Someone Please Tell Me Where I'm Wrong

Economics Economics Questions
1

I posted the following few things in another forum, and I’d like someone to point out where I’m wrong on this. My posts ASSUME the inevitability of an economic bailout, though I don’t favor the concept.

POST 1 (in response to the question of what would we have gained from directly paying off mortgages):

What do you mean by “come back” in this instance? I’m assuming you mean how much of the money would we have recovered? Well, I’m thinking that we wouldn’t have crashed in the first place and therefore wouldn’t have lost as much money as we did. From what I understand of the situation (and I’m an engineer, not an economist), the impetus for this entire crisis was the mortgage industry. Lenders lent out this money to people who couldn’t pay them back (and the lenders knew this going into the deals). The catch is that subsequent bets were made on these loans, in the form of complicated financial instruments like mortgage-backed securities, collateralized debt obligations and credit default swaps. However, the underpinning of the bets were the mortgages themselves. So when the owners began foreclosing en masse, the properties quickly lost value. The bank was repossessing the homes at cutrate prices and losing MASSIVE amounts of capital in doing so. The imaginary value of the mortgages and by extension the value of those financial instruments began to collapse, wiping out hundreds of millions of dollars of “capital” in the process (I say “capital” because the money was really never there in the first place).

So, how to solve the problem? My solution would have been to prevent the foreclosures because, as I said before, these loans were the underpinning of so much of the bad sector of the financial industry. Save the mortgages and you prevent the collapse of all of those financial instruments, consequently staving off the wider financial crisis we saw. At the same time, you get the added pleasure of helping your fellow human being who may be struggling to stay in a home. It would have been a win-lose-win for Americans (a win for the poor, a loss for the middle class - who largely funded the bailout - and a win for the upper class). Instead, what we got was a lose-lose-lose(-win) (that’s a loss for all classes of Americans, with a caveat because the financial industry made out with all the cookies). The result of the government’s real-world actions was that the financial industry went through a crisis, homeowners still lost their homes and taxpayers lost trillions of dollars. Literally only the financial class won in this deal. I firmly believe that saving the mortgages outright and directly (i.e. not giving the money to an intermediary like a bank to be lent out) would have immediately averted the crisis we saw and will see again.

I think the real problem is that we’ve let them run wild with no sherriff in town. They’ve created extremely complicated and convoluted financial instruments that are so intertwined that I doubt even the people who created them know how precarious they are. What’s worse is that Wall Street has sold these financial instruments to the high rollers of the investing world so that trillions of dollars are tied up in them. When that one card is removed from the bottom of the pyramid, it’s going to all come crashing down. I don’t think we’ve really seen a crash/collapse yet. I think we’ve only seen the beginning of this fiasco.

POST 2:

Another problem I think we have in the US is the myth of the American dream. People have come to the conclusion that the American dream means the ability to own as much shit as possible. This translates to home ownership in many cases. People are not satisfied with renting or any other alternative to owning. So banks gladly obliged with dangerous sub-prime lending options, most notably the adjustable rate mortgage (ARM), which I liken to thievery. If I had been in a position of power at the time of the financial crisis, I would have:

  1. Gathered a list of ALL mortgages that were delinquent or in the process of foreclosure from the lending institutions.
  2. Brought all of these mortgages current with the money we used for the bailout.
  3. Paid the mortgages out to one year with the money we used for the bailout.
  4. Given a flat $1,000 rebate to all taxpayers, as they are the ones who funded the rescue in the first place.
  5. Used that 1-year moratorium on the troubled mortgages to renegotiate the usurious terms of the subprime mortgages that failed.

I believe the effect would have been far more beneficial. First, it probably would have cost far less to do this. Secondly, it would have allowed those people who were in trouble with their mortgages to stay in their homes at least one more year and during that time devise a plan to keep their homes or come up with an orderly sale of the property to someone who could afford to own it. Third, it would have eliminated the exploding ARMs and other subprime lending instruments. Fourth, all of those complicated investment instruments wouldn’t have collapsed as they did, because the collateral that was used as a basis for the investments would have remained solid. In fact, the government subsidizing of mortgages would likely have made the investments more stable and thereby attracted more investors. And lastly, because these investments would have been stabilized, we likely wouldn’t have seen the panic which led to many people yanking their money from the stock market … which ultimately led to further destabilization. In the end, the return on a direct subsidization of troubled homeowners would have had a 10 fold return.

