Who gets hurt by toxic mortgages?

Felix Salmon points us to Mike at Rortybomb, who “explains just how dangerous mortgages can be, even to people who avoid the toxic ones”:

If I was a degenerate crackhead who snuck into your neighborhood and mugged you for $50, the Wall Street Journal Opinion Page would want me thrown in jail. Now imagine that I’m a degenerate crackhead who took out a subprime loan to move next door to you, in an arrangement that I’m likely not going to pay off. I might not even make one payment. If I default you’ll lose 10% of the value of your home from the externality effect. Assuming your home is worth $300,000, there’s a 20% chance I default in 2 years (realistic numbers), and you lose 10%; 300,000*.2*.1 = I’ve just robbed you for $6,000 while the Wall Street Journal Opinion Page cheered me on. And that’s one house – I’ll have a dozen neighbors. Now mind you, the product was great for me – I got to smoke crack indoors, in a house I could never realistically afford, which was a big plus. The subprime lender sold my loan to a pension fund in Denmark for a nice fee. It goes in the win column for us.

Dan Walters: Historic tax overhaul plan to hit Capitol

This is, um, interesting.

Dan Walters: Historic tax overhaul plan to hit Capitol

… The California Commission on the 21st Century Economy, better known as the Parsky Commission for its chairman, businessman Gerald Parsky, is on the verge of proposing a massive tax system overhaul to Gov. Arnold Schwarzenegger and legislators.

Although revenue-neutral – that is, not changing the amount of money now collected – the plan will probably propose abolishing corporate income taxes and the state sales tax in favor of a “net receipts” tax that’s similar to the value-added taxes common in European countries, replacing the steeply progressive personal income tax with a flat tax, perhaps 6 percent, and adding a “carbon tax” to reduce fuel use. …

You might be forgiven for not knowing what the hell a Parsky Commission is.

Depressing to be Krugman

Well, maybe so, but this is an especially acute angle on the question. This is John Hinderaker writing at Power Line in August 2005. I forget how I got there.

61B15090-93BB-41A7-B35B-B4305AAA9C15.jpgIt must be depressing to be Paul Krugman. No matter how well the economy performs, Krugman’s bitter vendetta against the Bush administration requires him to hunt for the black lining in a sky full of silvery clouds. With the economy now booming, what can Krugman possibly have to complain about? In today’s column, titled That Hissing Sound, Krugman says there is a housing bubble, and it’s about to burst:

Meanwhile, the U.S. economy has become deeply dependent on the housing bubble. The economic recovery since 2001 has been disappointing in many ways, but it wouldn’t have happened at all without soaring spending on residential construction, plus a surge in consumer spending largely based on mortgage refinancing. Did I mention that the personal savings rate has fallen to zero?

Now we’re starting to hear a hissing sound, as the air begins to leak out of the bubble. And everyone — not just those who own Zoned Zone real estate — should be worried.

Well, if we believed anything Krugman writes, we’d be worried all the time. …

What, we worry? But wait, there’s more:

There are, of course, obvious differences between houses and stocks. Most people own only one house at a time, and transaction costs make it impractical to buy and sell houses the way you buy and sell stocks. Krugman thinks the fact that James Glassman doesn’t buy the bubble theory is evidence in its favor, but if you read Glassman’s article on the subject, you’ll see that he actually makes some of the same points that Krugman does. But he argues, persuasively in my view, that there is little reason to fear a catastrophic collapse in home prices.

Krugman will have to come up with something much better, I think, to cause many others to share his pessimism.

Michael Lewis on GPS

Fareed Zakaria interviewed Michael Lewis on GPS last Sunday. It’s one of the better takes on the underlying dysfunction of our financial system that I’ve heard.

Fareed sits down with author Michael Lewis to discuss the economic crisis. In his best-selling book “Liar’s Poker,” Lewis chronicles his days as a bond salesman at the investment bank Salomon Brothers, where the idea of the ‘mortgage-backed security’ was invented. Lewis talks to Fareed about the roots of the current crisis and the future of Wall Street.

America’s Socialism for the Rich: Corporate Welfarism

It’s time for another Joe Stiglitz post!

