Brief Discussion of Foreclosures & the Credit Market
By John Miller, Executive Director, New Albany Community Housing (Nonprofit Housing Developer / Homebuying Educator)
Foreclosures
Frequently the mortgage crisis is blamed on homebuyers buying more house than they could afford. This is a simple and easy way of rationalizing putting foreclosed homeowners on the street, and forgiving our guilty conscience. While there may be some cases of this kind of speculation, mostly at the high end of the real estate market, this is both unfair and untrue.
Buying a house is a very complicated process, made more complicated all the time by efforts to clean up the dishonest practices and shady characters who have invaded this very vital part of our economy. Most current homeowners could not pass a simple test of terms and rules in the process. Topics like fixed rate, adjustable rates, prepayment penalties, closing costs, prepaids, downpayment assistance, mortgage insurance, title insurance, owner’s title insurance, grants, seller financed, origination fee, processing fee, recording fee, attorney’s fees, real estate taxes, escrow accounts, equity & appreciation, appraisals, inspections, disclosure forms and many, many more each have variations, traps and tricks that keep bankers, regulators and educators on their toes, and new problems come out every day.
One simple question most seasoned homeowners couldn't answer: What is the difference between Interest Rate and APR?
So imagine if you come from a background where your parents, friends and relatives never owned a home, and you are being sold by a glib, high powered, predatory broker that will tell you anything to get you to sign on the dotted line. So, most first time homebuyers are totally unprepared. Most homeowners are barely better.
This is no way to run an economy that is primarily based on real estate.
Another question: Why do homes appreciate in value? Why is a home generally worth more next year than last year? The answer is that someone is willing to pay more for it. They trust that the home will increase in value and are less fearful that it will depreciate.
So the foundation of the world's economy is based on confidence, and we allowed:
Originators—Inspectors—Processors—Underwriters—Appraisers—Assessors--Loan Officers--Bankers--Investment Bankers--Hedge Fund Managers--Mutual Funds salespeople. No one this list have any vested interest in loans being repaid. The best of these actors could never be trusted with this vitally important part of our lives without some oversight and enforced rules.
The Spread
Banks were always the final curb on risky behavior--they would never allow the market to be sold off to the risky speculators, right? They were also limited by regulators who insisted on levels of capitalization (reserve). But since banks live on the spread, the difference between the cost of funds and the interest earned, when the cost of money is so low, and predatory rates are so high, then conservative players are looked as as fools, and the riskier the behavior, the more rewards reaped upon the daring. When the Fed Funds Rate Vs. Prime is good, then Vs. Sub prime is better, and Vs. Predatory is just too attractive for many to resist.
Fannie Mae & Freddie Mac were looked at as too conservative, and were encouraged to get into the game and take advantage of The Spread. And since everyone was doing it, the restraint of pushing Reserve limits was just too tempting. And this doesn't even count the investment banking industry which had few regulations about reserves and capitalization.
The Credit Market
Derivative: A financial instrument whose characteristics and value depend upon the characteristics and value of an underlier, typically a commodity, bond, equity or currency. Examples of derivatives include futures and options. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. These techniques can be quite complicated and quite risky.
So how large is the Derivative Market? If you assume that the Stock Market is the height of a person, the total value of the Derivative Market is about a 200 story building. That's the insured part--the total payout in the event of a total collapse. The consequences of rolling snake eyes again and again.
Derivatives are like a wager or a bet, similar to most insurance. If everyone had a claim, then the insurance companies wouldn't be able to pay off the claims, but that is unlikely. The actual market value of derivatives vs the stock market has been described as more like the comparative size of a mouse verses somewhere between an elephant, or maybe a full sized Buick. Banks and insurance companies are regulated to keep capital reserves as percentage of the total possible payout. As long as everybody doesn’t claim at once or withdraw their money at the same time, you're ok. Government frequently guarantees the long odds with a nod and a wink like the FDIC.
The Derivative markets have little or no reserve requirements. Actual market value, about $15 trillion. More than the entire US Economy. But the value of the insurance is $668 trillion. The 200 story building.
More than half of the $668 billion ($393 billion) is interest rate swaps. Insurance against rising or falling interest rates on bonds, etc. Not wildly risky, but risky. $55 trillion is Credit Default Swaps which Warren Buffet called "financial weapons of mass destruction" in 2002. Insurance with a big payout but tiny chance of catastrophe.
So on the Trust Vs Fear scale, we're fine unless the market collapses, and everyone begins to lose faith in the ever increasing value of real estate, that banks will be totally backed up by the FDIC (which used 15% of its assets in the first large bank failure, IndyMac) and that people will continue to work at ever increasingly high paid jobs and be able to keep making their mortgage payments that they never understood and are paying for houses that are worth only a fraction of the value of the real estate.
No trust & no reserves. Uh oh.
