The Language of Love

I think they should all wear circus clown suits as an official uniform. Just imagine Paulson saying those things with poofy orange hair, a little top hat,a big red nose, and painted tears leaking from his eyes. Bush's speech was a real crack-up, too.

 

Poor lending standards are merely a proximate factor in our current predicament, not the ultimate. I'll attempt to give an incomplete and very abbreviated sequence of events which led to this point and maybe show why creating and enforcing mortgage lending regulations are like putting a band-aid on a bullet wound in your chest. And if you didn't have the bullet wound, you wouldn't need the band-aid.

 

In 1995, the US bailed out the Mexican economy and Mexican bond holders. The Mexican crisis followed the massive credit expansion in the country from 1988-1994.

 

The Reverse Plaza Accord of 1995 reversed the Plaza Accord of 1985. The Plaza Accord was an agreement by the G-5 to subsidize US exporters by artificially lowering the exchange rate of the dollar against the Yen and the Mark and thereby improving the profitability of US manufacturing. However, by 1995, Japanese manufacturing firms were faltering and many Japanese banks were facing insolvency.

 

Instead of obviously bailing out another country in crisis, the Reverse Plaza Accord basically reversed the previous agreement and in effect subsidized American consumers' purchases of Japanese and German manufactured goods. This was accomplished by lowering Japanese interest rates and by huge purchases of instruments such as Treasury bonds by Japan, Germany, and the US in order to increase the exchange rate of the dollar against the Yen and the Mark. This,in effect, allowed the US to pursue inflationary monetary policies (credit expansion) during the late nineties without a rise in CPI figures, due to the suppression of prices levels by the artificially low prices of imports.

 

The Bank of Japan cut its discount rate to 0.5% which created guaranteed profits by borrowing Yen at the low rates, then bringing the money to the US market to reinvest at a higher yeild. Also, other Asian governments were now purchasing much larger quantities of US government securities.

 

At the same time, tech IPOs starting with Netscape were popping up and literally making people extremely rich overnight. It was not uncommon for these offerings to double on their first day of trading. It was this historical contingency that drew so much of the credit expansion into the dot-com boom.

 

The Fed started cutting interest rates in July and kept them relatively low throughout the late Nineties despite the fact that the Fed had met its goal of 'full employment' (5-6% unemployment). One of the justifications for doing so was that the computer revolution had made labor so much more productive and therefore increased labor demand to point that it dropped the full employment rate much lower. It had supposely also ushered in some kind of new economic evolution which made old economic principles obsolete and allowed for the simultaneous achievement of low interest rates, low inflation, low unemployment, and sustainable economic growth without any busts. Greenspan even came up with some simplistic function that was supposed to empirically prove and mathematically necessitate the point.

 

Many East Asian companies who has pegged their currencies to the dollar were now being affected by the Reverse Plaza Accord by making it increasing difficult to compete with the Japanese competitors being subsidized by the agreement. By pegging their currencies, they were actually helping to pay their competitor's subsidies. However, unpegging the currencies would cause these currencies to drop against the dollar and thereby magnify the cost of their debt to the US and negatively affect credit. The end result when they eventually unpegged was a reversal from $93 billion of capital flowing in to the region to $12 billion of capital flowing out of the region during the course of 1997.

 

In 1998, Russia defaulted on its debt, much of it held by US investment banks. Brazil had its own financial crisis and the Y2K scare really started rolling. When the Long-Term Capital Management hedge fund in the US started to fail, the Fed reacted with three consecutive rate cuts, one of which was announced between Fed meetings at a finacially strategic point in time in regards to stock options, which I won't discuss. The Fed also prompted GSEs like Fannie and Freddie to drastically start stepping up their borrowing and lending activities. The rate of increase of MZM (a measure of money supply) was 15% in 1998 compared to about 2.5% just a few years earlier. It hit over 20% in 2001.

 

In 1999 alone, the NASDAQ Composite (the primary stock exchange for tech firms) rose more than 80%. By 2000, the personal savings rate was negative... something unprecedented in the previous half century. This meant that regular consumers were spending more than they earned by relying on credit. The essence of this is that people were consuming future wealth; foregoing future consumption for immediate consumption. Debt as a proportion of personal disposable income was 97%. In the absence of savings, all credit must be produced by the creation of new quantities of fiat money or fiduciary media.

 

In less than six month during late 1999 and early 2000, the NASDAQ rose 83%. During this time, the pinnacle of Y2K, the Fed engaged in money pumping sufficient enough to deviate the Federal Funds Rate from its target of 5.5% to below 4%. More than 50% of new mortgages had less than a 10% down payment and mortgage refinancing into lower interest rates became almost rampant.

 

After Y2K turned out to be a non-event, the Fed started to increase its rates to try to bring the credit frenzied market under control. However, with negative savings and a market with its foundation in a long streak of constantly accelerating credit expansion, this was obviously the needle in a very large balloon. Many tech companies riding this wave were completely invalid and had no real way of generating a real profit, except when credit was pouring in; something supposedly assured by the "New Economy" - the 90's version of the New Plateau of Prosperity of the 20's.

 

In 2001, facing yet another crisis brought on by the Dot-Com bust along with the September 11th attacks, the Fed started dropping the Federal Funds Rate back down from 6% to 1.75% over the course of that year. The Fed kept it under 2% until December 2004. Consumer spending was supported by massive mortgage refinancing, home equity lines of credit, and zero interest auto loans. Take a look at these articles from 1999 and 2001:

 

http://query.nytimes.com/gst/fullpage.html...75AC0A96F958260

http://query.nytimes.com/gst/fullpage.html...752C1A9679C8B63

 

If you want to see the source of our current crisis, look no further.

