THE BE YOUR OWN ECONOMIST ® BLOG
Is the cat back in the bag? Is the bailout back on track?
Today’s stock-market gains say “yes:” Dow +485, Nasdaq +99, S&P +58.
Perhaps the President can sway enough House Republicans to change their votes. Maybe Nancy Pelosi will convince some Democrats to play along. We’ll see on Thursday.
In any event, let’s hope for the best. And let’s also hope that the Senate agrees as well.
Then what? Then we take the experts at their word that the financial system will not fail.
But does that mean everything is now OK? Not at all. Everything will not be OK even if the bailout works as intended. The economy is going into recession and will remain depressed for some time.
Recent events have probably exacerbated the housing crisis, not alleviated it. The onset of recession, with its rising unemployment and general economic malaise, will also deepen the housing slump. Lower home prices and less construction will accentuate the gloom. It will be years before real estate climbs out of the ditch.
Meanwhile, there’s no savior on the horizon. There’s no incipient hi-tech boom. There’s no upsurge in business investment in plant and equipment. There is nothing out there, not even Federal Reserve policy, that can offset the glut of homes on the market. The real-estate slump must run its course before the economy turns up again.
© 2008 Michael B. Lehmann
Tuesday, September 30, 2008
Monday, September 29, 2008
Today’s Defeat
THE BE YOUR OWN ECONOMIST ® BLOG
Stunning. That’s the only word for it.
We all knew that the House Republicans were against the bailout. But we also thought their leadership had agreed to the deal and that the package would now go forward.
Instead, the House’s Republican leadership could not keep its members in line. They voted “no.” Then the Republican leadership had the audacity to blame Nancy Pelosi for the “no” vote. That’s like blaming the U.S. for Japan’s attack on Pearl Harbor. What chutzpah.
Meanwhile, while the Republicans are fiddling, Rome is burning. The stock market fell off a cliff: Dow -778, Nasdaq -200, S&P -107. And still, the fundamental, underlying issues have not been resolved.
Events seem to be spinning out of control.
© 2008 Michael B. Lehmann
Stunning. That’s the only word for it.
We all knew that the House Republicans were against the bailout. But we also thought their leadership had agreed to the deal and that the package would now go forward.
Instead, the House’s Republican leadership could not keep its members in line. They voted “no.” Then the Republican leadership had the audacity to blame Nancy Pelosi for the “no” vote. That’s like blaming the U.S. for Japan’s attack on Pearl Harbor. What chutzpah.
Meanwhile, while the Republicans are fiddling, Rome is burning. The stock market fell off a cliff: Dow -778, Nasdaq -200, S&P -107. And still, the fundamental, underlying issues have not been resolved.
Events seem to be spinning out of control.
© 2008 Michael B. Lehmann
Friday, September 26, 2008
The Triumph Of Ideology Over Common Sense
THE BE YOUR OWN ECONOMIST ® BLOG
The following op-ed appeared in today’s San Francisco Chronicle:
While congressional leaders continue to struggle to produce an agreement on the $700 billion financial bailout, now is the time to ask: How did we get into this predicament?
The Federal Reserve’s 2001 – 2003 expansionary policy – with its rock-bottom interest rates – triggered the real-estate boom. But lack of market regulation, oversight and supervision lies at the heart of the problem.
President Reagan said, “Government is not the solution to our problems. It is the cause of our problems.” The unarticulated corollary to that doctrine was: Unfettered markets are the best providers of goods and services. That’s true but, as we have seen, there are exceptions.
The Bush Administration and the Federal Reserve bet the ranch – and a lot of peoples’ homes – that the market could deal with all issues. Folks would borrow; firms would lend; houses would be built. No problem.
Federal regulators warned the administration and the Fed that lenders were encouraging borrowers to take on excess debt on terms they could not afford. But the administration and the Fed turned a deaf ear and hoped that rising real-estate values would save everyone.
When defaults and foreclosures began to rise, the administration and the Fed invoked the doctrine of moral hazard and said they did not wish to encourage risky behavior by assisting those that had loaned and borrowed recklessly. When financial institutions began to fail, the administration and the Fed rescued some but refused to help all.
Now we are at the end of the road. No more pretending. The market failed – and failed spectacularly. With the entire financial system on the verge of dysfunction, the administration and the Fed came forward with their rescue plan. Since they refused to provide the ounce of prevention, we now await the efficacy of the pound of cure.
