Capitalism 2.0

Mortgage Cram-Downs a *Terrible* Idea

I had hoped to pen a considerable article about the Obama administration's currently (rumored) mortgage "cram-down" plan.  But I won't have time until after Wednesday of this week (at which point I'll revise this article and spell out the arguments) [Note, I've decided to just contribute my thoughts in the form of comments below.  I may write a more formal essay later, but for now I'm just going to argue in real-time].

But in case anyone wishes to discuss in the interim, have at it.

In short, I think mortgage cram-downs are a terrible terrible terrible idea.  I agree that something needs to be done regarding the flood of foreclosures.  But I'm more for an "orderly devaluation", if you will.  I'd slow down the process, and put more effort into being thorough.  I'd go after those who committed mortgage fraud aggressively, lenders & borrowers.  I'd also go after lenders, borrowers and home builders who exploited or outright avoided taxes.

But I would not punish responsible homeowners who've been paying their mortgages, along with responsible savers who waited to buy, along with the struggling people who are working 2-3 jobs just to barely make the mortgage they can't really afford by _rewarding_ the worst of the worst.

Yes, this plan punishes someone who's working 3 jobs to just make payments, and rewards his lazy neighbor who'd rather sit around and whine for a bailout.  And don't get me started on the banks/lenders.  Yet another bailout for them?  The government will "match" their loan workouts? 

This is getting ridiculous.

--- More on why my plan to allow foreclosures to take place in an orderly fashion *helps*, later.  First I must make a living...

Sticky Bay Area Housing Prices, Redux

A thoughtful question from reader "sun_kan" asked:

randy, i have read your price stickiness argument (in patrick.net) in detail & i have seen it play out precisely as you expected it to be, in the bay area, till the recent credit crisis. now i see a slightly different behavior from sellers, with a lot of them accepting the reality & cutting prices in bigger chunks. it is still expensive but i do see cuts in the range of 50K-100K, even in nicer areas (hills, school district etc). in not-so desirable areas where there is a lot of foreclosures/short sales, i am seeing sellers trying to price very competitively with (or sometimes lower than) the reo prices. is there a tipping point in the sellers psychology, just like the one in stock market? and if so, how would that affect the price stickiness?

The Great In/De-flation Debate

Presently there is an increasingly raucous debate brewing between those who believe there will be long-run inflation, and those who see an extended period of deflation.  I have elaborated my position here and elsewhere, which is basically that we're currently at the head-end of a deflationary period which risks collapsing into a broader deflation cycle.  The actions of the Federal Reserve in concert with other world central banks strongly suggests that monetary policy leaders also fear deflationary forces.

This subject is particularly interesting being that it has generated the most email I've received on any topic since I wrote about the Second Life virtual world economy.  Following are a few examples...

How about a $600 trillion headache?

Coming Soon:  The $600 Trillion Derivatives Emergency Meeting (link).  The Prudent Investor posted the linked article on SeekingAlpha over the weekend.  It's a must-read.

Realizing that by no means is the entire derivatives market at risk, and that a good deal of the notional values of these derivatives net out (theoretically) should give some comfort.  But only some.  This is still a big problem.  Well beyond the ability of any government to "bail-out".  Not even all governments acting in unison could hope to bail-out the derivatives-related fallout should systemic failure spread.

Will it spread?  I wish I could say no.  But, right now, everything is on the table.

One interesting notion I'm hearing discussed more and more, including in the comments on that article, has to do with a purely legal solution to the looming derivatives defaults and unwinding problem.  It goes roughly like this:

Default swaps (and related instruments) were unregulated.  Those instruments were basically a form of trade-able insurance positions; sometimes used to insure, sometimes to hedge, often to simply speculate -- ie., to bet.  Not regulated by financial authorities.  Not regulated by insurance authorities.  Not regulated by gaming regulators.  Therefore, these things constitute a form of illegal gambling.  As such, they violate public policy, are not protected by any international treaties or trade agreements, and are subject to nullification by a court.  So, just nullify them all.  All; every single one.  Tell all the parties, "Tough, you should have known better.  Be happy we're not going to prosecute you for illegal gambling". 

Then, effectively, every party has what they have today, and we move foreward tomorrow.  Lot's of upset folks.  Lot's of rhetoric about the end of capitalism, the end of markets, the end of credibility.  But it will pass quickly.  Only a select, elite few ever played in this market to begin with, and they were just running giant bets against one another.  So, knock out the hundred trillion or so of default swaps and dependent derivatives and move on to the next crisis -- which is consumer credit defaults.

