Jul 05, 2008
People have been trying to call a bottom to the current housing and mortgage crisis for some time. Chartists, technical analysts, real estate gurus, even soothsayers and tea leaf readers have all seen false bottoms and have predicted upturns in the market in the very near future.
Unfortunately, the worst is yet to come. We are not even halfway into this housing price decline. In books published in 2003 and 2006, respectively, my predictions of 25% home price declines nationwide and 50% price declines in many cities on the coasts are rapidly coming true. You can see that we have a long way to go because most ARMS are just now resetting, most foreclosures to date have been 2006 and 2007 mortgages and the banks are not going to lend 10 times your combined income in the future, but rather something more like 5 times. Unless you are willing to put up 50% down payments, homes have to come down further in price.
The country and the global financial system came closer to a complete collapse this year than any time in our history with the possible exception of 1929. While we will all pay for it in much greater inflation, Bernanke and the world's central bankers have to be congratulated for printing and distributing to the world's banks and investment banks approximately $1.5 trillion. It was our hard-earned taxpayer money, but it was well spent as we would have faced a global bank run and depression without his intervention. The fact that it happened without many Americans even realizing it only assures that we have not learned our lesson and are doomed to repeat our mistakes until we understand their underlying cause.
They had no choice. We no longer live in a capitalist financial market in which banks compete and inefficient and poorly run institutions go bankrupt and exit the playing field. In the modern world, thanks to the $400 trillion derivatives market, no major bank or investment bank can be allowed to fail. They each in themselves are important nodes in an extremely complex web of derivative contracts such that the removal of any single major firm would cause a collapse of the entire system. The best analogy is to look what happens to our entire network of nationally scheduled air flights when a single major hub like Chicago is closed temporarily due to weather. Just as airplanes fly between any two cities, so derivative contracts are made between two counterparties, but the resulting interlocking and interdependent relationships are so complicated that no financial system could survive if a major hub dropped out.
Banks know that they are too big for the government to allow them to fail. The moral hazard that is created will be reflected in their continuing to take on high degrees of debt and financial leverage and invest in risky assets with no concern for the consequences. And much of the activity in the derivatives market is nothing more than mere speculation. When Bear Stearns was saved from bankruptcy it had $120 billion of debt outstanding, but for some crazy reason there were $2.8 trillion of credit derivative contracts written guaranteeing that comparatively small amount of Bear Stearns debt. If Bear had gone bankrupt and these counterparties had to actually pay, it would have caused massive bankruptcies of hedge funds and other financial institutions, not to mention the fact that Bear itself was also a counterparty to tens of trillions of derivative contracts and their prime brokerage business financed trillions more of derivative positions at their hedge fund clients.
When I wrote my books on housing I hinted at what I thought the real cause of the problem was. Yes, I said that the banks were acting crazy by extending such large amounts of money to homebuyers, but I also hinted at why we allowed this to occur. The reason is that the banks, the investment banks, the hedge funds, the mortgage companies and the private equity firms are some of the biggest political lobbyists in America and give more money to your President and Congressmen than any other industry. And what do they expect in return? Deregulation. They spent $400 million on lobbying to have Glass-Steagle overturned to allow commercial banks to get into the investment banking business. This opened the door for banks to arrange mortgages, but suffer little to no consequence as these mortgages were quickly packaged and sold to investors upstream.
Banks and corporations argued that regulation got in the way of free markets. Until the housing and mortgage collapse, few people understood that regulations and rules are the basis of any free market system. You cannot buy and sell anything unless you have a strong rule of law that enforces property rights and assures contracts will be honored and fraud exposed. The greatest injustice I see in America today is the ability of banks and corporations to bribe-yes, that's the right word-our elected officials in return for trillions of dollars of value creation to their shareholders in sleazy mortgage regulation, phony ethanol programs, high energy prices, costly pharmaceuticals and healthcare, and wars that only seem to profit the defense industry. I believe the housing crisis is just a symptom of a much bigger problem of trying to constrain lobbying, which will continue to fester until the American people conclude they have had enough and just won't take it anymore. Let's all do something positive to make sure this hijacking of our system of government is never allowed to occur in this country again.
John R. Talbott called the causes of the current housing and mortgage crisis spot-on in his 2003 book, The Coming Crash of the Housing Market and even nailed the peak of the market with his January 2006 book, Sell Now! The End of the Housing Bubble. His new book, Obamanomics: How Bottom-Up Economic Prosperity Will Replace Trickle Down Economics, will be published on August 1st.
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