Email Rant February 2009

The danger of "we need to do something" is the assumption that we will do the right thing. Worse still is the assumption that Government will do the right thing. Government will never do the right thing because it is not in the best interest of politicians to do so. The motivations of politicians are completely disparate from individuals, companies, free markets and capitalism. Politicians/government focus on short-term, self-interested and politically expedient "solutions" to problems that invariable create bigger problems. Politicians can not actively claim credit for the benefits created by free markets. They can only claim credit when they "do something" regardless of the inevitable damage of such action.

The US has prospered in spite of a growing federal government over the past 100 years because capitalism, despite being restrained by government interaction, produced surplus economic benefit faster than they could confiscate it, redistribute it or destroy it. This is not inevitable and doesn't even appear particularly likely given our federal debt, proposed deficits, unfunded future liabilities, growing government intervention and institutionalized social programs.

Government can not be trusted and should be chained to the basement floor and beaten regularly.

Members of Our Government Are Propogating Self-Serving Lies

I am neither a Republican nor a Democrat. I revile the political class and despise the bloated Federal Government which both parties have created for their own enrichment. That said, I find myself especially disgusted by a self-serving fiction currently being manufactured by the Democrats in defiance of reality and the facts. Even worse, this fantasy is being used to attack the freedoms and economic system that made the United States the envy of the World.

Neither capitalism, nor George Bush, nor tax cuts caused our economic calamity. Congress created the Housing Bubble while pursuing the politically expedient, but disastrously misguided social agenda of increased homeownership for minorities and the poor during the 1990s. By overtly manipulating the lending industry, Congress proactively extended mortgage availability to people with poor credit, little capital and insufficient cash flow. It was a recipe for creating an inevitable economic disaster.

Today the uninformed and the politically expedient, including our current President, are weaving a self-serving narrative that bluntly ignores the facts. One can not attribute responsibility for the Housing Bubble without understanding what actually caused the crisis. The first order of business in making such a determination is to assess when the Housing Bubble actually began. The data necessary to isolate the economic distortions that contributed to the Housing Bubble are readily available.

While a detailed analysis of the predictable and inevitable excesses of capitalism during the latter years of the mania is interesting, an analysis of the root cause of the phenomenon is necessary to gain a real understanding of the Housing Bubble.

The Relevant Questions:

Why did subprime lending become so prominent?

When did subprime lending become material, begin to grow and why?

When did homeownership rates start to climb rapidly and set all-time records?

When did housing prices in bubble cities begin to appreciate more rapidly than inflation, more rapidly than the rate of income growth and begin to consistently accelerate?

For 30 years preceding the Housing Bubble homeownership rates had fluctuated within a band of 2% ranging between 63.5% and 65.5%. From 1985 through 1993 there was little variation in homeownership rates with the exception of annual seasonality.

The conclusion is simple. The U.S. economy structurally supports sustainable homeownership rates of approximately 64% to 65%.

So what happened in 1994 that caused homeownership rates to skyrocket from 64% to 69% over an 11 year period? Was it evil President Bush who was sworn into office in 2001? Was it his evil tax cuts for the rich? Was it even a bumbling Alan Greenspan who slashed interest rates during 2001? I attribute fault to both Bush and Greenspan, but the fact is that the Housing Bubble began in the early 1990s and was 7 years old by the time Bush became President. So if it wasn’t the soulless Republicans and greedy investment bankers who caused it, what did?

In 1994 the government began to aggressively implement social policy designed to provide mortgage availability to people who could not access homeownership which dramatically altered the market forces and inevitably influenced prices.

Congress through revisions to the Community Reinvestment Act forced lenders to make loans to uncreditworthy borrowers, minorities and in inner-cities. Congress further and inappropriately used its influence over the supposedly independent GSEs, Fannie Mae and Freddie Mac, to proliferate subprime lending. Fannie and Freddie were and are functional monopolies within the mortgage market. Any major lender or mortgage originator must have a relationship with the GSEs and is dependent upon Fannie and Freddie to exist and succeed. When Fannie and Freddie require lenders to make subprime loans, even when unprofitable to do so, lenders engaged in the activity as a cost of doing business.