America’s Socialism for the Rich: Corporate Welfarism

By Joseph Stiglitz

With all the talk of “green shoots” of economic recovery, America’s banks are pushing back on efforts to regulate them. While politicians talk about their commitment to regulatory reform to prevent a recurrence of the crisis, this is one area where the devil really is in the details — and the banks will muster what muscle they have left to ensure that they have ample room to continue as they have in the past.

The old system worked well for the banks (if not for their shareholders), so why should they embrace change? Indeed, the efforts to rescue them devoted so little thought to the kind of post-crisis financial system we want that we will end up with a banking system that is less competitive, with the large banks that were too big too fail even larger.

… The Obama administration has, however, introduced a new concept: “too big to be financially restructured”. The administration argues that all hell would break loose if we tried to play by the usual rules with these big banks. Markets would panic. So, not only can’t we touch the bondholders, we can’t even touch the shareholders — even if most of the shares’ existing value merely reflects a bet on a government bailout.

I think this judgment is wrong. I think the Obama administration has succumbed to political pressure and scare-mongering by the big banks. As a result, the administration has confused bailing out the bankers and their shareholders with bailing out the banks.

… Some have called this new economic regime “socialism with American characteristics.” But socialism is concerned about ordinary individuals. By contrast, the United States has provided little help for the millions of Americans who are losing their homes. Workers who lose their jobs receive only 39 weeks of limited unemployment benefits, and are then left on their own. And, when they lose their jobs, most lose their health insurance, too.

America has expanded its corporate safety net in unprecedented ways, from commercial banks to investment banks, then to insurance, and now to automobiles, with no end in sight. In truth, this is not socialism, but an extension of long standing corporate welfarism. The rich and powerful turn to the government to help them whenever they can, while needy individuals get little social protection.

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don’t break them up, then we have to severely limit what they do. They can’t be allowed to do what they did in the past — gamble at others’ expenses.

This raises another problem with America’s too-big-to-fail, too-big-to-be-restructured banks: they are too politically powerful. Their lobbying efforts worked well, first to deregulate, and then to have taxpayers pay for the cleanup. Their hope is that it will work once again to keep them free to do as they please, regardless of the risks for taxpayers and the economy. We cannot afford to let that happen.

Milton Friedman on radical reform

This nice quote from Milton Friedman (in the context of overhauling the Federal Reserve, as it happens) was recently quoted in the context of health care reform, specifically in support of considering single-payer systems. I’d add democratic reforms such as proportional representation to the list.

… it is worth discussing radical changes, not in the expectation that they will be adopted promptly but for two other reasons. One is to construct an ideal goal, so that incremental changes can be judged by whether they move the institutional structure toward or away from that ideal. The other reason is very different. It is so that if a crisis requiring or facilitating radical change does arise, alternatives will be available that have been carefully developed and fully explored.

The Crisis and How to Deal with It

NYRB (longish).

The Crisis and How to Deal with It

Following are excerpts from a symposium on the economic crisis presented by The New York Review of Books and PEN World Voices at the Metropolitan Museum of Art on April 30. The participants were former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, and Robin Wells, with Jeff Madrick as moderator.

—The Editors

A bit of Krugman:

… As I’ve written, we need a boring banking sector again. All of this high finance has turned out to be just destructive, and that’s partly a matter of regulation. But in the political economy there was also a vicious circle. Because as the financial sector got increasingly bloated its political clout also grew. So, in fact, deregulation bred bloated finance, which bred more deregulation, which bred this monster that ate the world economy.

The other thing not to miss is the importance of a strong social safety net. By most accounts, most projections say that the European Union is going to have a somewhat deeper recession this year than the United States. So in terms of macromanagement, they’re actually doing a poor job, and there are various reasons for that: the European Central Bank is too conservative, Europeans have been too slow to do fiscal stimulus. But the human suffering is going to be much greater on this side of the Atlantic because Europeans don’t lose their health care when they lose their jobs. They don’t find themselves with essentially no support once their trivial unemployment check has fallen off. We have nothing underneath. When Americans lose their jobs, they fall into the abyss. That does not happen in other advanced countries, it does not happen, I want to say, in civilized countries.

And there are people who say we should not be worrying about things like universal health care in the crisis, we need to solve the crisis. But this is exactly the time when the importance of having a decent social safety net is driven home to everybody, which makes it a very good time to actually move ahead on these other things. …

The Only Sure Way to Fund Universal Health Care

Tax employee health benefits, says Robert Reich.

