Bailout

[David Farber <dave () farber net>]

Begin forwarded message:

From: John Levine <johnl () iecc com>
Date: October 5, 2008 6:48:51 PM EDT
To: dave () farber net
Cc: Brett Glass <brett () lariat net>
Subject: Re: [IP] Bailout

> Such a bill would have gone to the source -- bad real estate loans
> foisted upon homeowners by irresponsible lenders -- by doing
> everything possible to prevent the borrowers from having to default,
> thus salvaging as much of the value of those loans as possible. This
> would have helped both ordinary citizens -- by helping them to keep
> their homes and preventing a continuing downward spiral in real
> estate prices -- and the banks who held securities backed by those
> loans. ...

I'm sorry, but this is way too simplistic and misses some of the key
problems that make the financial situation so tough.  This is not to
deny for a moment the greed and excess that went on both in Wall St
and in banks in general, but it ain't just foreclosures.

The first key problem is that in a lot of the country, housing prices
are still unrealistically high.  Historically, housing prices have
tracked both rental prices and incomes pretty closely.  They track
rents because landlords have to pay their carrying costs from the rent
they charge, and they track overall income because in a sane market
the amount that people can pay for a house is limited by the mortgage
payment they can afford.  By these yardsticks, markets like San Diego
and Miami are still overpriced, and no matter what we might try to do,
they're going to drop until the fundamentals make sense again.

The second key problem is that there were a lot of irresponsible
borrowers to go with the irresponsible lenders.  Some of the people
facing foreclosure would be OK if their house were marked down to a
realistic price and the mortgage marked down to match, but the
no-documentation loans (NINJA, for No Income, No Job or Assets)
generally couldn't afford their houses under any scenario short of an
endless bubble.  Somehow we have to figure out how to tell these two
groups apart, and treat them differently.  I have no interest in
punishing people who got into houses they can't afford, but I'm
equally uninterested in providing them permanent subsidies to pay
their mortgages.

Finally, the problem that the bailout is facing in the short run is
not mortgage default, but bank liquidity.  If banks knew what the
houses underlying their mortgages were worth, and what the incomes of
the owners were, they could figure out what the mortgages were worth,
and there'd be a market for them.  But since at this point they know
neither, there's no market, banks don't know how much capital they'll
have left after it shakes out, and they don't dare make new loans to
anyone, no matter how creditworthy, which is making credit dry up.
This is bad news for the large and small businesses that routinely
depend on bank credit.  Try getting a car loan, for example.

So while it's quite true that we need to work on the underlying
mortgage mess, e.g., by allowing banks to rework mortgages where it
makes overall sense, even if the owners of some of the slices of them
don't like it, and by authorizing bankruptcy judges to modify
mortgages on primary residences, that's less urgent than getting the
credit markets working again, which is what last week's bailout does.

Incidentally, the press has done a dreadful job of reporting what the
$700G bailout actually is.  It's not a gift to Wall St, unless Hank
Paulson acts unusually stupidly.  It's basically a big bank to buy up
those unpriceable mortgages.  The plan is the Treasury buys a whole
lot of mortgage paper at a discount in return for cash, so the banks
now know how much money they have, then after it becomes possible to
figure out what the mortgages are worth, they sell them, quite
possibly at a profit.  The final cost will be way, way less than
$700G, and might even be less than zero.  See, for example, this
article by the well informed Bill Gross of Pimco:
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/23/AR2008092302322.html

Regards,
John Levine, johnl () iecc com, Primary Perpetrator of "The Internet for  
Dummies",
Information Superhighwayman wanna-be, http://www.johnlevine.com, ex- 
Mayor
"More Wiener schnitzel, please", said Tom, revealingly.




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