By 1996, HUD was directing Freddie and Fannie to provide at least 42% of their mortgage financing to borrowers with income below the median in their area. In addition, HUD required Freddie and Fannie to provide 12% of their portfolio to “special affordable” loans. Those are loans to borrowers with less than 60% of their area’s median income. These government-directed expenditures represented a huge sum of money allocated to subprime lending and presented an extraordinary profit opportunity to mortgage originators with fee-based revenue models.

With artificially increased availability of and demand for mortgages, housing prices began to rise.

Unsustainable, inflation-adjusted housing appreciation began around 1996, accelerated consistently and persisted until 2005.

The housing industry is a slow moving market. Price moves lag changes in market conditions, sales volumes and other price determining forces. Sales volumes and homeownership rates had been rising for two years before prices started to move dramatically. This lag closely parallels what we have seen since the peak in 1995. Sales transaction volumes crashed in 2005 and 2006 but house prices didn’t begin to collapse until the end of 2007 and 2008.

The Case-Shiller Home Price Index and Annualized Appreciation charts above demonstrate that prices began to rise broadly and unsustainably on an inflation-adjusted basis in 1997.

Any genuine analysis of national housing appreciation rates or of most local markets which defined the Housing Bubble definitively demonstrates that the phenomenon manifested itself between 1994 and 1997. National and city-specific prices began to rise during this period after having stagnated for years. Price appreciation began to outpace inflation and accelerated uniformly until the Housing Bubble hit the wall in 2005 and 2006.

Those individuals who focus solely on the abuses and excesses at the tail-end of the Housing Bubble are missing the point. Analysis of the mania-portion of the bubble ignores the forces that created it. Those people who want to blame free-markets or capitalism for our woes are misguided.

Capitalism and the free markets do not operate with an agenda. They simply exist within and react to the environment. The United States consists of hundreds of millions of self-interested individuals and companies making trillions of daily decisions about how best to utilize scare time, capital and resources. And in doing so our economy as a whole functions as efficiently as any system ever has. There is nothing immoral or nefarious about this process and it doesn’t inevitably lead to the excesses we witnessed during the mania.

The immoral, abusive and excessive activities were predictable given the environment that the Government created within the housing industry. The Housing Bubble was not created by capitalism, greed, President Bush or tax cuts but was in fact the inevitable result of efforts to achieve a social agenda through government manipulation within the economy.

Sadly, the Democrats are being allowed to divert responsibility for our Global Economic Depression to the free-markets as a justification for even greater government intervention, regulation and manipulation. It is once again inevitable that the result will be disastrous.

Email Sent November 24, 2008

You consistently demonstrate far more insight into the crisis than any of our policy makers. Capitalism, free markets, market determined prices and Libertarianism are about the only things you can depend on in the world of economics and politics.

The car companies were destroyed by the government. Unions created unfunded pension liabilities that add thousands of dollars to every car. Union workers earn $75 an hour versus the Japs in the South who pay $48 an hour. Then the fuel restrictions and Green aspirations of the Congress have created an environment where they don't have a chance. There is no reason why we need 3 or even 2 car companies in this country. Not to mention if there is a need more will spring up. Saturn.

All the Wall Street prosperity of the last 5 years was a false house of cards, yet lots of people made lots of blood money. Plenty of bonuses will still be paid, but no where near the zenith.

You mention that the car companies can barely operate in good times. Our entire economy has been geared over the past decade to operate in an expanding credit environment and an economic bubble. Entire industries have been built to only work during "great" times. 10 years ago there wasn't a single $1 billion casino in Vegas. Today around 10. Restaurants have proliferated as people had money to eat out. Malls have grown at an unbelievable rate as cheap, easy money and aggressive developers built them everywhere. Condos, houses. The car companies have sold to everyone who might have ever wanted a car with Zero percent down offers. etc.... All of this will reverse itself. 2009 will be a year of massive bankruptcies in anything to do with retail or consumer.

Every sizeable action taken to date by the government has accomplished nothing and likely made things worse. The primary reasons:

Govmt. refuses to recognize that it was their intervention which caused the bubble and has triggered the catyclism. If you don't understand the cause how can you fix it?

