Illusory "Bright Lines"

Two Types of Housing Distress

The key to understanding [the administration's housing] plan will be remembering that there are two different groups of homeowners who are at risk of foreclosure. The first group is made up of people who cannot afford their mortgages and have fallen behind on their monthly payments . . . The second group is far larger. It is made up of the more than 10 million households that can afford their monthly payments but whose houses are worth less than what is owed on their mortgages. In real estate parlance, they are underwater.

--David Leonhardt, "Bailout Likely to Focus on Most Afflicted Homeowners"; The New York Times (2/18/09)

Want to know which group of homeowners receives the higher priority in President Obama's housing bailout, due to be announced today in Phoenix? Look at the price tag.

Conventional wisdom seems to be that helping the first, most distressed group will require around $50 billion; the second, closer to $500 billion.

However, if there's one thing that has become apparent the last two years or so, it's that bright lines dividing one group of troubled homeowners from another are illusory.

Illusory "Bright Lines"

Initially, of course, it was thought that the financial fall-out from the housing downturn was limited to so-called "subprime borrowers" -- all the marginal homeowners who put nothing down using toxic loans with low, initial teaser rates.

With housing nationally now down 20%-25% from the 2006 peak, clearly the pain has spread to the entire market.

Now, the focus is all the homeowners who can afford their mortgages, at least for the time being, but economically would seem to have an incentive to default because their homes have lost so much value.

As the Times' Leonhardt points out, it is the behavior of this second group that holds the key to the housing market -- and perhaps the economy. If they honor their mortgages, things get better; if not . .

P.S.: My post, "What's So Bad About Bad Credit?," addresses this subject as well.

"10 . . 9 . . 8 . . 7 . . "

George Bush's Role in
Today's Economic Car Crash

Everyday Americans -- if not historians -- are likely to remember George W. Bush as the President who crashed the family car (the economy).

However, it would be too easy to simply lay it all on #43 and move on (or try to -- right now we're all sort of waiting for Triple A -- Obama and team -- to show up with the tow truck).

If we're honest about it -- and there will never be a better time than Inauguration Day -- we have to allow that there were other, contributing factors. Such as:

--The car Bush got the keys to had major flaws and defects, at least a few of which were non-obvious (at least to people other than Warren Buffett). The role of credit derivatives, the shadow banking system, the (far too) interdependent global banking system and the consequently high risk of financial contagion -- all these phenomena are only now clearly being understood and dealt with.

--The family "car" wasn't in such good repair. In fact, its chassis and fundamental design date back to The Great Depression. As economic systems go, that's the equivalent of a car with 200,000 miles on it. The economy Bush inherited had none of the latest, technologically advanced safety equipment (like air bags, electronic sensors, etc.), and the basic ones it did have -- like brakes -- were old and poorly maintained.

(In fact, there's ample evidence that, in what can only be called an act of economic sabotage, the brakes were intentionally disabled by the very mechanics hired to fix them.)

--The car crashed not just because the driver was inept -- although that's clear -- but because of poor weather and road conditions. Specifically, visibility was poor, the road was slick, and safety features such as guard rails and proper lighting were sorely lacking.

--Unfortunately, we let the insurance premiums partially lapse. The reason people buy insurance is to make them whole in the unlikely event of a catastrophe. We're now in the position of owning a totaled car, without all the money needed to replace it.

What Would Lincoln Do?

So what do we do now?

The first step is to attend to those passengers and innocent bystanders most severely harmed (financially) by the current crack-up. That includes, but is not limited to, people who've lost their homes, their savings, and their jobs. Over time, we must also attend to those who've lost less tangible but no less real things: their faith, their trust, and their hope.

The next step is to make sure that the current driver is the best possible person for the job. On that score, thank God for -- and God bless -- Barack Obama.

Once those two pieces are in place, the last step is to set about re-designing a brand new car.

As Lincoln understood at Gettysburg, the best (and only way) to honor an otherwise unfathomable sacrifice is for the survivors to rededicate themselves to the completion and perfection of the cause at the heart of that sacrifice.

In this case, that means designing a better, market-based, capitalist economy -- one that's fairer, more productive and even more durable than the one FDR bequeathed us (and LBJ and Reagan adjusted).

FDR Redux?

The Financial Crisis So Far

The country -- and world's -- biggest financial crisis since the 1930's has reopened a long dormant debate regarding 1930's economic policy.

Democrats today subscribe to the notion that FDR did too little during The Great Depression, unnecessarily prolonging it. Had he used even more fiscal stimulus (public works, capital spending, etc.), they believe, the economy would have recovered faster.

Republicans today subscribe to the notion that FDR did too much during The Great Depression, unnecessarily prolonging it. According to them, government overreacted to the 1929 Stock Market Crash and subsequent downturn, greatly exacerbating it.

In retrospect, about the only thing that everyone agrees on is that FDR didn't end the Great Depression -- World War II did.

That said, it seems unassailable that FDR was a beloved figure to many, many Americans. If voters thought he was doing a poor job, their actions belie it: they re-elected him a record three times (of course, future generations may wonder how George W. got elected twice!)

Fast forward to today.

Given an incoming Democratic President and continued deterioration in the banking system and broader economy, you'd certainly bet on more intervention -- and more aggressive intervention -- rather than less. As Americans, we can only hope (and pray) that whatever course of action President Obama chooses is effective.

