When the cheerleaders are worried, shouldn’t you be?
The business press points to unstable underpinnings
| The cycle turns and the prices based on unrealistic wishes turn to dust. As the nadir approaches, even the boosters point fingers at the losing players. We trim and blend four 2008 articles. |
Given the global economy, many nations are in the same phase of the land-price cycle, commonly and incorrectly refered to as “housing prices”. In Australia, prices fell in the first quarter by the most in five years to A$458,488 ($439,644) for a median priced house. Yet affordability fell further to the worst on record; to repay an average home loan, a family must spend 38% income. (Bloomberg, June 7)
In the US, prices fell 14.1% in the year to the first quarter, bigger than the 10.5% drop in 1932, the worst point of the Depression. Today inflation is running at a brisk pace, so property prices have fallen by a staggering 18% in real terms over the past year. People who count others’ mortgages as their assets will be hurting. (From Economist.com, May 29)
Fannie Mae and Freddie Mac are supposed to buy mortgages made to lower income people, so banks will lend to them. Houses for which those people borrow cost about $100k. But as a favor to better off buyers and risky lenders, in February Congress raised the two enterprises’ upper limit above $417,000. Now, as investment banks unload their mortgage-backed “securities” (MBS, not exactly very secure), Fannie and Freddie buy them. The twins hold 84% of total MBS issuance in the first quarter – up from 33% at the peak of the US housing boom in 2006.
The two enterprises support their giant operations with only a thin cushion of equity capital. While a well-capitalized bank would hold about 6% in tier one capital, Fannie had core capital of only 0.4% at the end of Q1, while Freddie had negative equity. Loans from 2005-07 now falling into negative equity, increasing their likelihood of default, make up a large share of the total book – 53% at Fannie and 56% at Freddie.
At the end of March, Fannie and Freddie had total credit outstanding of $5,300bn $1,600bn in debt and $3,700bn in credit obligations – a total that is equivalent to the entire publicly held debt of the US government. Thus, if both quasi-public companies go belly up, the US debt would double and people’s tax burden would, too. (Financial Times, June 3)
Prudent Bear featured “The End of the Beginning – Developments in the Credit Crisis” by Satyajit Das (May 27) who made some revealing points:
Credit markets have become dysfunctional. As Walter Bagehot observed: “Every banker knows that if he has to prove that he is worthy of credit, however good may be his argument, in fact his credit is gone”.
The US Federal Reserve as of May holds $537 billion of US Treasury notes which includes $143 billion of Treasury bonds fully collateralized by MBSes.
The Federal Reserve has provided over $400 billion (around 3% of US GDP) in funding to banks and now investment banks. Given that they’re lending at a rate lower than inflation, the Fed is doing more than providing liquidity; it’s underwriting the solvency of banks. Such actions create moral hazard and reward greed.
There seems to be no choice. If a bank can not repay the advance, the Fed will keep lending to avoid triggering default. Bear Stearns was technically solvent when a withdrawal of liquidity brought it to the brink of a bankruptcy.
There will be a high price to be paid but that will come later. As Charles Kindleberger noted in his history of financial crisis: “today wins over tomorrow”.
Present proposals are tepid and do not address the fundamental problems. Such ideas as derivatives clearing houses have been doing the rounds for 20 years. Giuseppe di Lampedusa (author of “The Leopard”) noted, “everything must change so that everything can stay the same”.
Failure to address the major structural problems of financial architecture and global economic imbalances may mean that any improvement is short-lived. It will also sow the seeds of future, perhaps more serious, financial crises. The present problems and government steps already are creating problems in commodity and emerging markets.
Resolution of the crisis requires brave and decisive steps that transcend geography, jurisdiction, regulatory silos, nationalism, and rigid economic formalism. John Maynard Keynes knew the problem well: “the difficulty lies not so much in developing new ideas as in escaping from old ones”.
But as John Kenneth Galbraith observed: “faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.”
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Jeffery J. Smith runs the Forum on Geonomics.
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Also see: Fannie has been a Bad Girl
he “Crash of 2007-8” is underway
Land Booms and Peace Dividends |
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