I liken the government’s actual response to the following analogy. Let’s say Hoover Dam began to develop cracks and slowly leak water. My solution would be to temporarily fix the leaks and stop the water. At the same time, construct a new dam that would be able to hold the water back. The government’s solution would be leave the dam in disrepair and simply add water to the back side of the dam to replace the water that had already leaked through. In fact, this is still their solution. As more and more water leaks through the dam, they simply want to add more and more water behind the dam. It blows my mind.

POST 3:

I further believe that our troubles with unemployment speak directly to the inadequacy, idiocy and greed inherent in the government’s bailout of the banks. Because the banks have actually tightened their hold on their money (much of which is bailout money they were supposed to turn around and lend out), many businesses have been shuttered or put into financial straights. This results in businesses laying off workers, cutting salaries and cutting benefits, leading to a self-sustained cycle of debt and debt default as people struggle to sustain themselves. I feel that the solution I proposed would have averted this situation, as banks wouldn’t have ended up so constrained with their lending, thereby giving businesses access to funds and allowing them to keep their employees.

2

This is a big TLDR. You’ll get more help if you boil it down more… sorry to be unhelpful.

3

Basically it boils down to my argument that the government should have simply identified troubled mortgages (those that were delinquent and those that were already in the foreclosure process) and subsequently brought these troubled mortgages current. As the troubled mortgages were the collateral for so many investment instruments, their collapse in value was the real impetus behind the ensuing panic as waves of homeowners began foreclosing (foreclosures which were pushed along by the exploding ARMs and other dangerous sub-prime lending instruments). I contend that bringing the troubled mortgages current and even paying them forward six months or a year would have had a far more positive and effectual impact than throwing “money” at the banks.

My question for the forum is why is this reasoning incorrect. And just to re-emphasize, I would have preferred no bailout. I am assuming that it was inevitably going to happen, and this is my alternative to the government’s solution.

4

James Dudley,

Here’s a few thoughts after reading your boiled down post:

  1. The money to bring past due mortgages current would come from taxes, Federal borrowing, or printing. As this merely redistributes existing wealth, no economic effect would be felt overall. The plan would fail.

  2. The problem is not merely delinquent loans. The problem was the mortgage was $300,000 and the house was worth $190,000. The owner would be foolish to continue to pay for an asset so overvalued. Would your plan pay down the mortgages to fair value? If so, which home owners get to pay their loans down to fair value? Only those who are delinquent? What if I kept my home current? Do I get my mortgage balance paid down to fair value?

  3. After you pay the delinquent payments for six months, what happens then? Does the taxpayer continue to pay my mortgage after the person loses his job?

  4. The problem was not limited to sub-prime or just residential mortgages. There were commercial developments under water, commercial high rise condo projects, other commercial real estate like owner occupied warehouses and office space. Under your plan, would the taxpayer make these payments too, and pay down these mortgages?

  5. How would you have saved Goldman Sachs and their $12 billion investment in AIG derivatives?

Your plan has noble intentions, as an alternative to what was actually done. But your plan ignores the purpose of the central bank (to bailout the system and maintain a market for government debt) and the purpose of the Federal Government (to tax the people and spend the money as Congress sees fit).

P.S. Your plan wouldn’t save the United Auto Workers Union. You couldn’t let the Union go down, could you?

5

The problem is, you don’t want to maintain the structure. There has been an inflationary bubble. What you want is an economic collapse, which is what allows for a recovery. Micro-example: you refer to doing good for your fellow man by helping people stay in their homes. Why is that good? First of all, it’s not about helping them stay in “their” homes, as they don’t own the homes. It’s about helping them stay in homes other people own. Second of all, what about people like me, who would love to buy a home but instead are sentenced to not being able to when your policies keep housing prices up? Why is it a gift to humanity to keep me from having a home?