What an irony that the administration and the Fed, whose free-market ideology abhorred regulation and warned against moral hazard, devised a bailout that entailed the greatest moral hazard in our nation’s history. We will, after all, rescue the lenders who brought about this massive crisis for $700,000,000,000. An unbelievable sum of money.
We are in this pickle because, from 2001 through 2008, the administration and the Fed let Ideology triumph over common sense. Government regulation may not always be the answer, but a little more of it would have helped.
© 2008 Michael B. Lehmann
The following op-ed appeared in today’s San Francisco Chronicle:
While congressional leaders continue to struggle to produce an agreement on the $700 billion financial bailout, now is the time to ask: How did we get into this predicament?
The Federal Reserve’s 2001 – 2003 expansionary policy – with its rock-bottom interest rates – triggered the real-estate boom. But lack of market regulation, oversight and supervision lies at the heart of the problem.
President Reagan said, “Government is not the solution to our problems. It is the cause of our problems.” The unarticulated corollary to that doctrine was: Unfettered markets are the best providers of goods and services. That’s true but, as we have seen, there are exceptions.
The Bush Administration and the Federal Reserve bet the ranch – and a lot of peoples’ homes – that the market could deal with all issues. Folks would borrow; firms would lend; houses would be built. No problem.
Federal regulators warned the administration and the Fed that lenders were encouraging borrowers to take on excess debt on terms they could not afford. But the administration and the Fed turned a deaf ear and hoped that rising real-estate values would save everyone.
When defaults and foreclosures began to rise, the administration and the Fed invoked the doctrine of moral hazard and said they did not wish to encourage risky behavior by assisting those that had loaned and borrowed recklessly. When financial institutions began to fail, the administration and the Fed rescued some but refused to help all.
Now we are at the end of the road. No more pretending. The market failed – and failed spectacularly. With the entire financial system on the verge of dysfunction, the administration and the Fed came forward with their rescue plan. Since they refused to provide the ounce of prevention, we now await the efficacy of the pound of cure.
What an irony that the administration and the Fed, whose free-market ideology abhorred regulation and warned against moral hazard, devised a bailout that entailed the greatest moral hazard in our nation’s history. We will, after all, rescue the lenders who brought about this massive crisis for $700,000,000,000. An unbelievable sum of money.
We are in this pickle because, from 2001 through 2008, the administration and the Fed let Ideology triumph over common sense. Government regulation may not always be the answer, but a little more of it would have helped.
© 2008 Michael B. Lehmann
Thursday, September 25, 2008
$100 Oil
THE BE YOUR OWN ECONOMIST ® BLOG
Today was a good day. Congress reached – or is close to reaching – agreement on the financial-rescue package. Most observers believe implementation of the package will have a salutary effect on the credit markets.
Better still, oil closed at $108 a barrel. That’s above a recent low of around $90, but well below its all-time high of about $140. Say we’re in the $100 range. That’s good news, too.
Maybe and maybe not. Oil fell because recession is systematically and systemically reducing demand for most goods and services. This is especially true for industrial commodities such as oil. Demand for and the prices of materials such as ferrous and nonferrous metals, cement, chemicals, wood products, textiles and oil surge during business-cycle expansions and drop during the follow-up recessions. The prices of these goods, which have relatively little value added, fluctuate dramatically.
(The prices of raw materials, with little value added, fluctuate more than the prices of finished goods, with a great deal of value added, because the value added – chiefly wages – fluctuates little. Therefore, price volatility varies inversely the degree of processing.)
Oil’s decline is a good sign that inflation will abate. But it also signals a weaker economy ahead.
© 2008 Michael B. Lehmann
Today was a good day. Congress reached – or is close to reaching – agreement on the financial-rescue package. Most observers believe implementation of the package will have a salutary effect on the credit markets.
Better still, oil closed at $108 a barrel. That’s above a recent low of around $90, but well below its all-time high of about $140. Say we’re in the $100 range. That’s good news, too.
Maybe and maybe not. Oil fell because recession is systematically and systemically reducing demand for most goods and services. This is especially true for industrial commodities such as oil. Demand for and the prices of materials such as ferrous and nonferrous metals, cement, chemicals, wood products, textiles and oil surge during business-cycle expansions and drop during the follow-up recessions. The prices of these goods, which have relatively little value added, fluctuate dramatically.
(The prices of raw materials, with little value added, fluctuate more than the prices of finished goods, with a great deal of value added, because the value added – chiefly wages – fluctuates little. Therefore, price volatility varies inversely the degree of processing.)