Govmt. does not understand the law of unintended consequences. The Bear bail-out caused Lehman to not raise money because they thought access to govmt funds was enough. Private equity wouldn't invest in Fannie/Freddie because they didn't know the terms of a govmt bail-out. TARP has every city, state, company, industry, etc... lining up for handouts. Insurance companies are buying banks to get free money. Healthy companies are accepting money because they don't want to appear too weak to qualify. AmEx turned into a bank. Govmt actions simply distort the market and make thigs worse because the free market way is always best.

Govmt can't do nothing. It isn't in there nature and it isn't politically viable. We would be better off with nothing, but the politicians need to appear to be trying to help.

The stimulus checks did nothing as employers recognize that they are one-time events and that things will get worse. And who benefitted from the checks? The Chinese who made the goods.

Obamas giant 2 and 1/2 year stimulus plan resembles FDR. Unfortunately building bridges accomplishes nothing. As you know WWII got us out of the great depression as the entire manufacturing industry started to supply the allies in a massive way. Then 11 million men were pulled out of the economy but still needed to be supplied.

The ONLY thing that will work is unfettered capitalism. Let the markets clear. And slash taxes on EVERYTHING. Sustainable opportunities to form capital, make investments, build businesses are the key, not govmt direction.

The really scary one is that govmt appears intent on trying to prop up housing prices or delay inevitable foreclosures, which will drag this thing out.

Foreclosures Are Not the Problem

The Obama administration appears to have focused on promoting a single idea as their justification for overt efforts to avert foreclosures through government intervention, homeowner bailouts and direct mortgage subsidies. This stated rationale is that foreclosures should be prevented at all cost because when they occur these transactions injure all Americans by lowering the value of neighboring properties. The argument is that good citizens, who are paying their mortgages, didn’t borrow more than they could afford, didn’t buy overvalued houses and didn’t take out home equity loans, should be forced to bail-out bad citizens who did because it is actually in their best interest to do so.

This is a pathetic proposition. This same logic could be applied to price moves within all markets that have ever existed. Each time a seller accepts a low bid in any market transaction every other owner of that particular stock, bond, commodity or other asset is injured as the market price has dropped.

The stock market is presently down close to 50%. Why doesn’t the President’s administration bail out the stock market and actively attempt to prop up prices? Recent stock sales have been forced by similar themes as are driving foreclosures. Positions are being liquidated over fears about the future, concerns about risk, liquidity requirements, the damage of already realized losses, collapsing portfolio values, job losses, bankruptcies, worries over adequate retirement funds, 401k losses, margin calls and liquidating hedge funds. Yet each time Citigroup’s stock ticks lower by a penny, driven by a single transaction which lowers the bid, tens of millions of Americans are directly injured. How is it that we understand that it is ridiculous to attempt to set prices in financial markets, yet we are willing to overtly meddle in the housing market in an attempt to prop up values?

Beyond the flawed logic, it is laughable that these same sanctimonious politicians did not decry the identical, and equally damaging, phenomenon while prices were rising. Every time some fool, dullard, speculator, optimist, con-artist or little old lady purchased a home at a higher than market price, the valuations of all comparable and neighboring houses increased in value. This phenomenon was extraordinarily dangerous as it created a Housing Bubble, dramatically distorted economic activity and gestated the conditions necessary to collapse our economy, yet none of the government entities that were contributing to the problem and are now attempting to prop up housing values complained or protested as prices rose dramatically and homeownership rates increased. It is morbidly amusing how quiet the political class is when unsustainable economic phenomenon serves their purposes by increasing tax receipts and perpetuating the impression of false prosperity. By their stated logic and deafening silence, I conclude that the government’s position is that the housing market should only be allowed to go up. When housing prices rise everyone benefits, which is great, but when prices fall everyone gets hurt which must be resisted with government intrusion and price fixing?

