Let me preface this post by saying that I am an Economist by NO means. I have a rudimentary understanding of advanced market studies on economy... but I do understand economic principles, and am currently enrolled in a Leadership Program which teaches the capitalist economy.
With that said, I have to restate my blog title: America's Economy has Failed
President Bush's relief plan is the next sign of the failing times.
A year ago, I moved away from California, mainly due to work reasons, but also on the burner were the reasons of overcrowding and real estate prices. a 500 sqft shack in the worst part of San Jose was being sold for $500,000... That is right. I stated at the time that there was no way that the market could survive when the middle class could not even afford housing.
Moving to Colorado, where the foreclosure rates were pretty much leading the nation until recently, I was excited to find affordable housing... and when I talked to the banker regarding home loans, I was sure to specifically request a 30yr fixed. Why? Not because the rates were great, but because I knew that a few years down the road, if I had an adjustable, that I would be out on the street with a LOT of other Coloradans.
Now, the Federal govt. is freezing the rates all together. So in a sense, it is a bad time to be a banker. The federal govt. is dictating who they have to do business with and at what price... Anybody see any resemblance to Ayn Rand's Atlas Shrugged?
The president says that he is bailing out the citizens... what is really happening is that he is bailing out the bankers. Though the citizens will initially lose their houses, the banks will be left with useless real estate, which they will have to unload at a lower price (market correcting itself), and the banks will take the loss. Then, the $500,000 houses will be back on the market for the $150,000 that it is worth, and the citizens can afford a lower mortgage at a higher rate, the banks make their money back over time... everyone is happy in the long run, and the free market works...
The problem is that the rate freeze will help people keep houses that they cannot afford, house prices will remain high, and at the end of the five year freeze there is going to be an economic implosion. Banks retain their wealth, the people continue to barely make their high mortgage payments, and the economy stagnates.
This, as a free market guy, is wrong on so many levels... so many, in fact, that I am still learning the impacts in my class.
Any opinions?
When we first look at an issue, things can seem simple but the devil is in the detail. Which requires us to take a more detail and longer view of the issue. The real estate problems have nothing to do with ARMs (adjustable rate mortgages). The US is one of very few countries a person can get a 30 year fixed mortgage, most of the world has adjustable rate mortgages. Many folks have used ARMs for years without defaulting on their loan. The real issue are the loans where owners have little if any equity in the property combined with poor underwriting and appraisals. We created an environment that allowed individuals to easily get loans that in the past would have been denied. This created increase demand for housing that resulted in increase in prices. This was ok as long as real estate prices were increasing. If the owner got into trouble, he or she could quickly sell their property for more than they paid (after paying realty fees) and no one got hurt. The problem kicked in when the price of housing got way out in front of what the wages in the area could really support. Graph income growth and housing prices and you will see what I mean. You will see the bubble very quickly. When the market softened and folks were not able to flip property like they had in the past, things started unravelling. Folks who bought real estate with no money down because they had shakey finances or were just looking to flip the property quickly started defaulting on loans. At first the financial institutions were not cocerned as them had fooled themselves into believing that their fancy math had reduced the risk that the lending practices had produced. As we are now aware the risk was not small but large as it has always been. As the number of properties for sale grew, good old supply and demand can into play and prices fell. This resulted in other folks that had some equity but still small to come under pressure and we can see how we got into todays situation. Now to your question of just letting the market sort it out. Markets only work when everyone invovled are honest. Folks are honest about their financial situation. Lending institutions are honest about the risk. So the first thing that needs to be done is to have honest disclosure back into the system. That is why you are seeing lending institutions tighten up then credit standards for loans. You see large banks acknowledging the true risk in their loan portfolios. Now we need to deal with all of the loans that are questionable. Is it in everyones best interest to just dump all these questionable loans? The impact could be large if this resulted in real estate prices dropping 30 to 50 percent. If this were to happen those with available capitol would make large amounts of money at the expense of others. Or is the fix that the President pushing where we try to keep folks in their homes and paying their mortgages while acknowledging that the financial institutions played a part in this. Therefore they will make a little less on the loan but at the same time having a smaller impact on other loans that they because they will not be dumping as much real estate and depressing the prices farther. To say one approach is open market and the other isn't, is well, not that accurate. The bigger question is who is going to take the loss and how is the loss going to be distributed. It seems to me that the President's plan takes the approach that we are all in this together and that restoring honesty will in the long run keep open markets working best. Just more 2 cents worth.
ReplyDeleteI live in England and over the past 30 years have witnessed the ravages of Milton Friedman's market economics. In Britain during the early eighties our politicians wilfully closed down our manufacturing industries, claiming that they were unprofitable. In turn, to maintain their living standards people began to borrow heavily against whatever they could. The housing market became a new investment vehicle and the British became a nation of property entrepreneurs. The market supposedly dictated which businesses would survive. In reality it developed into a parasitic economy with Government departments setting up new business advocacy schemes and outsourcing programmes supposedly creating a lean burn economy. In truth we impoverished our workforce. For every job lost overseas four others fell away leaving local businesses failing all over the UK. The domino effect has reached it's ultimate conclusion. Without opportunity to work the workforces in the UK and USA will inevitably default on their debts. They simply do not have the resources to pay them back. If the US government want an answer to this crisis there is only one answer. Rebuild your manufacturing base get your people back into well paid work and stop outsourcing. For now we may have to prop up the people who have caused this mess but that is only a short term soloution. We need to stop paying the talkers and start paying the doers.
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