Sunday, December 9, 2007

US equivalent of CMHC?

From here.

In a pair of moves that might once have seemed too cynical even for Washington, it looks like policymakers have decided the cure for a crisis created by too much cheap credit offered too long is very simple: Extend the terms, encourage more borrowing and have someone else foot the bill.

It's the financial equivalent of the hair-of-the-dog "cure" for a hangover: a big interest-rate cut from the U.S. Federal Reserve next week and, as just announced by President Bush, a massive bailout plan for distressed U.S. mortgage holders.

Have we completely lost our common sense? Is it really desirable to provide easier money to people and companies that got into trouble by abusing their access to money in the first place? And is it really a good idea both to cancel mortgage bondholders' contracts for the sake of an adjustable-mortgage-rate freeze and to provide a couple of years of grace for stressed-out home borrowers who are likely to eventually default anyway?

I don't think so. It's as if the U.S. Federal Reserve and U.S. Treasury believe the best way to treat heroin addicts is through long-term, government-supplied crack. To be sure, lower interest rates and a U.S. mortgage-rate freeze might ease borrowers' pain temporarily, but they do nothing to solve causes or habits -- and without a doubt launch a new cycle of abuse and dependence.

Building bad habits
Unfortunately, this is pretty much the history of U.S. economics in the past decade. We call ourselves a free economy but repeatedly let the government intervene to make sure that no one who votes gets seriously hurt. As a result, individuals who make bad choices -- from U.S. Gulf Coast residents who build homes in the path of hurricanes to low-income citizens who take out expensive loans for overpriced real estate -- are rescued time after time in well-intentioned but misguided programs such as the one the Bush administration has cooked up for foreclosure-facing U.S. mortgage holders and their lenders.

What has to irk you is the disparity between who wins when things are going well and who loses when things go sour.

When banks make a lot of money, after all, they suck down the profits by giving their executives and boards outrageous pay packages worth tens of millions of dollars, justifying their actions under the rubric of entrepreneurship. And when the opposite happens? They beg taxpayers for a handout.

Veteran observer Satyajit Das has disdainfully called the financial industry's attempt to patch over its problems with taxpayer funds the "socialization of losses." It's an approach that may sound good to politicians in an election year yet is not only morally bankrupt but will also merely delay the ugly final reckoning for companies, individuals and policymakers alike.

Postponing the undeniable anguish involved in making participants own up to debt-fuelled losses is exactly why it took Japan more than a decade to shake off the bursting of its own credit bubble back in 1990. Interest rates were cut essentially to zero, but because moribund banks and real-estate tycoons were given government stipends, they drew funds and attention away from more-productive uses, and the country entered a recession that haunts Japan to this day.

Broken promises
The program proposed by U.S. Treasury Secretary Hank Paulson -- hammered out in round-robin meetings with U.S. mortgage lenders and borrowers' representatives in the past few weeks -- would freeze interest payments on hundreds of thousands of adjustable-rate mortgages for three to five years.

That sounds nice, but here's the catch: Rising interest rates were contractually promised to the mortgage lenders, which then passed along that promise to companies that bought the loans as part of asset-backed securities and associated derivatives.

Though the rate freeze would be awesome to a mortgage holder in Muncie, Ind., who wants to get out of his adjustable-rate obligation, it sounds terrible to a pension-fund manager in Munich who isn't getting the income stream he paid for, as well as to the mortgage-servicing company that won't be getting its own piece of the future income stream.

The breaking of these obligations will not be free. Foreign investors will demand a higher "risk premium" to invest in U.S. real estate, which will make it more expensive for future mortgage seekers to get loans. And they are bound to sue to get the payments they thought they were owed, which will drive up mortgage banks' expenses.

Moreover, American courts and bureaucrats will be tied up for years in a struggle to define exactly who deserves loan forgiveness. People who are making payments on time will naturally demand to get something out of the deal -- why should they essentially suffer for being responsible? As the cost of the bailout goes up, there's little doubt that U.S. state and federal governments will float bonds to pay the refinancing fees and, of course, interest payments on those obligations will be paid by all citizens.