And while it is convenient to argue for the greater good in justifying the manipulation of prices, I argue that “everyone” is not injured by falling prices. In fact lots of people were directly injured by rising prices and are only now benefiting by a return to rationality. Think about the 35% of Americans who don’t own homes? As prices fall these people directly benefit from the availability of increasingly affordable housing. What about the children of 100% of Americans who will directly benefit from reasonably priced housing? I personally have never owned a house because the value proposition never made sense and the financing mechanisms being employed to purchase overvalued houses were the equivalent of gambling at best and financial suicide at worst. I am thrilled by falling house prices. Now I am being forced to subsidize an effort to prop up housing prices, which will fail but be extraordinarily costly, in an effort to keep housing prices unaffordable?

As real estate transactions go, the fact is that foreclosures are the hero of our story. These transactions rapidly force housing prices towards sustainable valuations based on new market fundamentals. They force the market to clear. Before foreclosures proliferated housing transaction volumes had collapsed because sellers had not come to terms with changed market conditions. Foreclosures extricate owners from bloated mortgages they can’t afford and allow lenders to resolve non-performing loans. Anyone who can afford a mortgage on an overvalued house can, by definition, afford rent on an equivalent property while saving money in the process. Those people who could never have afforded their mortgages, should never have been able to buy a house, and will be better off renting something they can afford. The government’s efforts to postpone inevitable foreclosures are not doing anyone any good.

The villainous transactions in this ongoing narrative are numerous and include house purchases which were consummated due solely to the government-mandated availability of subprime mortgages, transactions funded with little or no down payment, transactions which were affordable only due to introductory teaser rates which would adjust over time, transactions affordable using negative amortization mortgages, transactions which were purely speculative and transactions which were frauds executed to steal money from lenders. These are the transactions which should be demonized.

Whether the current administration wants to become self-aware or not, the market will solve this problem regardless of the interests of the political class. Housing prices will eventually reflect the reality of market conditions despite attempts to delay foreclosures and prop up housing values.

And the Insanity Continues…

We have a new entrant in the competition for most insane and economically devastating event perpetuated by the Government in what is a Government-created, global economic disaster.

A quick review of a few of the other nominees includes:

• Banning shortselling
• Blaming speculators for the Federal Reserve created oil bubble
• Forcing Fannie and Freddie, while on the verge of collapse, to increase lending in an absurd and suicidal attempt to prop up housing
• Pressuring banks to increase lending in an environment that any sane, profit-seeking entity would be tightening lending standards
• Believing that Stimulus Checks would stop the economic collapse

Christopher Dodd’s last minute addition to the “Stimulus” Bill of retroactive compensation limits on bailout recipients is truly unconscionable and will have devastating effects. This proposal is immoral, unconstitutional, smacks of command economy aspirations and should be a stark warning to every entity beholding to the Federal Government.

Would these companies have accepted money from the Treasury if they knew that Congress could arbitrarily change the terms of the agreement and dictate to recipients how they ran their businesses? Why would any company going forward take a dime from the U.S. government if Congress can arbitrarily change the terms of that arrangement and burden the recipient with any debilitating restriction it feels is politically expedient? Only failed entities, that should cease to exist, will be willing to accept such partial-nationalization.

This is a warning to every State in line to receive Stimulus or Federal assistance. Why couldn’t the government 9 months from now order each state to close its coal power plants, cease off-shore drilling, provide universal healthcare or any other preposterous and economically disastrous policy.

What about all those people who received Stimulus Checks last year. Why can’t the government place unreasonable burdens on those recipients? Why not mandate that each buy an electric car, join a union or register as Democrats? Think of all the people receiving foreclosure assistance. I recommend that Senator Dodd confiscate/nationalize each and every one of these homes as a lesson to these sycophants.

Senator Dodd demonstrates a complete lack of understanding of how our finance industry functions and how executives are compensated. He also exhibits a fantastical disconnection with reality. Dodd’s proposal will accomplish nothing positive. Companies will figure out ways around the limits. Should the government prevent this and until Congress freezes all pay and locks employees into their present positions, (which once seemed far fetched) good executives will simply depart their jobs for private sector destinations not beholding to the Government.

The Stimulus Bill Will Fail... Again

The Stimulus Bill will not work because it can not work. Anyone who truly understands what is transpiring in the economy will recognize that this is the largest, single instance of waste in the history of the World.