6

It appears my question / proposal has been misunderstood. First and foremost, I am not advocating the bailout that happened or any bailout that may happen in the future. I firmly believe that a completely free market is self-correcting but that our governmental leaders are too afraid to let it fix itself (for various reasons which are open to debate).

Secondly, I’m simply posing the question why were the banks bailed out instead of the homeowners? The homes were collateral for the volatile investment instruments that eventually collapsed as the collateral evaporated due to a wave of foreclosures. Seems to me that IF you are going to throw “money” at the situation, you would want the effect of ending the evaporation of that collateral. And if this is your goal, wouldn’t directly subsidizing troubled mortgages (as opposed to giving that money to banks) accomplish your goal, thereby stemming the tide of foreclosures and subsequently the evaporation of capital?

7

You ask why not subsidize the bad loans to keep the collateral propped up to avoid the banking system collapse. You ask why bailout the banks directly. Read my #2, and the paragraph I wrote regarding the purpose of the central bank.

You would have to make the home owner’s payments and pay down the mortgage balances to fair value. How would you determine fair value unless values collapsed? Which home owners would get their mortgages paid down? By how much do you pay them down? The central bank was created to bail out the system, at everyone’s expense, of course.

Plus, it was more than residential mortgages. It was housing developments, commercial real estate, business loans.

Am I misunderstanding your question?

8

I wrote a response, but now I’m not sure if it went through, so I’m writing this one. If it’s a double post, I apologize.

I do understand your point, and I’m sorry that my response was unclear (reading it, I see how unclear it was.) Here’s my point. I’m going to ignore a government perspective and just take an economic one. If I bail out the banks directly, the banksters take vacations, bonuses, and so on. That’s bad. On the other hand, if I bail out the “homeowner” and just pay off the mortgage, or partially pay it off, I’m preventing foreclosure, whereas when the banksters go on vacation, a foreclosure is still possible. In other words, when we pay off the mortgage, we keep the asset prices high, whereas when we pay off the banks directly, we don’t, although we might inflate yachts. If the money is going to go somewhere, my priority is keeping it from going to maintaining current asset prices. The prices have to drop. If they don’t, we can’t get reallocation of resources, and then we can’t get a recovery.

9

No, I wouldn’t say you’re misunderstanding my question with your NR 2 answer … perhaps I chose the wrong way to phrase that thought. But you cite the example of a $300k property being devalued to about $190k. What was the cause of such a deflation of property values? At least some of those properties were foreclosed on. Others were simply guilty of being in the vicinity of other properties that had been foreclosed. As for the rest, I don’t know what caused the rapid devaluation. So, prevent the foreclosure of one house on a block and not only do you save the value of that house, you also prevent the neighborhood-wide devaluation of property. My problem with the practice of giving banks trillions of “dollars” is that it did nothing to prevent property devaluation via foreclosure.

I guess it’s all really a moot question in the end, though. Because we’re not even talking about real money in the first place. We’re talking about money that was created artificially through inflated home prices. Maybe the market was trying to correct itself and the bailout prevented that self correction from occurring.

10

@JAlanKatz That’s the kind of argument I was looking for. Thanks! That makes sense.

11

Now that’s the $64 trillion question isn’t it? The banks were bailed out because the United States government is owned and operated by the banks. I guess everybody thinks Rothschild was kidding when he said that, given the power to issue a nation’s money, it does not matter who writes the laws. The banks can create money legally… it should be obvious what the inevitable consequence of this is. If you could simply wish $1 billion into existence, what “checks and balances” could possibly get in your way?

You should read Thomas Woods’ Meltdown. Here’s a speech by Woods explaining his book.

Clayton -

12

Yeah, I should read his works. I am guilty of listening to his lectures on podcast but not reading his books. That is a shame, and I plan to remedy the situation. However, right now, I’m working my way through Hayek’s The Constitution of Liberty.

13

Property values declined due to the collapse of the time structure of production that was not based on real savings. It was built on money created from nothing. When interest rates rose in '05 and '06 (the Fed tightened), the malinvestment was exposed.

Home values did not drop because a neighbor’s house went into foreclosure. The buyer’s subjective value scales shifted.

You got it.