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Beyond the Reach of Traditional Solutions
by John Wilborn
I discussed an article entitled "America's Economic Crisis; Beyond the Reach of Traditional Solutions" written by Paul Craig Roberts (PCR) that appeared in the Nov. 15 issue of "Counterpunch."
PCR was the Asst. Sec of the Treasury in the Reagan administration. His columns appear regularly in "Op-Ed News," "Online Journal," "Huffington Post," and others.
I am an accountant and not an economist and while reading through this article found it necessary to look up terms because I had only a vague awareness of their meaning. Two are monetary policy and fiscal policy. MONETARY POLICY is the process by which the gov't, central bank, or monetary authority controls (i) the supply of money, (ii) availability of money, and (iii) the cost of money, or interest rates in order to attain a set of objectives oriented towards growth and stability of the economy. FISCAL POLICY refers to gov't attempts to influence direction of economy through changes in taxes, or through spending.
PCR states that our current economic problems differ from our past times of troubles and argues that traditional remedies, such as the public works programs that Robert Reich ( an advisor to President-elect Obama ) proposes are unlikely to succeed in reviving the U S economy.
Consumer debt expansion is the fuel that has kept the US economy alive. the growth of debt has outstripped the growth of income to such an extent that an increase in consumer credit and bank lending is not possible. This fact takes monetary policy out of the picture.
Economists are thus left with fiscal policy and PCR agrees with Reich there are problems with it. He states that Reich is correct that neither a reduction in marginal tax rates nor a tax rebate is likely to be very effective. That leaves spending and Reich proposes spending "a lot" on infrastructure projects on top of a trillion dollar budget deficit ( shortfall ).
PCR does not oppose infrastructure projects. His issue is who will finance the trillion-dollar deficit plus the additional red-ink spending on projects. For years the US gov't's budget has been dependent on foreigners ( Japan, China, Saudi Arabia ) financing the red ink, or deficit. The open question is: how much longer will they do so?
PCR recommends an approach that assumes foreigners will no longer finance America's mistakes. Thus, to reduce the budget deficit America halt pointless wars and close the 700 overseas military bases. Further, the corporate income tax structure must be overhauled to provide an incentive that encourages corporations to bring jobs back to the U.S.A. That means that corporations would be taxed according to the value added in the US. The higher the value added in the US, the lower the tax rate; the lower the value added, the higher the tax rate.
PCR concludes by stating "With bailouts eating up the world's supply of capital, continued foreign financing for Washington's wars of aggression is out of the question."
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The Best and Only Solution
by Carol Johnson Smith
I discussed the aspects of the best solution, in my opinion, the only solution to the monumental crisis that we face in this nation and indeed, the world today. This would be a return to what has worked -- the American System of Economics approach that Franklin Roosevelt used so effectively to build out of the Depression and defeat Hitler.
The original American System was based on a new philosophy - that the mission of this nation was to break the back of the rule of the many by the few powerful groups at the top. The laws of the land would be made with the welfare of the population, as a whole, at the top of the agenda. This meant that trade between nations would be for the benefit of all. This was American fair trade in opposition to the 'free-trade' of empires which had ruled the world for centuries. The American System consists of three components 1) Protecting industry 2) Government investments in vital national infrastructure and 3) a National Bank policy that promotes the growth of productive enterprises for the benefit of all.
Today's crisis has been brought on by the same methods as the last Depression; that is, putting money before people. Roosevelt spoke of this in his first inaugural - " ... stop speculation with other people's money" . Roosevelt's protections for the people have been dismantled -- and massive speculation with other people's money has brought the post-Roosevelt floating exchange rate monetary system crashing down. This system is dead, we must bury it and return to the American System with its dirigistic aspects of government directed infrastructure development, as seen in Roosevelt's programs thru an entity like the Reconstruction Finance Corporation. We must write off the speculative bets ( credit swaps and most other derivatives) There is NO WAY that they can ever be paid and trying to do it will sink the economy further and create hyper-inflation.
There is a Plan B - a comprehensive three part proposal before the nation today on this meltdown. It is called The Homeowners and Bank Protection Act. It has passed in over 100 city councils across the nation, including here in Shively and Indianapolis. This proposal has been around since Sept 2007 and it begins with freezing foreclosures and putting banks thru bankruptcy reorganization, rather than hyper-inflationary bailouts. This will be followed by a two-tiered credit system to dry up destructive speculation and promote vital infrastructure investment and the convening of a New Breton Woods treaty agreement between nations based on FDR original intentions.
I believe that we must, as Ben Franklin advised us, be eternally vigilant and we must be proactive in fighting for own best interest -- we must call, write, challenge ever elected official we have to step up and sponsor, endorse and push for an American System solution to this total crisis we face today. Ask all your elected officials to join leaders like Kentucky Senators Perry Clark and Joey Pendleton and Kentucky Representatives Joni Jenkins and Tom Burch in stepping forward with today's American System economist, Lyndon H. LaRouche's Plan B proposal - The Homeowners and Bank Protection Act; the first step in the only comprehensive program being put forward today.