An economic overview:

• Overvalued assets are returning to equilibrium prices based on dramatically different market conditions.
• Dramatically excessive and inappropriate leverage attached to individuals, corporations and government entities is being resolved through lengthy pay-downs or restructured through bankruptcies and foreclosures.
• Consumer spending, which was distorted by excess liquidity, credit availability and a Housing Bubble, has collapsed because it was unsustainable.
• The Savings Rate, which was also unsustainable, is returning to some reasonable level. Increased savings, while positive for the long term, will continue to crush an economy overly dependent on consumer spending and geared for unsustainable growth.

Spending huge sums of money that we don’t have, burdening our economy with the liability of having to service and repay another trillion dollars of debt, all to create a few government dependent jobs which produce no real economic value will do nothing to alleviate any of the economy’s problems. What it will do is distort the economy further, obscure what is really transpiring, slow down the economy’s inevitable reset, deepen the economic crisis and threaten the US Government’s solvency and credit rating.

The argument being advanced is that we MUST pass the Stimulus Bill NOW or we face DISASTER. They have it backwards. Every major government initiative to date has made things worse not better. Yet, even though each program has failed, policy makers advance the factually incorrect and cowardly explanation that “Things Would Have Been Worse” without government action.

• The Federal Reserve slashed interest rates in an uncoordinated fashion causing massive volatility, devaluing the dollar and creating an oil bubble that undermined consumer confidence. The economy imploded anyway, yet policy makers argue that “things would have been worse”.
• Congress mailed out Stimulus Checks to low income Americans arguing that this was EXACTLY what the economy needed. This was the stimulus which would stop the slide and lead to a rapid recovery. The initiative was a total failure, accomplished nothing but to increase the deficit yet backers argue that “things would have been worse”.
• The Treasury argues that without a $700 Billion TARP plan to buy up toxic assets IMMEDIATELY the global financial system would collapse. Congress didn’t pass it immediately and the Treasury wasted the money on a totally different boondoggle. The global economy has continued to worsen.
• The government has instituted a myriad of misguided programs designed to forestall foreclosures. Each is designed to help homeowners and stabilize the housing industry. All have failed dramatically but in doing so have slowed down the inevitable collapse of housing prices.
• Now the Stimulus Bill is the “right size” and “exactly what we need” to stabilize the economy. When it fails policy makers will argue that “things would have been worse”. They can always argue that things would have been worse! This is an intellectually vacant argument based on faith not fact.

There are a number of smart people who predicted the current financial disaster. These people have credibility. The policy makers who created our troubles and were oblivious to their impending manifestation have none. Prognosticators who understand what is transpiring have consistently pointed out that the government’s initiatives would fail and make things worse. These people have correctly predicted the future based on a dynamic understanding of the facts, and yet they are ignored. The politicians who have only been consistent in being wrong are allowed to continue to make extraordinary policy errors, are not held accountable for their mistakes and every time they are proven to be wrong they argue their own self-importance by advancing the notion that “things would have been worse”.

Things will get worse. This is inevitable. No government initiative designed to distort economic activity, prop up prices or encourage a return to unsustainability amongst consumers will work.

Congress Just Stopped Housing Sales

The senate just passed a version of the so-called Stimulus Bill that includes a $15,000 tax credit for anyone who buys a house. The House version includes a different but compelling incentive for home purchasers. The final form of the Bill will be ironed out by misguided politicians in the weeks to come.

These kinds of attempts at price fixing are always disastrous. The government continues to overtly attempt to prop up housing values at levels that are above equilibrium rates given market conditions. Such efforts will fail and inevitably result in unintended consequences and distortions, but that is another analysis.

I feel badly for Americans who do not possess the wherewithal to understand that a $15,000 tax credit isn’t worth much when you lose $100,000 on a home purchase. Caveat Emptor!

The important thing to understand is that housing sales just stopped. Anyone who can read a newspaper, watch TV or has internet access and is considering a home purchase just put their ambitions on hold. A $15,000 tax credit has value. It is certainly worth waiting for. If you buy a house today you might not qualify for this advantageous treatment. By creating the expectation of a tax savings in the future, Congress just canceled or delayed all pending and contemplated home sales until such a time as the Stimulus Bill is completed.