The Only Sure Way to Fund Universal Health Care

… But, face it, it’s become a crazy system. You’re not eligible for these benefits when you and your family are likely to need them most – when you lose your job and your income plummets. And these days, as we’re witnessing, no job is safe. The system also distorts the labor market. It prevents lots of people from changing jobs for fear they’ll lose their health insurance, or won’t get the benefits they do now. And it invites employers to game the system by seeking young, healthy employees who pose low risks of ill health and will therefore keep insurance costs low, while rejecting older ones who are likely to have more costly health needs. The system also encourages employers to try to push married employees onto their spouses’s health insurance plan so that the spouse’s employer bears the cost. …

Can You Find Twelve Errors in Ben Stein’s Column?

Go ahead and peek at the answers.

Can You Find Twelve Errors in Ben Stein’s Column?

People who get upset over the appearance of Ben Stein’s columns in the Sunday NYT simply fail to understand their purpose. They are not to be treated as serious analysis of the economy or economic issues.

Rather, Stein’s columns are meant to be treated like a puzzle. Readers are supposed to find all the various inaccurate statements and outright errors that appear in each column. They are like the game where two pictures are juxtaposed and the reader is supposed to find the twelve subtle differences between the pictures.

Let’s see how many of the errors we can find in today’s piece, which is supposedly reflecting backward from 2089 on the collapse of the U.S. economy:

—Dean Baker

Krugman worries about California

A snippet from a longer column. It’s no less worrying to us living here.

State of Paralysis

… What’s really alarming about California, however, is the political system’s inability to rise to the occasion.

Despite the economic slump, despite irresponsible policies that have doubled the state’s debt burden since Arnold Schwarzenegger became governor, California has immense human and financial resources. It should not be in fiscal crisis; it should not be on the verge of cutting essential public services and denying health coverage to almost a million children. But it is — and you have to wonder if California’s political paralysis foreshadows the future of the nation as a whole.

… But the California precedent still has me rattled. Who would have thought that America’s largest state, a state whose economy is larger than that of all but a few nations, could so easily become a banana republic? …

US Defense Spending In Context

Matthew Yglesias.

US Defense Spending In Context

I’ve shown charts before showing how absurd the American defense budget looks in context. Now a new chart making the same point, but with slightly more up-to-date 2007 spending data:


As you can see, not only is the United States spending well over double the combined defense budgets of Russia and China, but America’s close allies constitute the bulk of the other big spenders. Indeed, if you add all the European countries together, they spend about 50 percent more than Russia and China combined.

Washington Post Victim Blaming

Washington Post Victim Blaming

The Washington Post has an incredibly insightful oped column noting that the spendthrift baby boomers will have almost nothing saved for retirement. This is true as serious economists have tried to point out.

The problem with the column is that the reason the baby boomers didn’t save is because they believed the claims about the bubble economy from the experts cited in the Washington Post and elsewhere. The Post used to have James “Dow 36,000” Glassman as a regular columnist. Its most cited expert on real estate prices was David “Why the Real Estate Boom Will not Bust” Lereah, who worked as the chief economist for the National Association of Realtors for his day jobs. Of course similar views were put forward by people like Alan Greenspan and Ben Bernanke.

The views of those of us who tried to warn of both the stock and housing bubbles were (and are) almost completely excluded from the Post’s pages. They were far more likely to hear the Post’s endless tirades, in both the news and editorial pages, about how Social Security was going to bankrupt the country.

There is a well-documented wealth effect whereby people consume based on their stock and housing wealth. The excessive consumption of the baby boom cohort was a predictable result of the stock and housing bubbles. This spending would have been entirely rational if this bubble wealth was real as the Post and the rest of the media told the boomers. If the boomers can be blamed in this story it is for listening to the media and the experts that whose views they convey.

—Dean Baker

Naked rants

In case you missed them (shame on you if you did), here are a couple of fine rants from Yves Smith at Naked Capitalism. Well, fragments of them; click for the unexpurgated versions.

First rant:

Yet Another Program to Enrich Banks at Taxpayer and Borrower Expense

The chicanery never ends.

The latest bit of looting fobbed off as a win for homeowners is a program to shovel money to second mortgage lenders:

The Obama administration unveiled a new program to help borrowers with second mortgages stay out of foreclosure, offering cash to servicers, investors and borrowers who modify loan terms.