Oil’s decline is a good sign that inflation will abate. But it also signals a weaker economy ahead.
© 2008 Michael B. Lehmann
Wednesday, September 24, 2008
Ideology Has Its Price
THE BE YOUR OWN ECONOMIST ® BLOG
Many of us remember President Reagan’s favorite line: “Government isn’t the solution to our problems. It is the cause of our problems.”
There was an unarticulated corollary to that doctrine: Unfettered markets are the best providers of goods and services.
By and large that’s true. Markets do a good job with soda pop and software and many other goods and services.
But markets can’t supply us with public goods such as fire and police protection or Golden Gate Park. And markets often operate to give us things we don’t want, such as air pollution and global warming. Moreover, some markets require regulation and supervision, such as the production and dispensing of pharmaceuticals.
Yet the Reagan acolytes won the day: Less regulation triumphed over more regulation, and that included mortgage markets.
Now we are left with the $700 billion tab for their free-market ideology.
© 2008 Michael B. Lehmann
Many of us remember President Reagan’s favorite line: “Government isn’t the solution to our problems. It is the cause of our problems.”
There was an unarticulated corollary to that doctrine: Unfettered markets are the best providers of goods and services.
By and large that’s true. Markets do a good job with soda pop and software and many other goods and services.
But markets can’t supply us with public goods such as fire and police protection or Golden Gate Park. And markets often operate to give us things we don’t want, such as air pollution and global warming. Moreover, some markets require regulation and supervision, such as the production and dispensing of pharmaceuticals.
Yet the Reagan acolytes won the day: Less regulation triumphed over more regulation, and that included mortgage markets.
Now we are left with the $700 billion tab for their free-market ideology.
© 2008 Michael B. Lehmann
Tuesday, September 23, 2008
Bad Bet
THE BE YOUR OWN ECONOMIST ® BLOG
The Bush Administration bet the ranch – and a lot of peoples’ homes – that the market could deal with all problems. Folks would borrow; firms would lend; houses would be built. No problem.
Now we know that the market failed – and failed spectacularly.
But every step of the way – even when some called for more regulation – the party line was: “No regulation.”
Instead, as the crisis loomed, the administration doubled down and let the situation run: Bear Stearns, Merrill, Fannie & Freddie, Lehmann, AIG.
Now we’re at the end of the road. No more pretending. It’s bailout or bust.
Government regulation may not always be the answer, but a little more of it would have helped this time.
© 2008 Michael B. Lehmann
The Bush Administration bet the ranch – and a lot of peoples’ homes – that the market could deal with all problems. Folks would borrow; firms would lend; houses would be built. No problem.
Now we know that the market failed – and failed spectacularly.
But every step of the way – even when some called for more regulation – the party line was: “No regulation.”
Instead, as the crisis loomed, the administration doubled down and let the situation run: Bear Stearns, Merrill, Fannie & Freddie, Lehmann, AIG.
Now we’re at the end of the road. No more pretending. It’s bailout or bust.
Government regulation may not always be the answer, but a little more of it would have helped this time.
© 2008 Michael B. Lehmann
Monday, September 22, 2008
Ounce of Prevention vs. Pound of Cure
THE BE YOUR OWN ECONOMIST ® BLOG
The residential-mortgage market failed when millions of homeowners began having difficulty paying their mortgages, thereby imperiling mortgage lenders. That, in turn, imperiled our nation’s financial system because of the lenders’ important place in the system. Financial institutions grew reluctant to do business with one another because they mistrusted each others’ credit worthiness.
As financial markets began to freeze up, the federal government proposed that it borrow $700 billion and use those funds to purchase distressed mortgages from the lenders at prices that would preserve the lenders’ solvency. The federal government – already operating in a deficit – would go deeper in debt in order to purchase mortgages from lenders who could no longer collect on the debts owed them.
What an irony that an administration whose free-market ideology abhorred regulation and warned against moral hazard has now brought on the greatest moral hazard in our nation’s history by turning its back on the very regulation that could have prevented the mortgage-market’s failure.
Federal regulators warned the Bush administration that lenders were encouraging borrowers to take on excess debt on terms they could not afford. But the administration turned a deaf ear and hoped that rising real-estate values would save everyone harmless.
When defaults and foreclosures began to rise, the administration invoked the doctrine of moral hazard and said it did not wish to encourage risky behavior by assisting those that had borrowed recklessly. When financial institutions began to fail, the administration was forced to assist some but refused to help all.