Thoughts?

Another Plan to "Repair" the Housing Market

John Peterson Preston authored a fairly long housing repair essay on SeekingAlpha.com today:  My Plan to Repair Housing in America.

Although the essay is long, I encourage everyone to read through it.  It resembles a number of other proposals, including one circulating from the Dean of my b-school alma mater.  I dropped a few comments directly on SeekingAlpha, but I'd also be interested in a more detailed discussion here.  I think it's important because a plan of this sort is very likely to be implemented.  Especially with the prospect of a fully Democratic government (though I think even Republicans will implement something, just it would take them a bit longer to do it).

In short, I believe these plans are just further securing a Japanese-style deflationary episode for the USA.

Is Your Money Safe in the Bank?

The Federal Deposit Insurance Corporation (FDIC) states there are currently 117 "troubled banks" on its watch list.  The FDIC is supposedly prepared to insure the deposits (up to the FDIC limit) for those banks, should they fail.  But, Washington Mutual and Wachovia -- two of the largest bank failures in history -- weren't even on the FDIC's list before they collapsed.

That begs the question, how accurately is the FDIC tracking potential bank failures.  And, more importantly to each of us:  how safe is your money if the FDIC is terribly wrong?

Worried about Inflation, Stagflation or Hyperinflation? You shouldn't be.

For at least 3-4 years now there has been a lot of fretting and hand wringing over the fears of inflation and its uglier siblings.  Certainly, consumer inflation has been growing fairly steadily since the late 1980s.  But with this Great Deleveraging that's now occurring globally, are we really right to worry about inflation, stagflation or hyperinflation?

Inflate, Deflate or Default

Craig Jones has written what I think is an excellent article on seekingalpha.com which I strongly encourage you to read:

Inflate, Deflate or Default

He starts off describing how some fifteen years ago he came to the well-studied, theoretically grounded conclusion:

I came to the simplistic conclusion that we, as a country, had but three choices for righting our hopelessly listing fiscal super-tanker; Inflate, Deflate or Default.

However, that didn't happen.  Instead something very different occurred.  Now he reasons that we're finally back to a fundamental point where his original thesis is valid. 

Read for yourself, and read the comments (one of which you'll recognize), and let me know what you think.  In my opinion, Craig cleanly summarizes the conversations, arguments and reasoning many of us have been having over the past many years on macro subjects.  I'm just no[t] so sure he will be any more right this time around.

No Honor Among Thieves

In the past few days I've seen, heard and read interviews with various CEOs and industry advocates from the worlds of the home builders, realty agencies and mortgage brokers/lenders.  Three years ago you would have thought these groups constituted one giant, happy family.  All of them denying the existence or even the possibility of a bubble.  All of them congratulating themselves on achieving historically high home "ownership" levels.  All of them urging potential buyers to "buy buy buy".  Buy as much as you can, as fast as you can, as often as you can was the mantra.

Enter the Great Deleveraging, a historic credit crunch, and home prices dropping faster than ever in American history:  and the once happy family are stepping all over each other to point fingers and defer blame.

No Treasury Bailout ... For Good?

The US House of Representatives today defeated the Paulson Bailout Bill.  Leaving the politics of this aside, what are the real economic and financial consequences?  Are we really now doomed to Great Depression 2.0?  Or is this the beginning of the healing process?

Some things to consider:

• Free market fundamentalism is likely to fail as bad as, or worse than, wreckless interventionism.  Hopefully we learned those lessons in the Great Depression 1.0.  Laissez-faire economic policy is arguably just as bad as command socialistic economic policy.
• Failure of this plan alone is not sufficient to ensure a Great Depression 2.0.
• The DOW is not the economy.  I, for one, am tired of the media running around acting like the DOW is a proxy for the health of the economy.
• Calling the bailout plan a "rescue plan" won't change anything other than what the talking heads on television spew.  They've lost that battle anyway, my 70 year old mom in Ohio calls it a "bailout".  Therefore, it is a "bailout" to Main Street.  Get over it, media and Wall Street apologists.
• And most of all -- for anyone in the real estate industry:  look out below!  You thought home prices were coming down before?  You ain' seen nothing yet.  (By the way, I just saw a new construction home we looked at earlier this year, which had then been marked down from $1.55mm to $1.395mm, and was advertising $1.098mm a couple months ago...$699K.  And it's _still_ overpriced.  If you're the guy next door who paid $1.6mm for your nearly identical unit in 2007, what do you do now?  That home won't retrace that price in your lifetime.)