Brass Backwards

Okay, let me see if I’ve got this straight.  The world’s credit markets have seized up creating a  global lack of liquidity—in other words, no-one wants to lend to any one.  As a consequence businesses, governments and individuals can’t borrow sufficient funds to keep businesses, governments and individuals doing what they need do to keep the economy—global and domestic—from heading into the tank,

The reason for this is that banking and investment  institutions around the world  are holding trillions of dollars in potentially worthless–or, at least paper worth less than when obtained–investment instruments that included mortgage-based securities heavily laden with  subprime obligations.   These subprime mortgages are problematic because they consist of hundreds of thousands—millions—of loans issued by financial companies flush with excessive liquidity a few short years ago to hundreds of thousands—millions—of borrowers whose personal income and assets should otherwise of precluded them from receiving said loans in the first place or receiving them for substantially lower amounts under substantially different conditions.  Moreover,  most of these loans were structured with massive balloon payments–Adjustable Rate Mortgage or ARM–which, apparently was financial shorthand for “we’ll loan you the money now cheap but come back and break your arm  in a couple of years if you can’t pay.”

All this loaning was based on three assumptions.  First, global financial liquidity would continue to pour endless amounts of money into American financial houses.  Second,  home prices would continue to rise across America in an endless bubbling boom allowing subprime mortgage investors to endless refinance their ways out of their massive ARM  balloon payments  thanks to constantly rising home equity.  Third, there really is a Santa Claus/Tooth Fairy/Easter Bunny who  will make every thing right no matter how colossally unrealistic/self-delusional assumptions one and two might be.

In other words banks with way more money than they new what  to do with gave way to much cheap up-front money to too many people with way too little income to afford the loans they were taking. Once the housing bubble popped people unable to refinance due to sinking equity were also unable to pay their massively ballooned ARMs.  And now that debt, bought up in fancy sounding but ultimately simple–as in “this security is backed up by the ability of a truck driver in Detroit making thirty thousand dollars a year to continue to make five thousand dollar per month mortgage payments”–bonds and funds produced and traded  by the best  and the brightest products of the Wharton School, Harvard Business and University of Chicago, is poisoning global finance like monetary e-coli  outbreak.   The reality underlying the subprime mortgage meltdown is not rocket science.  The rocket science lay in taking a five thousand dollar a month morgtage held by a truck driver making thirty thousand a year and turning it into a security that did not scream insolvency.  Once upon a time I think they had a word for that.  What was it?  Oh yes.  Fraud.  But I digress.

And now a  financial crisis based on arcane , obtuse  hedge funds, derivatives, inverse derivative,  credit default-swaps and the like understandable to, perhaps, a few hundred Ph.D.s in advanced fields of math and science at any given time now threatens to spill over into the real economy that  employees people, produces stuff and, basically, keeps us all alive.  In summary:  The global liquidity and credit crunch and looming recession/depression is the product of financial institutions holding to much shaky debt issued to American homeowners.

Okay, do I have it right so far?

Meanwhile, facing the evaporation of global liquidity and the looming chasm of economic recession—if not financial and economic collapse—the governments of the world are collective pouring trillions of dollars into the gaping maw of the same global financial community that created the global financial problem in the first place.  In other words, the world’s governments  are attacking the problem from the top down.  Or, to use a medical analogy, they’re treating the most manifest symptom of the disease without directly addressing the underlying pathology.  It’s as if a doctor, seeing a patient wasting away due to advanced cancer,  recommends the patient go out and eat more Home Town Buffet instead of acting immediately and aggressively to cut out the underlying tumor.

Am I still on target?

But if the ultimate tumor in all of this are millions of mortgages with inflated payments and interest rates that average Americans can no longer afford, isn’t that precisely the place the surgeon’s knife of government must first be applied?  Unless you move to immediately and aggressively to cut out the underlying tumor won’t it simply continue to metastasize throughout the body economic? Even if government policy aimed at stabilizing the top of the financial system by subsidizing poisoned financial portfolios and buying direct stakes in busted banks works in the short term, what happens over the next three, six and twelve months as millions of Americans continue to see the equity in the houses slide, their ability to meet mortgage payments decline and their ability to access credit collapse?    Given the underlying weakness of the real economy—that would be the two thirds of it that is driven by what consumer like that of a thirty thousand dollar a year truck driver in Detroit spend —wouldn’t a prudent investment class take advantage of all these government bailouts and buyouts to cash out now before the real economy falls into the tank?

For what does it gain a nation to save its investment class in the short term if it loses its middle class in the long?

So what is to be done?  Senator Barack Obama had the makings of a good idea yesterday when he called for a ninety-day national foreclosure moratorium to give homeowners and mortgage holders time to work out more equitable loans that would keep homeowners in their houses, keep houses off the market and keep mortgage holders out of the red.  The only problem with his plan is that it is not immediate, aggressive and daring enough.

What Senator Obama should call for is an immediate ninety day Foreclosure and Mortgage Holiday.  Details of which are in my next blog, “Happy Holidays”

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4 Responses to “Brass Backwards”

  1. mlaiuppa Says:

    I heard (on NPR probably) that the subprime mortgages were created to meet a demand. A demand for mortgage backed investments was created and there weren’t enough to meet the demands of those wishing to buy. So more were created. How? Subprime loans.

    I agree that the only way to make home worth something is to take these sub-prime loans and refinance them into something people can afford to pay. Pop the balloons. When property is worth something, everyone wins. Even people like me who have a fixed rate 30 year loan and a steady job and have been making my payments regularly and am not in any danger of foreclosure. Except my home has dropped in value 25% or more. *I* didn’t do anything risky to deserve this but I’m paying for it anyway.

    And yes. Voting Obama. (told you so.)

  2. Robert Says:

    So the logic behind the bailout is…?

  3. Told You I Was Going To Tell You « Political Lunacy Says:

    […] To Tell You October 20, 2008 — carlluna Last week I published a post entitled “Brass Backwards.”  In it I laid out my belief that the current supply-side focused economic stability and […]

  4. Happy Holidays « Political Lunacy Says:

    […] far the government’s response has been the antithesis of Keynesianism.   I recently wrote that the Reagan revolution amounted to a subversion of Keynesian demand-side economics (which […]


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