Finally, when the entire financial system verged on dysfunction, the administration came forward with its rescue plan. Since the administration refused to provide the ounce of prevention, we now await the efficacy of the pound of cure.
© 2008 Michael B. Lehmann
The residential-mortgage market failed when millions of homeowners began having difficulty paying their mortgages, thereby imperiling mortgage lenders. That, in turn, imperiled our nation’s financial system because of the lenders’ important place in the system. Financial institutions grew reluctant to do business with one another because they mistrusted each others’ credit worthiness.
As financial markets began to freeze up, the federal government proposed that it borrow $700 billion and use those funds to purchase distressed mortgages from the lenders at prices that would preserve the lenders’ solvency. The federal government – already operating in a deficit – would go deeper in debt in order to purchase mortgages from lenders who could no longer collect on the debts owed them.
What an irony that an administration whose free-market ideology abhorred regulation and warned against moral hazard has now brought on the greatest moral hazard in our nation’s history by turning its back on the very regulation that could have prevented the mortgage-market’s failure.
Federal regulators warned the Bush administration that lenders were encouraging borrowers to take on excess debt on terms they could not afford. But the administration turned a deaf ear and hoped that rising real-estate values would save everyone harmless.
When defaults and foreclosures began to rise, the administration invoked the doctrine of moral hazard and said it did not wish to encourage risky behavior by assisting those that had borrowed recklessly. When financial institutions began to fail, the administration was forced to assist some but refused to help all.
Finally, when the entire financial system verged on dysfunction, the administration came forward with its rescue plan. Since the administration refused to provide the ounce of prevention, we now await the efficacy of the pound of cure.
© 2008 Michael B. Lehmann
Friday, September 19, 2008
Common Sense Triumphs Over Ideology
THE BE YOUR OWN ECONOMIST ® BLOG
It appears that the Bush Administration will let common sense triumph over ideology.
We hear no more talk of moral hazard and the evil of bailouts. It’s time to get to work.
If a homeowner has a $500,000 mortgage on a house whose value has fallen to $300,000, whoever holds that mortgage is in trouble. The homeowner can’t or won’t pay, and the mortgage-holder can’t realistically continue to value the mortgage at $500,000. It can’t be sold for more than $300,000, either.
A bailout will save the mortgage-holder by taking the mortgage off the holder’s hands for $500,000 while writing down the mortgage’s value to $300,000. That way foreclosure is avoided and the homeowner remains in the house.
The federal government, of course, must pay the $200,000 shortfall. Multiply that by all the distressed home-loans, and you can see why hundreds of billions of dollars may be needed.
The ideologs will be displeased. They’ll complain of moral hazard. But at least we’ll extinguish the fire before the neighborhood goes up in flames.
© 2008 Michael B. Lehmann
It appears that the Bush Administration will let common sense triumph over ideology.
We hear no more talk of moral hazard and the evil of bailouts. It’s time to get to work.
If a homeowner has a $500,000 mortgage on a house whose value has fallen to $300,000, whoever holds that mortgage is in trouble. The homeowner can’t or won’t pay, and the mortgage-holder can’t realistically continue to value the mortgage at $500,000. It can’t be sold for more than $300,000, either.
A bailout will save the mortgage-holder by taking the mortgage off the holder’s hands for $500,000 while writing down the mortgage’s value to $300,000. That way foreclosure is avoided and the homeowner remains in the house.
The federal government, of course, must pay the $200,000 shortfall. Multiply that by all the distressed home-loans, and you can see why hundreds of billions of dollars may be needed.
The ideologs will be displeased. They’ll complain of moral hazard. But at least we’ll extinguish the fire before the neighborhood goes up in flames.
© 2008 Michael B. Lehmann
Wednesday, September 17, 2008
Back in the Real World
THE BE YOUR OWN ECONOMIST ® BLOG
Rumors of a government fix for the mortgage crisis fueled today’s stock-market rally. It was a sigh of relief that Washington might finally deal with the root of the matter.
But even if the financial system does not freeze up, a recession continues to unfold.
Today the Conference Board announced (http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1) that its index of leading economic indicators declined again in August. This was the third decline in the last four months. The index, which now measures 100.8 (2004 = 100.0), is 2.7 percent below its year-ago level. Note, moreover, that the index is about where it was in 2004. The economy has stalled.
