I recommend "Are the banks in trouble?", written by Mike Whitney for the Online Journal. This piece offers details on the phenomenon that has us all worried: The banking system's precarious balance atop a mountain of "assets" which are really nothing more than bad loans.
The situation resembles the infamous "Mississippi bubble" which occurred in France in the early 18th century under John Law. In that case, the financial system rested on imaginary gold thought to line the banks of the Mississippi river. In the present instance, the system rests on the imaginary ability of Burger King schlubs to pay the mortgages on $400,000 homes.
What can we do about the problem? The very idea of a government bail-out galls -- yet what other choices do we have? Even so, I doubt that any bail-out will suffice.
6 comments:
The best site covering the housing bust that I have seen is patrick.net. That site frequently links to a blog called globaleconomic analysis. The problems are not only in the mortgage markets according to what I have read.
This problem cannot be contained because (a) there's simply not enough Fed money they can throw at it to make it go away; and (b) the credit issues extend into other parts of the market other than mortgages. Here's what's happening in the US housing market right now. Here's the ARMS charts. All these worthless mortgage funds have to get their loans renewed later this year and onwards but no-one is going to lend them the money. They're going to the wall and their big bank affiliates will face multi billion dollar liabilities.
The serious commentators are talking about a global credit crunch. As Henry Liu says:
On the pages of Asia Times Online over the past two years, I have tried to put forth the rationale for the inevitability of a US housing bubble burst, pointing out reasons that the resultant financial meltdown will be much more widespread and severe than has been generally acknowledged.
Through mortgage-backed securitization, banks now are mere loan intermediaries that assume no long-term risk on the risky loans they make, which are sold as securitized debt of unbundled levels of risk to institutional investors with varying risk appetite commensurate with their varying need for higher returns. But who are institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages.
When a homeowner loses his or her home through default of its mortgage, the homeowner will also lose his or her retirement nest egg invested in the securitized mortgage pool, while the banks stay technically solvent. That is the hidden network of linked financial landmines in a housing bubble financed by mortgage-backed securitization to which no one until recently has been paying attention. The bursting of the housing bubble will act as a detonator for a massive pension crisis.
Stephen Roach, Morgan Stanley's chief economist, on April 24 of this year wrote that a major financial crisis was in the offing and that the ability of global institutions to forestall it -- ranging from the IMF and World Bank to other mechanisms of the international financial architecture are "utterly inadequate". (See also here and here.)
Think 30% off the stock market and house prices, rampant inflation and unemployment and a devalued US$. Then go from there.
Hi Joseph,
The current liquidity crisis is one of those stories that both the mainstream media and alternative media are almost fated to get wrong, simply because it is a technical subject about a closed world to most people. In a former life, I used to design and draft trust instruments for asset backed securities, and I wrote a little primer about how they work here, at DemocraticUnderground:
http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=389&topic_id=1561876&mesg_id=1561876
The one thing most commentators are getting wrong is the idea that asset backed securities were "risky" and based on "bad loans." The opposite is true, and that's why there is a crisis. First it's important to understand that banks have always accounted in a way opposite to the way other businesses do. There is nothing wrong with a bank having a "mountain" of loans as assets. It's always been that way. The accounting joke/cliche always was that for a bank, a loan is an asset; a deposit is a liability. For businesses who take out loans and deposit their money in banks, the opposite is true. But it makes perfect sense for banks, because the deposit is the depositor's loan to the bank (the bank's liability), and the loan that generates income (its asset).
Moreover, mortgaged backed securities were designed to be ultra safe, not risky. They are treated almost like cash and treasury bills. They were designed to have small "spreads" above treasuries -- ie, their interest rates are just a bit better than those paid by the government because they are almost that safe. A huge proportion of mortgage backed securities are guaranteed by Fannie Mae and other quasi governmental (or formerly quasi governmental) entities. Even the sub-prime asset backed securities were designed to be ultra safe, although they are not guaranteed. That's why institutions, like pension funds and banks, that are only allowed to invest in ultra safe investments, were allowed to purchase mortgage backed securities.
It is the fact that they were perceived to be safe that is causing the credit crisis. I can't emphasize enough this point. If they were risky investments, then the fact that some of them went bad would be irrelevant to the larger economy, because only risk-taking investors would have purchased them.
And not that many mortgage backed securities are going bad. Now here is the key point to understanding what is going on, in terms of their perceived safety: What would happen if it was announced this morning that one in one hundred dollar bills (the most ultra safe investment) of all denominations was invalid. Let's say every $1, $5, $10, $20 and so on whose serial number ended in "47" was for some reason, invalid. What would happen when you go to the grocery store or gas station or pub? Commerce would slow to a standstill as each person receiving cash payment would laboriously have to go through each bill to check that it was valid. Heck, even strippers would check whether there was a 47 in the serial number of the $1 being slipped in her g-string. That would be a liquidity crisis: no one could easily buy and sell stuff because the markets would freeze up and not be "liquid."
That's why there is a crisis in the banking system, in particular a "liquidity crisis." Most mortgage backed securities are just fine, but some proportion of them have gone bad. Mortgage backed securities were so safe they were used in the same way as cash and t-bills to settle transactions between banks. Suddenly no one knows which ones are valid and which ones aren't. Even worse, unlike in my "bad dollar bill" hypothetical, there is no quick way of identifying which ones are bad and which aren't. To do so, you have to read the original prospectus for the issuance of the mortgage backed security as filed with the SEC -- about 200 pages of the densest, most incomprehensible legalese, accounting jargon and statistical modelling ever miswritten by mankind. When I was doing this stuff, including writing prospectuses, no one was smart enough to understand the entire thing -- lawyers could understand one part, accountants another, math geeks yet another part. So what has to happen is someone has to read hundreds of thousands of pages of prospectuses to figure out which are the good MBS's and which ones are the bad ones. Until then, each bank is afraid to take payment in MBS from other banks, and there isn't enough cash and t-bills to go around. That's the definition of a liquidity crisis.
--HamdenRice from DU
Great post, HamdenRice. Tell us more...how is this likely to play out, particularly with the staggered refinancing of the ARMs?
"Das Kaputtal" ? ..stupid, ... it's the SMALLPRINT !
Joe,
Glad to see you are giving this a little airplay. For us finance geeks its important. Would be hilarious if they try and schedule an Iran bombing run at the same time as a banking crisis kicks off.
As for "what's really going on" well I dont want to add my 5c. The interesting thing for me is I still cant quite imagine a solution. If you cant even imagine the solution then you really do have a problem. So why hasnt the equity market noticed and started to get really scared?
Just dont buy any real estate.
Harry
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