the street without homes and often without food."

And don't ya just love the reasoning on RESPONSIBILITY that goes with the line of argument that runs, subprime borrowers who made bad decisions based on insufficient knowledge of what they were getting into should BE HELD RESPONSIBLE for those decisions even if this means losing their homes. Who cares if they're on the streets since that won't affect the economy. All they do is produce products services. But investors who made bad decisions based on insufficient knowledge of the real values of their investments should .... NOT BE HELD RESPONSIBLE for their decisions and should be bailed out by the taxpayer. They must at all costs be protected from losses. Their coupon clipping and 'premia' are essential to the economy.

I think this is known as one law for the rich and another for the poor.

Paulson Gives Bottoms Up On Subprime Crisis

Posted by D.D.Grant at 11:26 PM

Since Secretary Paulson's remarks on the housing bubble in the Newshour segment for Thursday May 17, Treasury Secretary Discusses Wolfowitz, Chinese Economy , may have been drowned out by more salacious developments in the world of high level banking I give them here:

JIM LEHRER: One final question, and a third subject. How worried are you about the slump, so-called slump in the housing market in the United States right now? And what kind of damage, if any, is it doing to the economy?

HENRY PAULSON: Well, let me say this. As you've pointed out, we've had a major housing correction in the U.S. The U.S. economy had been growing at a rate that was unsustainable and, in housing, it had clearly been growing at a rate for a number of years.

That correction was inevitable; that correction has now been significant. We think it is near the bottom. It will take a while to work its way through the system. Fortunately for us, we have a very diverse, healthy economy. There are other things that are positive that are offsetting that.

We've had business investments start to pick up. They've got a very strong labor market, unemployment at quite a low level. We have good growth outside of the country. We've been talking about exports to China, but exports everywhere are picking up. The consumer remains healthy.

So my very strong view is that we are near the bottom and that this will be contained as -- the housing will be contained, and we're fortunate that we have a diverse, healthy economy.

The correction to which Sec. Paulson is referring is that beginning in 2006 when homebuyers courting default suddenly found themselves with no additional home equity to see them through. They also faced the additional obstacle to selling presented by a glut of inventory on the market. Refinancing options quickly evaporated as borrowers were unable to get appraisals matching the original purchase price of the home. But where is the evidence that would lead him to conclude that this is the extent of the correction that in his own words "was inevitable?"

The language Sec. Paulson uses is in itself instructive. All in the same breath he is able to say "we've had a major housing correction", "We think it is near the bottom. It will take a while to work its way through the system." and "we are near the bottom." The mixture of past present and future tenses doesn't exactly inspire confidence.

Another opinion can be found in the Credit Suisse Mar 12 2007 Mortgage and Housing Report which points out that "escalated delinquency rates on 2006 vintage loans are not being driven by the payment shock issue which is at the forefront of legislative and regulator debate, as rate reset has not yet occurred on these loans. As shown in Exhibit 42, [below but for a clearer image see the report] roughly $300 billion of securitized subprime mortgages (36% of outstanding subprime MBS) are set to reset in 2007 alone, with even more occurring in the non-securitized space. This, in our opinion, is the next shoe to fall and will likely contribute to additional delinquencies, foreclosures, inventory and additional pricing pressure." Perhaps this explains the hesitancy implicit in the Secretary's language.

As for the factors that are claimed to be "positive" and "offsetting," i.e., the "diverse, healthy economy", with "business investments start[ing] to pick up", "a very strong labor market", "unemployment at quite a low level", "good growth outside of the country", "exports everywhere are picking up", and the "consumer remain[ing] healthy", each in turn is in strongly disputed territory. At least with regard to the China trade Sec. Paulson admits that the administration have only "been talking about exports." So much less than a positive is this factor that talk of a developing trade war is more on the lips of commentators.

And for a glimpse of the kind of 'creative accounting' that is once again claiming impending losses as income visit the contribution by Aaron Krowne at iTulip Forums, Say Hello To Lendron . After noting that the breaking housing bubble has "already spread from subprime to other sorts of marginal lending, and mortgage lending in general, including 'Alt-A', prime second liens–which back home equity extractions–and any sort of high-LTV loan," this article draws attention to Pay Option ARMs, (adjustable-rate mortgages). These are the ones with the option of paying less than the normal monthly payment, the difference being added to the principal. Thus the label negative-amortization applied to these. And these offer the prospect of an even more explosive situation than the subprime meltdown.

What is startling is the way lenders or portfolio-holders of these treat negative amortization in their accounting, taking the negative amortization amount and adding it to earnings. There is a growing trend in which mortgage lenders and bankers with extensive involvement in this class of mortgage treat this as "capitalization of income from negative amortization" and show it as part of net income, as much as 72% in one particular case. We should all hope fervently that these are not the business investments that Sec. Paulson assures us are starting to pick up.

A New 'New Deal'?

Posted by D.D.Grant at 1:28 AM

If the unfolding contagion of the subprime crisis really has the potential to precipitate, (in the awkward translation of the Global European Anticipation Bulletin' No.14 report - see below.) 'America's Very Great Depression', then sooner or later the question of a "New 'New Deal'" must enter the discussion. And in the belief of many it is not only America's fate that is in the balance. If as many claim the money financing this housing bubble comes from global sources, the end of the US housing bubble could have disastrous consequences globally. If indeed 50% of “securitized” mortgage debt is held by overseas investors, the subprime meltdown could shake the entire global financial system.