Earlier in the week the Federal Reserve reported (http://www.federalreserve.gov/releases/g17/Current/default.htm) a drop in industrial production and capacity utilization. Industry was operating at 81.2 percent of its maximum-rated capacity in August of 2007. Now that figure is down to 78.7 percent for August 2008. Factory output has fallen, and as a result industry is using a smaller share of its capacity. Expect business investment in new pant and equipment to contract as a result.
Also this week the Census Bureau said (http://www.census.gov/const/newresconst.pdf) that work began on 895,000 housing units in August, of which 630,000 were single-family and 251,000 were apartments. A year earlier those figures were 1.337 million and 968,000 and 332,000 respectively. Note especially the 30 percent decline in single-family starts.
With respect to the overall data, the chart below reveals that we need return to the 1990-91 recession for figures that are so anemic.
Housing Starts
(Click on chart to enlarge)
(Recessions shaded)
Finally, early in the month the Bureau of Economic Analysis reported 13.7 million motor-vehicle sales for August. Compare that to the 16.2 million of a year earlier and what you see in the chart below. It’s been 15 years since sales dipped consistently below 15 million.
New-vehicle Sales
(Click on chart to enlarge)
(Recessions shaded)
The economy is contracting. Calmer financial markets will not stop that trend.
(The charts were taken from http://www.beyourowneconomist.com/. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)
© 2008 Michael B. Lehmann
Rumors of a government fix for the mortgage crisis fueled today’s stock-market rally. It was a sigh of relief that Washington might finally deal with the root of the matter.
But even if the financial system does not freeze up, a recession continues to unfold.
Today the Conference Board announced (http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1) that its index of leading economic indicators declined again in August. This was the third decline in the last four months. The index, which now measures 100.8 (2004 = 100.0), is 2.7 percent below its year-ago level. Note, moreover, that the index is about where it was in 2004. The economy has stalled.
Earlier in the week the Federal Reserve reported (http://www.federalreserve.gov/releases/g17/Current/default.htm) a drop in industrial production and capacity utilization. Industry was operating at 81.2 percent of its maximum-rated capacity in August of 2007. Now that figure is down to 78.7 percent for August 2008. Factory output has fallen, and as a result industry is using a smaller share of its capacity. Expect business investment in new pant and equipment to contract as a result.
Also this week the Census Bureau said (http://www.census.gov/const/newresconst.pdf) that work began on 895,000 housing units in August, of which 630,000 were single-family and 251,000 were apartments. A year earlier those figures were 1.337 million and 968,000 and 332,000 respectively. Note especially the 30 percent decline in single-family starts.
With respect to the overall data, the chart below reveals that we need return to the 1990-91 recession for figures that are so anemic.
Housing Starts
(Click on chart to enlarge)
(Recessions shaded)
Finally, early in the month the Bureau of Economic Analysis reported 13.7 million motor-vehicle sales for August. Compare that to the 16.2 million of a year earlier and what you see in the chart below. It’s been 15 years since sales dipped consistently below 15 million.
New-vehicle Sales
(Click on chart to enlarge)
(Recessions shaded)
The economy is contracting. Calmer financial markets will not stop that trend.
(The charts were taken from http://www.beyourowneconomist.com/. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)
© 2008 Michael B. Lehmann
Moralizing Our Way To Financial Debacle
THE BE YOUR OWN ECONOMIST ® BLOG
The following op-ed piece appeared in Tuesday, September 16th's edition of the San Francisco Chronicle, before the collapse and federal takeover of AIG.
Monday’s financial meltdown brought an analogous parable to mind.
Suppose your local fire department sold cigarettes and bedroom furniture, but refused to fight fires caused by smoking in bed. When the fire fighters arrived at the blazing home of a bedtime smoker, they returned to the firehouse without extinguishing the blaze. Their rationale: Avoid moral hazard. Don’t reward bad behavior. Their reasoning: We sell cigarettes and beds. We don’t tell people to smoke in bed.
You can imagine the neighbors’ reaction as the blaze leaped from structure to structure and the entire block went up in smoke. The fire fighters might say, “We don’t want to encourage smoking in bed, so we won’t fight those fires.” The neighbors would say, “Extinguish the blaze now. Make the moral case later.”