Guess what? Plenty of seconds are under water and have NO economic value. But they play like pigs in foreclosure and renegotiations. So this program will validate values above market value for these homes and unnecessarily enrich second mortgage holders, who otherwise would have to eat their losses.

Second rant:

On Pelosi’s Duplicity and Apparent Sandbagging of Elizabeth Warren

Despite her longevity as a California pol, house speaker Nancy Pelosi is looking like every bit as much of a dyed-in-the-wool financial services industry backer as the Congressmen on the New York-Boston corridor.

But if we are lucky (and we’d need to be very lucky) history might repeat itself. The original Depression investigation was also a sham exercise, but Pecora, brought in to write the final report after three previous investigators were fired or quit, asked to reopen the hearings, and some initial successes, plus the arrival of the Roosevelt administration, gave the probe a new leash on life.

But with the both the Democrats and the Republicans firmly in the hold of the banking classes, it will take something more on the order of a miracle to get a serious inquiry underway.

Repairing bank balance sheets

Calculate Risk has a post with some very instructive charts comparing the effects of various attempts to bail out banks as they affect the bank’s balance sheets.

Calculated Risk: Bank Balance Sheet: Liquidity and Solvency, Part II

In the previous post, I tried to present a conceptual overview of a liquidity crisis using a bank’s balance sheet: Bank Balance Sheet: Liquidity and Solvency, Part I. Note: I combined various types of financial institutions to illustrate a few points.

As we continue the story, the bank has suffered some losses, but the bank run has been halted by the efforts of the FDIC (increasing insurance limit), or the Fed (by providing liquidity).

This time we look at the bank’s assets. What I’ve labeled as “normal assets” are various categories of assets, perhaps commercial & industrial (C&I) loans, consumer loans, and others. Although the charge-offs are increasing for all of these loans during the recession, these assets have a market value or otherwise are in OK shape.

The larger problem is the toxic assets (now known as legacy assets). These are mostly related to residential real estate, but there are many other toxic loans (Construction & Development, foreign loans, LBO PE loans, etc.)

The banks are facing huge additional losses for these legacy assets, and these losses will make some banks “balance sheet” insolvent (liabilities will be great than assets). However, the bank is not insolvent in the business sense, because the bank can still pay their debts as they come due — at least for now.

Watch what they do

Barry Ritholtz. Corporate insiders don’t seem to believe that a bull market is coming any time soon. On the contrary.

Beware Insider Selling

“Nobody ever sold a stock because they thought it would go up. And as a group, corporate insiders obviously are scarcely enthusiastic about the prospects for a genuine bull market.”

Or so said Alan Abelson in this week’s Barron’s.

Is he right? How fallible are the CEOs, CFOs, and other execs regarding their own firm’s prospects? Consider:

“If those now infamous shoots of recovery are popping up all over, why would insiders be so aggressively dumping stocks?

Yet, they indisputably are. …

Baker vs NPR again

NPR’s he-said she-said stories are bad enough. I don’t actually think that NPR is particularly in the pocket of Big Real Estate, but it’s hard to come up with a better explanation for this kind of consistent laziness. Well, except for consistent laziness, I suppose.

NPR Conspires With Realtors to Fleece First Time Home Buyers

This one is very close to true. Morning Edition had a piece this morning about the increase in the number of first-time home buyers. Its two sources were Lawrence Yun, the chief economist with the National Association of Realtors and a realtor.

NPR did not include any analysts to give the obvious downside to buying right now, specifically that house prices nationwide are falling at the rate of almost 2 percent a month. In some former bubble markets prices are falling at the rate of 3–4 percent a month. The sharpest declines are at the lower end of the market, the homes that first-time buyers are most likely to purchase.

This means that they are enormous potential gains from deferring a home purchase. For example, at the current rate of price decline, someone thinking of buying a home in the bottom third of the market in Los Angeles can save themselves more than $40,000 by putting off their purchase by six months.

This is why experts on asset building encourage people to delay home purchases at the moment, if at all possible. NPR should have spoken to someone for this story who did not earn their living by selling real estate.

—Dean Baker

Wealth and the economy

Dean Baker is on NPR’s case again.

NPR Misinforms Listeners About Cause of Car Sale Slump

In the Morning Edition top of the hour news summary (not on web), NPR told listeners that car sales are down because of low consumer confidence. Wrong!