While it is true that assessments of the extent to which the New Deal rescued America from the ravages of the Great Depression vary widely, in any case, on this occasion perhaps we can for once commit ourselves to learning something from history. And this at a time when there is an unmistakable undercurrent of hopelessness abroad in the land. It is salutary to recall that the most pessimistic reflections on the New Deal conclude that it was all for nothing and that the real 'saviour' lay in the dreadful carnage of the World War.


A few areas therefore that strike me as candidates for deliberation. The first question that comes to mind is whether America today is in a position to undertake a new New Deal. Much has been written about America's changed position in the world economy. Whether this change is reflected in international wealth production rankings, the structure of international trade, or national and international debt liabilities, the picture is very different from that faced by FDR. Among European economists some hold the view that Europe could 'de-couple' from the impact of a New American Great Depression. Such opinions would have been unheard of in earlier periods.


A second question concerns the power of the nation state to intervene in an era of privatization and the global free market. It is said that 'the market' is the best mechanism for the solution of all economic problems and that matters should be allowed to run their course. However, whatever merit there is in this idea must surely meet its limit if the consequences are large scale social disruption and the attendant disorders that threaten the very social order that such a market mechanism is claimed to uphold.


There are signs that the implications of an economic disaster are being taken seriously in the centers of power. Witness Senator Charles Schumer's recent remark that, “The subprime mortgage meltdown has economic consequences that will ripple through our communities unless we act.” Federal regulators have called on lenders to work with those borrowers unable to meet their high-risk mortgage payments to help them keep their homes.


And those who perhaps have the most at stake in the spectacle of millions of homeowners defaulting on their loans are showing signs of action. Several major lenders have already unveiled plans for a housing market rescue. Citigroup and Bank of America have together created the Neighborhood Assistance Corporation of America. This will provide $1 billion in subprime loans assistance to allow homeowners to refinance their mortgages and avoid foreclosure. The 30 year loans envisaged will carry a fixed interest rate one point below prime with no fees and with the banks paying closing costs. Washington Mutual has announced a $2 billion program to forestall the worst of the foreclosures impact and Freddie Mac has committed $20 billion with the same goal in mind, adding that the term would be extended to a maximum of 40 years from the existing 30 year limit.


Perhaps what we see in these moves is the beginning of a 'privatized' New Deal? Perhaps this also signals that we are reaching the end of the period of widening income differentials? Whatever the case where is the logic in waiting for a disaster to happen before the necessary response is called forth? Surely the time for a New 'New Deal' is now and not when the damage is done. Sure, the people at Citigroup, BoA and WaMu are acting in their own best interests. But, I have to believe that people of honour and integrity are in the majority on this shrinking planet, the opposing view being too terrifying to entertain. And if that's Utopian perhaps the time has come for this word to be rehabilitated.

GEAB N° 14 A Chronicle of America's Very Great Depression

Posted by D.D.Grant at 1:03 AM

The (free) abstract of GEAB 14 is now available online. This issue claims that the "2007 Very Great Depression has indeed begun."

Two aspects are identified:

1. A historical reversal of global financial balances:

The report chronicles the decreasing role of the US in the field of international trade and wealth production signalling an end to a century-long tendency which began during WW1. This is supported by statistics showing the current dominant place of the EU in the external trade of oil-producing countries. In addition China has now surpassed the US as premier source of EU imports. It also notes that in March 2007, the value of European financial markets surpassed those of the US. This represents "a 'seismic tremor' for the global financial markets as it shows a displacement in the centre of gravity of the global financial sphere out of the US and towards the Old Continent."

The following US trends are identified:

1. relentless and durable decline of the US currency
2. decreasing share of the US in international trade and the production of global wealth
3. geographic remoteness of the US compared to the 'Old Continent's' Eurasian economic centres
4. impoverishment of the US consumer
5. collapsing competitiveness related to collapsing quality of education

2. An implosion of the US society:

US income disparity is now comparable to what it was on the eve of the Great Depression. The ratio of incomes between the richest 0.01% and the poorest 90% hovered in the 170-180 range throughout the period 1950 to 1980. It soared to 880 in 2005, this being about the same level (891) as in 1928. It is thought that this disparity will produce severe social and political tensions, a hint of which are already present in the number of foreclosure evictions. The report maintains that the economic recession will grow deeper and that US society is being split into two groups, one poor and the other very rich, with the middle class in increasing danger of falling into the poor group.

Unlike the situation during the Great Depression when the US was in the ascent as an economic power, the current depression will take place in a period when US economic power is eroding. It is claimed that in April 2007, the tipping point of the global systemic crisis is already occuring and that trends will speed up and their impact intensify and become obvious to everyone.

The full report (subscription) describes four other trends that will dominate the coming quarter:

1. The continuing contagion of other types of home loans and other sectors of the economy by the subprime crisis.
2. The return of stagflation with US growth falling below 1% by this summer. A further sharp increase in the US deficit by mid-2007.
3. An intensification of the geopolitical oil crisis in May 2007 with Iran and Venezuela on the frontline and Oil on the rise (USD$100) and the US Dollar suffering a further dramatic fall by summer 2007.