This metaphor reminds us of the federal government’s handling of the housing debacle. Lehman Brothers and Merrill Lynch are the latest victims. Fannie Mae, Freddie Mac and Bear Stearns preceded them. Are Washington Mutual and AIG next? And this short list does not include the hundreds of thousand of homeowners hit by foreclosure or the millions more struggling with debts they can not repay. Nor does it mention growing unemployment as the consequent recession unfolds and the trillion dollars of federal deficit that will arise due to that recession.
Federal authorities initiated the real-estate boom by depressing mortgage interest rates. Then they exacerbated conditions by refusing to adequately regulate mortgage-lending practices. The result: An unprecedented and unsustainable increase in real-estate values egged on by greed, skullduggery and tomfoolery. Then, when the boom went bust and home prices began to collapse, the federal government declined to come to the rescue of borrowers and lenders that the authorities deemed unworthy. The authorities invoked the doctrine of moral hazard, saying they did not want to use taxpayers’ money to reward bad behavior. “No bailouts” became a rallying cry and assistance was restricted to those borrowers least likely to lose their homes.
But where has this moralizing left us? We have lurched from one crisis to another, and still there is no end in sight. Abandoned dwellings blight neighborhoods, depressing the value of nearby structures. Home prices continue to fall, tempting ever-larger numbers of owners to walk away and leave their unpaid mortgages in the banks’ hands. Financial institutions fall like dominoes, creating additional turmoil in capital markets.
Suppose, instead, that the federal government had moved early and aggressively to assist borrowers and lenders facing foreclosure. The federal government could have reimbursed lenders who wrote down distressed mortgages to affordable levels. Assistance could have been restricted to homeowners living in primary residences, thereby excluding speculators, multiple-home owners and vacation-home owners. A way could have been found – such as a means test – to exclude those who falsely claimed inability to pay.
This would have stopped the runaway foreclosures, permitted homeowners to remain in their homes and eased the stress in financial markets. Home prices would have fallen, but much of the collateral damage could have been avoided.
But what about the moral hazard? Wouldn’t this plan assist those who had borrowed foolishly and wouldn’t it aid institutions that had loaned unwisely? Yes it would, But keep in mind the federal complicity in the real-estate mania. And, speaking of undeserving, also recall that the federal government’s economic-stimulus package issued tax rebates to almost every one. Is it possible that some of those beneficiaries are no more deserving than the stressed homeowners and mortgage lenders?
The real-estate collapse was ground zero for the current economic crisis. We could have focused relief on its immediate victims – both borrowers and lenders - rather than spread the tax rebates to those unaffected by the real-estate collapse. This may have curtailed the debacle. Now the federal government faces massive deficits as the resulting recession unfolds. Perhaps those deficits could have been mitigated with a bailout that risked a little moral hazard.
© 2008 Michael B. Lehmann
The following op-ed piece appeared in Tuesday, September 16th's edition of the San Francisco Chronicle, before the collapse and federal takeover of AIG.
Monday’s financial meltdown brought an analogous parable to mind.
Suppose your local fire department sold cigarettes and bedroom furniture, but refused to fight fires caused by smoking in bed. When the fire fighters arrived at the blazing home of a bedtime smoker, they returned to the firehouse without extinguishing the blaze. Their rationale: Avoid moral hazard. Don’t reward bad behavior. Their reasoning: We sell cigarettes and beds. We don’t tell people to smoke in bed.
You can imagine the neighbors’ reaction as the blaze leaped from structure to structure and the entire block went up in smoke. The fire fighters might say, “We don’t want to encourage smoking in bed, so we won’t fight those fires.” The neighbors would say, “Extinguish the blaze now. Make the moral case later.”
This metaphor reminds us of the federal government’s handling of the housing debacle. Lehman Brothers and Merrill Lynch are the latest victims. Fannie Mae, Freddie Mac and Bear Stearns preceded them. Are Washington Mutual and AIG next? And this short list does not include the hundreds of thousand of homeowners hit by foreclosure or the millions more struggling with debts they can not repay. Nor does it mention growing unemployment as the consequent recession unfolds and the trillion dollars of federal deficit that will arise due to that recession.
Federal authorities initiated the real-estate boom by depressing mortgage interest rates. Then they exacerbated conditions by refusing to adequately regulate mortgage-lending practices. The result: An unprecedented and unsustainable increase in real-estate values egged on by greed, skullduggery and tomfoolery. Then, when the boom went bust and home prices began to collapse, the federal government declined to come to the rescue of borrowers and lenders that the authorities deemed unworthy. The authorities invoked the doctrine of moral hazard, saying they did not want to use taxpayers’ money to reward bad behavior. “No bailouts” became a rallying cry and assistance was restricted to those borrowers least likely to lose their homes.