 

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

 

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

 

"Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements," said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. "Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market."

 

I can boil this all down into something very simple: Intervention -> Boom -> Unintended Consequences -> Crisis -> Intervention -> Boom -> Unintended Consequences -> Crisis -> Intervention -> Boom -> Unintended Consequences -> Crisis -> and on and on until everything is eventually nationalized. The housing boom was the means of recovery from the Dot-Com boom. If you want to take the time to study this, you can go all the way back to the inception of the Federal Reserve in 1913. There is no fix other than letting the system fail now and suffering the harsh consequences, or continuing the same cycle of postponement and ultimately suffering much harsher consequences. In an election year, the former is never an option.

 

A good metaphor would be a heroin junkie. He can quit now and go through a very hard time as he withdraws and rebuilds his life, or he can keep going for that next fix and eventually put himself in the grave and affect the lives of everyone around him. We 'need to' pass this bailout plan just like a junkie 'needs to' get more smack. We know its not good, but we can't keep going on the same way without it. I believe a system with a commodity currency like gold AND a 100% reserve requirement on demand deposits (something that has always been absent from our economy, but was an established legal principle in Rome) would spell the end of this crap. No artificial credit expansion through fiat currency printing and risky fractional-reserve banking, no massive-scale malinvestment, and no need for deposit insurance.

 

If you want to read something interesting take a look at Ron Paul's address to the House Financial Services Committee on September 10, 2003. Here is the proposed act, which died immediately. Think about what you were doing in 2003... at least one person had the foresight and principles to try to prevent this.

Either I'm tired, or I'm just not getting what exactly Paul's bill intended. I get that it keeps the federal government from bailing out Fannie and Freddie and any GSEs either by giving them money directly or by buying their debt obligations, which is basically what just happened. But what does repealing state tax exemptions do? That's the part I'm not understanding as being good, bad, or indifferent.

 

Either way, yes, I agree that these issues we're having now are not just recent, and really I wonder how much of it is a continual ebb and flow of any major economy. Human beings tend to think of the 'now' and focus on the present, and don't always look at the history of their culture with perspective, often forgetting that everything goes up and down, so to speak.

 

I wonder if now that we are a society which relies so highly on credit, if these hiccups will force people to re-think their lives. I mean, people say that they do, but then wallow in self-pity and self-guilt, and don't always really change. Too many that I know have gotten into financial trouble because of over-extended credit, somehow dig themselves out of debt, only to repeat the mistakes of the past. Something tells me that this type of crisis will happen again, and the financial Chicken Littles will be out again.

 

Also, I just get so sick and tired of rhetoric that is meant to be apologetic or even sympathetic, and instead shows nothing but ignorance. I purposely avoided Dubbya's speech--I refuse to listen to another word that man utters again--but I know the gist of what he said. It wasn't any better than Paulson and Bernake. What is warming my heart a bit is that Congress isn't just jumping to the line and passing this without thinking; they're talking about putting caps on golden parachutes, helping home-owners, and the like. They're looking for a type of methadone, I guess, and I just hope they can find it.

Actually it would have stopped the Fed from pumping credit into these GSE institutions which the government itself had urged to expand sub-prime lending. It would have effectively put the brakes on the housing bubble in 2003 and caused a long overdue corrective recession (provided that the Fed didn't find a way to blow up another bubble).

 

The tax exemption concerns this clause of the Federal National Mortgage Association Charter Act:

The corporation, including its franchise, capital, reserves, surplus, mortgages or other security holdings, and

income, shall be exempt from all taxation now or hereafter imposed by any State, territory, possession,

Commonwealth, or dependency of the United States, or by the District of Columbia, or by any county, municipality,

or local taxing authority, except that any real property of the corporation shall be subject to State, territorial, county,

municipal, or local taxation to the same extent as other real property is taxed.

It's intended to eliminate an additional corporate subsidy in the guise of an exemption of all forms of local taxation. The exemption also helped insulate the corporation from anything but Federal influence. The act was basically design to strip all government largesse and special privileges from these pseudo-government institutions because they were being used as tools to channel the credit expansion into the housing market. The government now directly controls these institutions.

 

There will be no choice but to rethink our lifestyles because our standards of living are going to take a few steps back, until we learn to get it right. With these bailouts and the sequence of events that they will unwind, the value of your money is going slip away like sand.

WaMu becomes biggest bank to fail in US history

 

Isn't that your bank, Magistra? Huh, serves them right for not returning your camera to you.

 

-- Nephele

Heh yes, it is...but like I told the Chicken Little I work with the other day, it's not anything I'm worried about. I don't have enough money anywhere, let alone in WaMu, to worry about! I guess it means that in the coming months I'll have a new account, but it's all good.

It's intended to eliminate an additional corporate subsidy in the guise of an exemption of all forms of local taxation. The exemption also helped insulate the corporation from anything but Federal influence. The act was basically design to strip all government largesse and special privileges from these pseudo-government institutions because they were being used as tools to channel the credit expansion into the housing market. The government now directly controls these institutions.

 

Now I got it...and, yes, what a difference it would have made!

 

There will be no choice but to rethink our lifestyles because our standards of living are going to take a few steps back, until we learn to get it right. With these bailouts and the sequence of events that they will unwind, the value of your money is going slip away like sand.

 

Interesting article on BBC which notes that the French economic society might be a model for both the US and the UK: don't spend what you don't have, and even the credit cards are set up that way. I'm not saying that the French have it right, but it's certainly something for most to think about.