Economist Martin Feldstein, a former Reagan administration official, told Bloomberg that among other problems, the plan would forever change foreigners' perceptions of U.S. investments. "What are they going to think about investing in American securities in the future if the government can say, 'Well, you thought these were the interest rates and the contract, but we're going to roll that back now, and you'll just have to settle for less'?" Feldstein asked.

Dr. Frankenstein's debt monster
When you start working your way though the ramifications, you may begin to understand why I called the great de-leveraging of America a very big, very long-range problem in this column back in September -- not something that can be ignored or wished away. Debt that was created, distributed, leveraged and re-leveraged by a factor of up to 30-to-1 over the past 10 years by financial Dr. Frankensteins has wormed its way into every corner of our lives and will alter the way we do business in ways we are only beginning to understand.

Indeed, everywhere you look now is evidence that the subprime-debt crisis is morphing and expanding like a creature in a horror movie. Just this week, we learned from hearings in Congress that strapped credit card companies such as Capital One Financial and Bank of America had begun to soak customers by jacking up interest rates on balances for the slightest changes in their credit profiles.

If Americans so much as apply for a new credit card, according to testimony gathered at the hearing, the current card provider can boost rates as high as 30% per year. This is not the kind of fee-generation method that card companies would normally like to pursue, but they have been pushed in this direction by losses elsewhere on their balance sheets.

In another morph, Americans scrambling to pay rising mortgage rates on houses that are declining in value are also punking out on their auto loans, student loans and home-equity lines of credit. According to a Lehman Bros. survey, 4.5% of auto loans issued in 2006 to well-qualified borrowers were 30 or more days delinquent through the end of September, up a whopping 3% from the previous month. Lehman said that was the largest single-month delinquency leap in eight years and that auto-loan delinquency rates are now the highest in a decade. Meanwhile, 12% of subprime auto borrowers are delinquent on their 2006 loans, according to Lehman Bros., which is the most since 2002.

Any solution that attempts to solve these issues by cutting rates further to allow people to borrow more will only drag out the effects. It will also force solvent taxpayers to foot the bill for their less responsible siblings and neighbours, a divide that will cause political strife we haven't yet begun to fathom. All of this may ultimately work out in the fullness of time, because Americans are forgiving and generous people. But in the meantime, financial stocks are likely to continue to suffer, so continue to avoid them even as they fitfully rally over the next weeks. They are likely headed much, much lower, as their fundamental value recedes with their profitability.

Not quite the same as CMHC of course but do we not see the similarities, especially when companies like this are actively promoting the sub-prime products and taking advantage of tax-payer backed insurance schemes.


Anonymous said...

This may just be political rhetoric. Like Hurricane Katrina, pay-outs will be too little and too late. Most of the subprimers will be out on the street before any see a dime.

God Bless America

Aleks said...

Like everything else Bush does, I'm confident he's not trying to protect home owners from foreclosure, he's trying to protect the banks and lenders from lawsuits. And to string this thing out just a little longer so the next president has to deal with it.

Anonymous said...

Also interesting that the .25 Fed rate cut really dissapointed Wall street. The perfect storm is really brewing now! Of course no one in Vic is paying attention, its different here.

olives said...

Not that this matters to anyone in Victoria:

"grave and urgent concerns" on the part of the central banks (including BoC), but looks like wer're okay until the "New Year"!!!

olives said...

oops that didn't work very good:

Anonymous said...

Follow up to Olives news clips.

Libor Fails to Drop From 7-Year High; Crunch Persists

The interest rates banks charge each other for short-term loans in Europe failed to decline from the highest levels in seven years a day after central banks joined forces to break a logjam in money markets.

Seized Up - Short-term credit markets seized up in August, raising concern that the lack of capital flow between banks will hurt the economy. Goldman Sachs Group Inc. in a report a month ago estimated losses related to record home foreclosures may be as high as $400 billion for financial companies. If accurate, banks, brokerages and hedge funds would need to cut lending by $2 trillion, triggering a ``substantial recession,'' the firm said.