But where has this moralizing left us? We have lurched from one crisis to another, and still there is no end in sight. Abandoned dwellings blight neighborhoods, depressing the value of nearby structures. Home prices continue to fall, tempting ever-larger numbers of owners to walk away and leave their unpaid mortgages in the banks’ hands. Financial institutions fall like dominoes, creating additional turmoil in capital markets.
Suppose, instead, that the federal government had moved early and aggressively to assist borrowers and lenders facing foreclosure. The federal government could have reimbursed lenders who wrote down distressed mortgages to affordable levels. Assistance could have been restricted to homeowners living in primary residences, thereby excluding speculators, multiple-home owners and vacation-home owners. A way could have been found – such as a means test – to exclude those who falsely claimed inability to pay.
This would have stopped the runaway foreclosures, permitted homeowners to remain in their homes and eased the stress in financial markets. Home prices would have fallen, but much of the collateral damage could have been avoided.
But what about the moral hazard? Wouldn’t this plan assist those who had borrowed foolishly and wouldn’t it aid institutions that had loaned unwisely? Yes it would, But keep in mind the federal complicity in the real-estate mania. And, speaking of undeserving, also recall that the federal government’s economic-stimulus package issued tax rebates to almost every one. Is it possible that some of those beneficiaries are no more deserving than the stressed homeowners and mortgage lenders?
The real-estate collapse was ground zero for the current economic crisis. We could have focused relief on its immediate victims – both borrowers and lenders - rather than spread the tax rebates to those unaffected by the real-estate collapse. This may have curtailed the debacle. Now the federal government faces massive deficits as the resulting recession unfolds. Perhaps those deficits could have been mitigated with a bailout that risked a little moral hazard.
© 2008 Michael B. Lehmann
Wednesday, September 10, 2008
Alternative Scenario
THE BE YOUR OWN ECONOMIST ® BLOG
Suppose your local fire department sold cigarettes, but refused to fight fires caused by smoking in bed. When fire fighters arrived at the blazing home of a bedtime smoker, they returned to the firehouse without extinguishing the blaze. Their rationale: Avoid moral hazard. Don’t reward bad behavior. Their reasoning: We sell cigarettes. We don’t tell people to smoke in bed.
You can imagine your neighbors’ reaction as the blaze leaped from structure to structure and the entire block went up in smoke. The fire fighters might say, “We don’t want to encourage smoking in bed, so we won’t fight those fires.” Your neighbors would say, “Extinguish the blaze now. Make the moral case later.”
This fable reminds us of the federal government’s handling of the housing debacle. Federal authorities initiated the real-estate boom by depressing mortgage interest rates. Private lenders exacerbated matters with their risky lending practices. Home prices soared. Then, when the boom went bust and home prices began to collapse, the federal government declined to come to the rescue of borrowers and lenders that the authorities deemed unworthy. The authorities invoked the doctrine of moral hazard, saying they did not want to use taxpayers’ money to reward bad behavior. “No bailouts” became a rallying cry. Assistance went to those borrowers least likely to lose their homes. Care was taken to punish the stockholders of distressed financial institutions.
But where has this moralizing left us? We have lurched from one crisis to another, and still there is no end in sight. Hundreds of thousands of houses are in foreclosure, and the number grows daily. Abandoned dwellings blight neighborhoods, depressing the value of nearby structures. Home prices continue to fall, tempting ever-larger numbers of owners to walk away and leave their unpaid mortgages in the bank’s hands. Financial institutions, from Bear Stearns to Fannie Mae, collapse or are placed in jeopardy. The US Treasury and Federal Reserve devise rescues, only to have them prove inadequate as matters worsen.
There is no doubt that home prices had to fall, destroying billions of dollars of real-estate value. That’s what happens when bubbles burst. Suppose, however, that the federal government had moved early and aggressively to assist almost all borrowers and lenders facing foreclosure. Assistance could have been restricted to homeowners living in primary residences, thereby excluding speculators, multiple-home owners and vacation-home owners. A way could have been found – such as a means test – to exclude those who falsely claimed inability to pay. Distressed mortgages could then have been written down to affordable levels and the federal government could have saved lenders harmless by paying lenders the difference between the loan’s original high value and the loan’s new low value.
