Arnold Kling  

Chief Financial Plumber

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SEC Demagoguery... Progressive Corporatism...

A Treasury Department press release offers a statement from Secretary Paulson.


The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy. When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.

Read the whole thing. What struck me were all the plumbing metaphors. You can almost picture Hank, with his pants riding down a couple inches, leaning over the financial toilet bowl and telling you that there is a lot of, er, stuff, in there that needs to come out. Then it will be un-clogged and we'll all be ok.

He's probably right. But let's pose some questions.

1. In Japan's "lost decade," they propped up the banks that had the bad loans on their books. Most economists think that was a bad idea. It kept the saving of the Japanese from finding its way to investments with good returns. Could we be repeating that mistake?

2. See Steven Randy Waldman, to whom I linked this morning. Of all the ways for government to spend money, is this the most socially useful?

3. Housing starts have dipped below one million at an annual rate, the lowest pace in umpteen years. I'm stunned that they haven't dropped to zero. No one needs new housing developments. Are the builders on crack, or do they expect Congress to buy their houses, which would mean that Congress is on crack?

I want to see the excess inventory of unoccupied housing go way down. I want to see houses that are either rented or bought by real owners, meaning 20 percent down payments. The sooner we get to that point, the sooner we'll know who lost what on mortgage defaults.

As for the financial system, we've got banks. Maybe give them a break on capital requirements at the margin to make good loans. Otherwise, I'm not sure we shouldn't just sit back and let things sort themselves out.


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COMMENTS (7 to date)
sd writes:

3. Housing starts have dipped below one million at an annual rate, the lowest pace in umpteen years. I'm stunned that they haven't dropped to zero.

Builders have long construction cycles. It takes about 10 years to aquire land, permits, bring utilities to a lot, put up traffic signs etc. Selling homes below average total cost ("at a loss") can still help pay some of the fixed costs. The "starts" you see reported primarily reflect a backlog of projects.

SheetWise writes:

I want to see the excess inventory of unoccupied housing go way down. I want to see houses that are either rented or bought by real owners, meaning 20 percent down payments. The sooner we get to that point, the sooner we'll know who lost what on mortgage defaults.

Looking at the unoccupied housing in California, Nevada, and Arizona -- these units aren't built in areas where people who have choices want to live (people having choices being those with 20% down). These homes were built on the periphery of already big cities where the commutes are long. For these homes, I think we're going to have to wait for the cities to catch up with the new building, bringing jobs into the area.

There's a lot of new building and redevelopment taking place where I'm at in Tempe, AZ. It's a great location. We've barely noticed any changes in prices over the past few years.

MD writes:

How come so many people are saying that this gigantic bailout plan will cost nothing to the taxpayer? How can all these people say that, in fact, the government may actually make a good return to the taxpayer on the acquisitions of this RTC-like institution? Are they all on crack or it is just me being clueless?

Tim Fowler writes:

Re: "I'm stunned that they haven't dropped to zero. No one needs new housing developments. Are the builders on crack"

I'm not an expert on real estate across the whole nation, but I doubt there is no need of new housing in any market at all in the US. If there is a ton of extra housing at locations A,B,C,D,E, and F, and an adequate amount of housing at G and H, that doesn't help someone at location I who needs some housing and doesn't have it available (at least not if he doesn't move).

Even within a market, housing isn't a single simple commodity. Different types of housing, or different specific locations for housing, may have some unmet demand even if the overall market for housing in that market if oversupplied.

Gary Rogers writes:

We are doing a huge loan consolodation where debt is moved under the treasury where it has less detrimental effect on the economy, but it is still debt and still needs to be repaid. This is like a homeowner that takes out a home equity loan when the financial pressures get too tough. If we understand what we are doing there is hope but I am not convinced that enough people do.

In defense of Hank Paulson and Ben Bernanke, they have to be thinking about United States Bank that was not bailed out at the beginning of the depression and led to the rest of the bank failures.

Oskar Shapley writes:

I want to see the excess inventory of unoccupied housing go way down.

I want to see excess inventory burned down like coffee in Brazil during the Great Depression. It's the fastes way of bringing prices into equilibrium. Might be even cheaper than pumping liquidity into the banking system.

SheetWise writes:

I want to see excess inventory burned down like coffee in Brazil during the Great Depression. It's the fastest way of bringing prices into equilibrium. Might be even cheaper than pumping liquidity into the banking system.

Broken window fallacy. It needs to be revalued with information. The current "crisis" is a man made (i.e. invented, by design) political event. There's only about $1.2 trillion total in subprime mortgages, of which only ~10% are in default -- and then we should credit the owners of that debt with a substantial underlying value. Under current accounting rules, they consider the entire CDO a loss. The issue here was/is liquidity -- not solvency.

Time is the currency of this situation. There will be winners and losers, and how the government proceeds -- determining who wins and who loses, and how that correlates with their risk management -- will determine whether there's confidence.

Thank God it's the Fed and not the courts.

Since liquidity and credit worthiness is the game, the game should be played as agreed. In that light, there will be losers. The losers will be investors -- not mortgage holders, and not the government.

The government is simply allowing a smooth transition, buffering the cash flow.

Imagine if you lived in a small town with one grocery store who everyone depended on for their supplies. This grocer becomes insolvent, declares bankruptcy, and is about to close their doors. Would the community be correct in making loans to keep their doors open until alternative services were in place? I would say yes -- as long as their influx of capital subordinated all other debts, and their immediate intentions were to transfer the existing assets to other providers ASAP.

This whole mess is about investment consolidators designing products which cannot fail because they've partnered with other investment consolidators who cannot fail because ...

If there's going to be incest in the investment community, lets have some transparency. Let the winners win, and the losers lose.

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