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I'll get to current events in a moment. First, Bob Shiller writes,


Consider investors in Fannie and Freddie bonds. While the US government never officially promised to bail them out, it did create a special agency, the Office of Federal Housing Enterprise Oversight, which was to assess their strength in an annual report. But this agency never even acknowledged that there was a housing bubble. Government leaders gave no warnings. So can we really say that investors must suffer the full consequences of any losses? How can this be fair?

Thanks to Mark Thoma for the pointer.

Next, I recommend Megan, for a chuckle for biting sarcasm, and for serious thought.


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COMMENTS (5 to date)
Robert Hunter writes:

I am having a problem reconciling two points concerning the "sub-prime" mortgage question. I have read and heard, within the last several days, that 95% of all mortgages are paid on time. Onlyy about 3% are actually in default. The rest are in various stages of delinquency. Can someone explain how 3% of the mortgage balances in the U.S. being in default can cause a "crises" of this nature. I just don't get it.

Luis writes:

The mortgage defaults are only part of the problem, or symptom of the real estate crash. The real problem is over-leverage by firms combined with a classic bubble.

These firms carry assets that derived their value directly or indirectly in many cases from the U.S. property market. Ever since the market began unwinding these assets have been continually marked down. Except that these banks did not have the sufficient capitalization because of their leverage to suffer significant mark downs. They could handle 10 or 15% but they did not anticipate 30% or greater declines. After all real estate is almost risk free, there’s never been a national decline in real estate.

Well Banks like Lehman and Frannie where carrying trillions on their balance sheet but only had billions in capital to back it up. 30% move on a trillion, wipes out 300 billion . Think of your own financial position. If you own a 500K home and have 50K in cash and 50K in equity. You could claim a net worth of 100K but if your house value fell 20% it would wipe out your net worth.. Now if you ran into tough times and needed to raise additional capital you would be stuck. Yes you would have 50K in cash but if you were forced to unwind your position on your home would actually have ZERO.

This is where regulations and accounting have made the problem worse. Accounting standards have forced these firms to Mark to Market the value of their holdings even though they are not necessarily unloading them at this time, the result is otherwise healthy businesses forced to state that they are illiquid. Many counter-party contracts and banking rules require the banks to maintain a certain ratio or “networth” so to speak above all other things. As banks where forced to take write downs they needed to continually put money forward to maintain these ratios to stay in business, forcing the cycle even further as they pull money from healthy businesses to support the toxic assets. As the real estate market collapsed a giant blackhole was created that has basically sucked many banking firms and ancillary firms like AIG that insured against losses.

Nathan writes:

I am having trouble figuring all of this out. Bailouts, mortgage crises, Dow plummeting, whether or not the government should bail out investment banks. What, ultimately, does this all mean? It seems as if there is much commentary but notreally any concrete explanations as to how this affects everyone, if it is the big deal it seems made out to be. If anyone can send me a link somewhere that can clarify, I will appreciate it.

Luis writes:

Nathan

that is the big question. No one really nows how this affects things. We are in uncharted territory. Every pundit has a different take

Initially people thought this would be a financial crisis tied to a few players and could be contained. 6 Months later it looks like we maybe staring at an abyss or the bottom. No one knows not Bernanke or Paulson.

At this point it remains to be seen how many more will fail. We know WaMU is next.

Greenspan and a many more talking heads are pretty much calling a recession likely even though so far the economy keeps moving forward like some Zombie who is missing a few limbs. It dragging but still moving forward. It just wont die. Which is a good thing.

The direct impact for the average joe looks like the following:
Credit is hard to come by right now.
Consumers are stretched thin.
Business are feeling the pinch and layoffs are picking up pace.
You and your grand kids are on the hook for even more National Debt.

Now remember the markets are forward looking so even though times maybe getting tough on Main Street, it maybe that we are seeing the worst beginning to pass on Wall Street.

If AIG is the last major save then I think we've seen a bottom, of course that what everyone said about Bear Stern, Countrywide, IndyMac, Frannie, Lehman, Merrill

Lauren writes:

For a podcast last week with Bob Shiller on this subject, see Shiller on Housing and Bubbles on EconTalk.

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