This would have stopped the runaway foreclosures and permitted homeowners to remain in their homes. There would have been fewer abandoned and blighted buildings and fewer ravaged neighborhoods. That would have reduced the downward pressure on home prices and eased the stress in financial markets. Most importantly, homeowners would have been spared the tragedy of home loss.
But what about the moral hazard? It is true that, had the above plan been implemented, some of the undeserving would have been helped along with the deserving. So what? The federal government’s economic-stimulus package paid out tax rebates to almost every one. Why were those folks more deserving than the homeowners? If we are so concerned about taxpayers, why have we run massive deficits? Besides, collapsing residential real-estate markets were ground zero for the current economic crisis. We could have focused relief on these immediate victims rather than spread the payout to those unaffected by the real-estate collapse.
The housing debacle could have been alleviated early on with a massive federal program directed toward mortgage holders and lenders. The firefighters could have saved many homes from the conflagration. Instead, the federal government dithered and raised concerns about moral hazard. This permitted an unfolding crisis to turn from bad to worse.
© 2008 Michael B. Lehmann
Suppose your local fire department sold cigarettes, but refused to fight fires caused by smoking in bed. When fire fighters arrived at the blazing home of a bedtime smoker, they returned to the firehouse without extinguishing the blaze. Their rationale: Avoid moral hazard. Don’t reward bad behavior. Their reasoning: We sell cigarettes. We don’t tell people to smoke in bed.
You can imagine your neighbors’ reaction as the blaze leaped from structure to structure and the entire block went up in smoke. The fire fighters might say, “We don’t want to encourage smoking in bed, so we won’t fight those fires.” Your neighbors would say, “Extinguish the blaze now. Make the moral case later.”
This fable reminds us of the federal government’s handling of the housing debacle. Federal authorities initiated the real-estate boom by depressing mortgage interest rates. Private lenders exacerbated matters with their risky lending practices. Home prices soared. Then, when the boom went bust and home prices began to collapse, the federal government declined to come to the rescue of borrowers and lenders that the authorities deemed unworthy. The authorities invoked the doctrine of moral hazard, saying they did not want to use taxpayers’ money to reward bad behavior. “No bailouts” became a rallying cry. Assistance went to those borrowers least likely to lose their homes. Care was taken to punish the stockholders of distressed financial institutions.
But where has this moralizing left us? We have lurched from one crisis to another, and still there is no end in sight. Hundreds of thousands of houses are in foreclosure, and the number grows daily. Abandoned dwellings blight neighborhoods, depressing the value of nearby structures. Home prices continue to fall, tempting ever-larger numbers of owners to walk away and leave their unpaid mortgages in the bank’s hands. Financial institutions, from Bear Stearns to Fannie Mae, collapse or are placed in jeopardy. The US Treasury and Federal Reserve devise rescues, only to have them prove inadequate as matters worsen.
There is no doubt that home prices had to fall, destroying billions of dollars of real-estate value. That’s what happens when bubbles burst. Suppose, however, that the federal government had moved early and aggressively to assist almost all borrowers and lenders facing foreclosure. Assistance could have been restricted to homeowners living in primary residences, thereby excluding speculators, multiple-home owners and vacation-home owners. A way could have been found – such as a means test – to exclude those who falsely claimed inability to pay. Distressed mortgages could then have been written down to affordable levels and the federal government could have saved lenders harmless by paying lenders the difference between the loan’s original high value and the loan’s new low value.
This would have stopped the runaway foreclosures and permitted homeowners to remain in their homes. There would have been fewer abandoned and blighted buildings and fewer ravaged neighborhoods. That would have reduced the downward pressure on home prices and eased the stress in financial markets. Most importantly, homeowners would have been spared the tragedy of home loss.
But what about the moral hazard? It is true that, had the above plan been implemented, some of the undeserving would have been helped along with the deserving. So what? The federal government’s economic-stimulus package paid out tax rebates to almost every one. Why were those folks more deserving than the homeowners? If we are so concerned about taxpayers, why have we run massive deficits? Besides, collapsing residential real-estate markets were ground zero for the current economic crisis. We could have focused relief on these immediate victims rather than spread the payout to those unaffected by the real-estate collapse.
The housing debacle could have been alleviated early on with a massive federal program directed toward mortgage holders and lenders. The firefighters could have saved many homes from the conflagration. Instead, the federal government dithered and raised concerns about moral hazard. This permitted an unfolding crisis to turn from bad to worse.
© 2008 Michael B. Lehmann
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