Tuesday, November 18, 2008

Why not help the homeowners?

Nouriel Roubini's back at it again- he's forecasting a long way down for residential home prices, for a cumulative drop of 40% from the peak.

Now this fall in home prices is important for 3 reasons. As long as it occurs, residential construction is going to keep on falling in absolute terms as a share of GDP. Secondly there is the huge wealth effect coming from a fall of $6 trillion of housing wealth. But most important factor I think is that right now ongoing is that with such a fall in home prices, by the end of next year about 40 percent of all households with a mortgage are going to be underwater, negative equity with the value of their homes below the value of their mortgages. So about 21 million out of the 51 million houses that have a mortgage. And there’s a huge incentive to walk away from your home, because the US mortgages are not recourse loans.

Now, not everybody is going to walk away. Let’s be even conservative. Let’s assume that only 1 out of 5 people that are underwater are going to walk away. If you do the math — I’m not going to go into the detail of it — you get additional losses for the financial system of the order of $400 billion dollars. This is on top of all the other write-downs that have already had been made through subprime-kind of a writedown. So that’s another huge loss for the financial system. This is just assuming that only 1 out of 5 people underwater are going to walk away. If it’s more like 40 percent, then the losses is another $800 billion. So you’re in a situation in which you can wipe out a good chunk of the capital of the financial system. So that’s what we are observing.

Of course, Paulson doesn't want to solve that problem, he wants to keep giving the money to the banks.

Paulson resisted pressure from lawmakers to commit to implementing a foreclosure-prevention program proposed by Federal Deposit Insurance Corp. Chairman Sheila Bair.

``There is a balance to getting money for those who need it as opposed to those who don't need it,'' Paulson told the panel. ``There's also a balance to not providing a windfall to the banks.''

Home prices fell in four out of every five U.S. cities in the third quarter, a record spurred by nationwide foreclosure sales, the National Association of Realtors said today. The financial turmoil sparked by the collapse of the U.S. subprime mortgage market has caused $996 billion of losses for banks, lenders and insurers.

So, if we're looking at further (semi-conservative) losses of $800 billion, plus the $996 billion already lost then we're pretty close to $1.8 trillion. Our entire GDP is only $13.8 trillion. If you really want to talk crazy then lets figure in the amounts already allocated, which CNBC is calculating as $4.3 trillion. By the way, that's more than the U.S. spent on WWII, on an inflation adjusted basis. So how much longer can we go on solving the problems caused by excessive debt and lax oversight by issuing new debt and handing out money without any oversight? As Naomi Klein says, it's a "multi-trillion-dollar crime scene".

Klein sees three areas of borderline illegality. The first is that rather than being used to get banks lending again, the bailout money "is instead going to bonuses, is instead going to dividends, going to salaries, going to mergers."

The second is that, without Congressional authorization, "the Treasury Department pushed through a tax windfall for the banks, a piece of legislation that allows the banks to save a huge amount of money when they merge with each other. And the estimate is that this represents a loss of $140 billion worth of tax revenue for the US government."

The third problem, which dwarfs the $700 billion bailout itself, is that "there’s another $2 trillion that’s been handed out by the Federal Reserve in emergency loans to financial institutions, to banks, that actually we don’t really know who they’re handing the money out to, because, apparently, it’s a secret."

"If the Fed has accepted distressed assets as collateral in exchange for these loans," stated Klein, "there’s a very good chance the taxpayers aren’t going to be getting this money back. ... So that’s why we’re calling this the 'trillion-dollar crime scene' or the 'multi-trillion-dollar crime scene.'"


  1. Glad you got to make use of the transcript. You might be interested to know that AEI now has an official one on the site for the whole 2 hours (the other speakers are worth a hearing).

    Looks like you've been thinking hard about TARP lately. Considering how critical some of these issues will be for everyone in the next months and years it's important for as many as possible to be reflecting on them.

  2. Thanks for making it available! I've read the majority of the transcript, and it's definitely worth reading!

  3. Hopefully the unofficial version gets finished. I think the slide cues are a help.

  4. I have respect for Roubini, but in that transcript you link to, he says something to the effect that "this tells me that the markets are no longer linked to reality".

    This astonishes me because anyone with a brain could have figured that out a long time ago. I figured it out myself by following the stock prices of Apple Computer for a while.

    Back in the late 1990s, Apple's stock fell to something like $13, and I started watching because it was interesting. At that time, Apple was having trouble, but they still had lots of assets. Had Apple immediately shut down, sold everything off, and given the money to the stockholders, each share of stock would have been worth something like $17. The stock market was, therefore, selling something worth a minimum of ~$17 at a price of ~$13. That's irrational, right there.

    Then Apple's stock started to rise. For a while it rose meteorically, usually for no very good reason. (If you were lucky enough to get in at, say, $15 and sold today, you would have made over $340 per share, since the stock has split twice since then and is now at $89.91.) But I noticed that whenever Apple announced positive financial news -- it beat the street estimates with regularity for years -- the stock would go down. Sometimes alarmingly so.

    The stock market is only vaguely related to the actual flow of wealth. In effect, it's just another betting shop.

  5. Vicar: Of course it's "just another betting shop", that's all it's ever been. I think what Roubini's pointing out (and you as well)is that usually good news makes the markets go up, bad news makes them go down; except now, when not even "good" news can force buyers back into this market for any kind of extended rally. Not that the market should be rallying at this point anyway.


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