To paraphrase what Santayana (not to mention Nietzsche) would say of our current predicament: those who disagree about history's big lessons . . . get to repeat them.

Obama's "Goldilocks" Approach

Obama's Fiscal Stimulus
Splits the Difference

"Obama's economic plan falls well short of what's needed."
--Paul Krugman, "The Obama Gap" (NYT, 1/9/09)

"Obama has vowed to do everything at once . . this will be the most complex piece of legislation in American history."
--David Brooks, "The Confidence Surplus" (NYT, 1/9/09)

Depending on who you believe, President-elect Obama has devised a $1 trillion(!) fiscal stimulus plan that either: a) is much too modest in scope; or b) wildly overreaches.

So far, so good . . .

'09 Stock Market Rally

Out of Treasuries, Into Stocks?

"Obama Warns Trillion-Dollar Deficit Potential"
--The New York Times (Jan. 7, 2009)

"Suddenly, a Markets Turnaround"
--The Wall Street Journal (Jan. 7, 2009)

The stock market is famously forward-looking, so it's certainly possible that the rally the last month or so -- up 10% to 20% from its lows, depending on the index -- reflects investors' optimism that the economy is due to start improving (or, as NYT columnist Floyd Norris puts it, that "things are getting worse at a slightly slower rate").

It's also true that tax-loss selling peaks near the end of the year, and that once it subsides stocks frequently rise (called the "January effect," which often as not now occurs in December).

However, it's at least a fair guess that some of the market's rise is due to investors taking President-elect Obama at his word, and exiting suddenly not-so-safe Treasuries. Where does that money go? Stocks, bonds, gold, commodities -- you name it, all these asset categories have rallied recently.

High Risk, No Reward?

For the uninitiated, literally trillions of dollars have flooded into U.S. government debt (T-bill's and bonds) seeking refuge from the stock and credit market crack-up's the last 18 months ago. The stampede has been so great that the yield on short-term debt has effectively been driven to zero -- less when you take account of fees.

Now, with the prospect of trillion dollar U.S. deficits as far as the eye can see, would-be Treasury buyers are faced with the double whammy of minuscule yield and debased currency (in truth, the latter has been a concern for some time, but the magnitude of the risk is clearly rising along with the deficit projections).

Such a combo recalls the Cal Tech football team's slogan: 'we may be small, but we're slow.' Not surprisingly, investors are taking the hint and deploying their money elsewhere.

Obama's Forebears

Obama's Forebears: FDR, Lincoln . . . Gorbachev??

Talk about anticipation: political pundits are already engaged in a spirited debate about which historical leader faced circumstances most closely paralleling the financial crisis now confronting President-elect Obama.

The most obvious candidate is FDR, and the broken economy he inherited in early 1933.

Now like then, the economy is dealing with the aftermath of an enormous asset bubble caused by easy (if not promiscuous) credit and exacerbated by excessive leverage. The carnage includes millions of foreclosed homeowners; a tanking stock market; catastrophic banking and insurance failures; impoverished savers and investors; and the specter of rising unemployment.

Lincoln comes to mind because he also saved the nation from a mortal threat, albeit a political, not economic one.

Through leadership, moral clarity, and sheer resolve, Lincoln prevented the Union from being ripped apart by slavery. Lincoln also appears to be a personal hero of Obama's, who seems to be emulating Lincoln's "team of rivals" leadership style. Of course, as the nation's first Black President, it would hardly be surprising if Obama felt a special affinity for, and kinship with, the Great Emancipator.

But there's a third, more contemporary leader whose situation and challenges at least superficially evoke Obama's: Mikhail Gorbachev.

"Change Agents"

Gorbachev's policies of Glasnost (openness and freedom) and Perestroika (economic restructuring) correctly perceived that the old, Soviet-style command-and-control system required radical reform. Like Obama, Gorbachev was also a figure of great personal appeal, and evident political and intellectual gifts.

Unfortunately (at least for Gorbachev), the changes he initiated spiraled out of his control and ultimately swept away the system he was trying to save (the old U.S.S.R.).

Like Gorbachev, President Obama must preside over a very tricky transition.

His task is to repair and reform a strained system that has already left millions of Americans without homes, without jobs, and with little or no retirement savings. Even before the current financial crisis, tens of millions lacked access to decent health care. As 2009 begins, there are signs that conditions may in fact be deteriorating.

While Obama enters office with a huge store of goodwill amongst everyday Americans -- and especially African Americans -- he must surely be aware that economic desperation and patience don't easily coexist.

It's one thing to campaign on a platform of "change you can believe in." Delivering the right change-- and the right amount of change -- is entirely another.

Floyd Norris Column

"Voting" your Home, or Your 401(k)?

New York Times business columnist Floyd Norris has a provocative piece today titled "Housing Prices and McCain":

http://norris.blogs.nytimes.com/

Norris' premise is that Obama defections are likeliest in "red" states where home prices have dropped the most. Could be, although you'd be hard-pressed to isolate just one factor in causing a former Bush supporter to switch.

When people are feeling this much economic pain, I doubt they make careful distinctions about the precise source(s) any more. However, as I posted on Mr. Norris' blog, you don’t get a monthly statement telling you how much your home price just dropped. It's also the case that, at any given time, only a small fraction of homeowners are actively in the market -- less as we head into the holidays.

Personally, my guess is that people are “voting” their 401(k)’s more than their home prices this election cycle . .