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March 2009

BAILOUT,BANKRUPTCY,BUST?

                        By   Sy Schechtman

 

            Words, like money,  are fungible.   And it is very important to know what you mean when you say “free enterprise capitalism”  that you now include much more government  intervention  and even ownership then ever before.    Just as,  in  the well known lyric “love is a many splendored  thing”,  capitalism  has many more strings attached than before.   Not that  it  was ever a chaste and pure effort prior to now, what with the  multi billions  already lavished  by the Bush administration on the already  depressed economy  with the hopeful prayer that supervised federal government  oversight will  result in  the nation’s taxpayers  being  repaid if and when, hopefully, the so called stimulus package really works.   And GM, Chrysler and Ford    continually  sucking around the public trough for more financial nourishment,  aided and  abetted by    the entire populace of Detroit and the almost moribund state of  Michigan economically.

        But we have been gradually inching toward    a more “paternalistic” state over the last decade, even within the façade of laissez faire individualism, with the senior citizen drug initiative,  and the  growing interest and pressure for universal health care.  That aspect of social and communal life that in Hilary Rodham Clinton’s political playbook “takes a village” to accomplish and not so much splendid individual initiative.   While the wishful mantle of  hope is for effective medical treatment  for all,  the mantra seems to be the single payer government  approach, one size fits all as the most economic way to this putative blessing.    We are gradually feeling our way  in this  crisis mode of economic uncertainty,  and the fact of our economic  slow pace of  growth over the last few  years has bred  some general discontent   and seems to condone this emergency mode of “throwing money at problems” does not necessarily mean that rampant socialism is just around the corner.  The balance of sentiment has shifted somewhat and the word “liberal”,  if not exactly fashionable is  definitely  much more appropriate at times. But rich people  are not exactly reviled.   We still have a fond place in our hearts for Donald Trump and his irascible  “you’re fired” peccadilloes on TV,  even though his real  estate  empire is somewhat “under water” financially.

        One immediate capitalist compromise, however,   is the subprime mess,  which has allowed, or even enticed,  new home owners who palpably had no valid credit  status and could not even make a down payment of any amount, a sizable adjustable rate mortgage on a new home,  whose monthly payments  became  impossible as interest rates  rose,  or the value of their property declined  below the boom level the property  originally   cost.  Even if these beleaguered  home owners could afford  refinancing   to a more comfortable  level many  of them could not    afford long term  monthly payments over the    20 years or so  that most   mortgages entail.  And ultimately foreclosure would result  or some sort of distressed sale  would occur.  At the very    least a few such foreclosures  in any neighborhood area  does not augment property values therein.   Usually they are neglected homes that need repair and  are a clear sign of possible trouble in the area.     And thus an impediment to the future prospects of resale

 In that neighborhood.   (Remember! the three sacred rules of real estate value-----Location!  Location! Location!)                                                                                                                                              

 

        Moral hazard, too, rears its dubious head.  Quite a few banks and professonial lenders  did not act ethically  in their business transactions with many  marginal home buyers; not explaining all the ramifications of   adjustable mortgages and not examining the basic financial  qualifications of applicants,  even unto whether they  could make the basic down payment  of 20%.    And many applicants lied about their financial resources  or salary with very little or no attempt at verification by the lenders.  All in the rosy glow of the quasi status of government backing afforded by Fannie and Freddie Mac—the largest mortgage brokers in the world. And the fertile nutrient of the Greenspan and Bernanke Federal Reserve  very low interest rates.   And in the political rush to attract  poor people into the exalted ownership status of home ownership both   Democratic and Republican parties approved.   Republican President Bush  exulted in the spread of our home ownership   society   to all classes, and democratic  Barney Frank, chairman of the  House Services committee assured people, erroneously,    that Fannie Mae stock was a good investment  just months before its bailout by the federal government.   (Fannie  Mae, and its  analogous  Freddie  Mac,   hold much of the sub prime mortgage paper issued and backed by the government).   Absent  and unaccounted for was the Securites and Exchange  commission (SEC)  the  federal agency that was to oversee the new type of  “securitized” subprime mortgage  contracts that were then sold world wide  with the quasi backing of the of the US Treasury.

           The question of who was to blame  becomes a “gotcha” game that is not productive.   The election is over and  many hands helped themselves plentifully in the cookie jar of the  booming real estate market of the last decade.   Among the  sad leftovers are  the millions  now faced with homes that are beyond their financial means  to afford.  And how to either  keep them afloat by  “modifying” (i.e. lowering) the original terms, or going through the more drastic foreclosure route, which maybe more realistic, since many previously “modified” marginal home loans have eventually failed and ended on the the foreclosure  block again.  The dubious record of the Japanese,  who  have kept on their collective balance sheet costs of original  purchases  unchanged and not “marked  to market”,  to current much lesser value of these purchases,   has produced  a static ten year period of economic stagnation,  is to be avoided  in our, hopefully more realistic and dynamic way out of  our current meltdown.   We must seek, however,  a more realistic path for stability  and less volatility.  Less boom and bust every decade or so and the inevitable financial agony of many   almost wild interest rate swings and stock market gyrations.

        In the short term—a year or two--  the Fed has the ability to control interest rates,  and keeping them artificially low gradually inflates the money supply in circulation and thus creates “bubbles”,  excess money chasing too little supply in certain economic spheres.   This becomes almost a manic  lemming like over the cliff debacle,  in previous times the classic pursuit of tulips as if gold,  and  only a few years ago of cyber space dot.com stock  issues that over reached,  at least for now,  their true growth value of technology leaders.   And  so  for now with the over heated  housing market.  We all delighted in the continued ability of our homes to escalate in value in the last ten years because of incredibly cheap mortgage rates and the delightful  refinancing  at higher home values.   In the immortal profound simplicity  of Pogo, “we have met the enemy and he is….us!”  And in the short run we must all the suffer for the overflow  from the over exuberant  economic punch bowl we have been enjoying.   After all, in l980  the Dow Jones Industrial average was around  800.   Only a year or so ago it was over 14,000,  when the housing bubble burst and  the Dow is down almost 50% at about 7500.   Of course  we are now agonizingly hoping that this is the bottom.   But around this level,  so far,  not too bad. But if  done more slowly and with less  or no indebtedness  and up and down gyrations,  we would have needed less prozac or ambien  along the way.   And, of course, if it does stabilize around this level!

           The cry now is that we need more regulation on the federal level of our financial markets.   We certainly need more oversight and supervision of  our existing  laws,  and an alert SEC commission  so that the excesses committed  and  ignored under our existing  laws are prosecuted.    But above all  no panic and too much  “throwing money at all our problems”.   It will take us much time and money to help the genuine basket cases involved in the salvageing or foreclosing  the multitude of marginal homes involved already.   Also time to fix our top priority,  our very ineptly, marginally functioning  financial system, which lamentably needs temporary federal jump starting on a massive scale  so that adequate credit can start to flow once more.    Remedying these two major disasters in our societal and economic fabric of existence will ignite the dynamic equilibrium that will make us the envy of the world once again.  Not, of course, instantly.  Lots of screening and evaluating will be    needed .     That heady mix  of freedom,  hard work,  and  compassion for our fellow human being. Balancing the essential need to assist our fellow man  in distress with the just rewards of  those who deserve the fruits of their hard earned labor.  

        Not Solomonic  wisdom, alas,  but dedicated democratic debate  and  honest compromise.