Car sales are down because consumers have seen $6 trillion in housing bubble wealth and have also seen around $8 trillion in stock wealth disappear. The reduced spending is the result of reduced wealth. Consumers need to rebuild their wealth, hence they are not buying things like cars.

The impact of wealth on household consumption is a well-studied economic relationship. NPR’s reporters should be familiar with the concept. This matters because happy talk will not get people to start buying cars again. The problem is much deeper.

—Dean Baker

I’m posting this as a continuation of the theme: no light at the end of the tunnel. The pessimistic economists keep asking where the recovery is going to come from. In the face of big drops in personal wealth, it’s going to take more than “confidence”.

Here are a couple more datapoints, this time via The Big Picture:

  • The net worth of American households – the difference between assets and liabilities — was $51.5 trillion, down $11.2 trillion or nearly 18% from 2007.That sets Americans’ total wealth back to levels lower than 2004. It is the first decline in American household net worth since 2002.
  • Americans’ homeowners’ equity as percentage of the value of their homes fell to 43% in 2008—lowest since before WWII.

Lots more where those came from.

After-Tax Income 1979-2006

Apropos the earlier post on reducing inequality, we have this chart, based on CBO data:


We had a rising tide, all right, but it didn’t trickle down to all boats. Or whatever…

via Matthew Yglesias

While we’re at it, here’s a chart from Lane Kenworthy that’s part of that same reducing-inequality package. Something happened, it seems, around 1980, and again around 2000.


Lane Kenworthy: Reducing Inequality

Lane Kenworthy, at his blog Consider the Evidence, has an illuminating series of posts on reducing (economic) inequality in the US.

Here’s a chronological list of posts:

3248A092-1D3C-42E7-A97F-E4C3AA7176F8.jpgReducing Inequality: What’s the Problem?

Reducing Inequality: Are Unions the Answer? Some, but not enough.

Reducing Inequality: Education to the Rescue? “Education is important for individuals and for society, and I certainly favor efforts to improve both its quality and its quantity. But it doesn’t seem to me likely to get us very far in reversing the rise in American income inequality.”

Reducing Inequality: Put the Brakes on Globalization? Nope.

Reducing Inequality: Boosting Incomes in the Bottom Half Boosting minimum wage and expanding the EITC would be a good start.

Reducing Inequality: Expand and Improve Public Services Yes. “But markets haven’t, and likely won’t, bring us affordability coupled with high quality in health care, education, child care, safety, and mass ground transportation. In these and other areas, government is needed.”

Reducing Inequality: What to Do about the Top 1% “The simplest and best strategy is to let markets largely determine high-end earnings and incomes and use the tax system to redistribute.… We should increase the top income tax rate and/or add one or more new rates for those with very high incomes.

Reducing Inequality: How to Pay for It Broad-based taxes, on both income and taxation.

How to pay for inequality reduction: follow-up “Let me emphasize that my aim isn’t to discourage increases in taxation of the richest. I favor doing that. Rather, it’s to encourage the American left to think beyond heightened tax progressivity when considering strategies for inequality reduction.”

My summaries don’t, obviously, do justice to the Kenworthy’s arguments.

The last quote, one more time: focus on the effect, not the mechanism.

Let me emphasize that my aim isn’t to discourage increases in taxation of the richest. I favor doing that. Rather, it’s to encourage the American left to think beyond heightened tax progressivity when considering strategies for inequality reduction.

Financial Crisis for Beginners

Simon Johnson, James Kwak and Peter Boone at The Baseline Scenario have been compiling a series of articles under the rubric Financial Crisis for Beginners, the latest being Financial Innovation for Beginners. Collect ’em all!

The Baseline Scenario
Financial Crisis for Beginners
What happened to the global economy and what we can do about it

We believe that everyone should be able to understand how the financial crisis came about, what it means for all of us, and what our options are for getting out of it. Unfortunately, the vast majority of all writing about the crisis – including this blog – assumes some familiarity with the world of mortgage-backed securities, collateralized debt obligations, credit default swaps, and so on. You’ve probably heard dozens of journalists use these terms without explaining what they mean. If you’re confused, this page is for you. Over time, we will be adding more explanations and more links to external sources, so check back for updates. (Some of the explanations on this page are simplified and not 100% accurate; their goal is to explain the key concepts to a general audience.)