From the beginning, the New Deal's Home Owners Loan Corporation (HOLC) was the appropriate model for dealing with teh fall in home values. Share the problem of bubble purchases between borrowers and lenders rather than force borrowers into foreclosure.

Protecting the lenders has been the preferred approach. Of course, the appropriate solution is fouled to some extent by the securitization of mortgages, which constructs legal Rubic cubes out of straightforward mortgages. But returning to the one-on-one coordination that will keep borrowers in their homes, their mortgages close to market prices, and the flow of payments continuing is the only effective way to keep the housing collapse from dragging down the economy for the next decade.

Here from the New York Times is an assessment of the latest attempt to finesse the essential write-down of principle.

Panel Says Obama Plan Won’t Slow Foreclosures
October 10, 2009
New York Times

By PETER S. GOODMAN

A day after the Obama administration proclaimed significant progress in its effort to spare troubled homeowners from foreclosure, an oversight panel on Friday sharply criticized the program and declared it would leave millions of Americans vulnerable to losing their homes.
In a report mild in language but pointed in substance, the Congressional Oversight Panel — a watchdog created last year to keep tabs on taxpayer bailout funds — said the administration’s program would, “in the best case,” prevent “fewer than half of the predicted foreclosures.”
The report rebuked the administration for failing to shape a program that addressed the most significant engines of the foreclosure crisis — soaring joblessness and exotic mortgages with low introductory interest rates that give way to sharply higher payments over the next three years. Many of those mortgages are too large to qualify for modification under the administration’s plan. People who lose their jobs often lack enough income to qualify for relief.
The administration’s plan appears “targeted at the housing crisis as it existed six months ago, rather than as it exists now,” asserted the oversight panel in its report. “The panel urges Treasury to reconsider the scope, scalability and permanence of the programs designed to minimize the economic impact of foreclosures and consider whether new programs or program enhancements could be adopted.”
In a telephone briefing with reporters, the oversight panel’s chairwoman, Elizabeth Warren, said the administration’s housing program was so limited that it was unlikely to keep pace with the growing wave of foreclosures.
“Even when Treasury’s programs are running at full speed, foreclosures are estimated to outpace modifications by about two to one,” Ms. Warren said. “It simply isn’t clear that the programs in place will do enough to tame the crisis and have a significant impact on the broader economy.”
The Treasury acknowledged that its anti-foreclosure program was limited, with the effect of rising unemployment not fully checked. But the department said other relief efforts, like extended jobless benefits and continued health insurance for people who lose work, were better suited to alleviating economic distress than the housing program.
“In developing this program, it was critical that we address challenges that could be solved quickly with the tools available to us to ensure the most effective use of taxpayer money,” said Meg Reilly, a Treasury spokeswoman.
The administration’s decision to limit the cost of its one program aimed at helping homeowners could become more contentious as the foreclosure crisis grinds on. Populist anger has flashed over the rescues of major institutions including Citigroup and the American International Group — the most prominent components of a $700 billion taxpayer-financed bailout — while homeowners struggle.
“These Treasury people are all from Wall Street, and they’re not doing anything but protecting Wall Street,” said Melissa A. Huelsman, a Seattle lawyer who represents homeowners fighting foreclosure. “They don’t care in the least about protecting homeowners.”
When the Obama administration began its $75 billion Making Home Affordable program in March, it said the plan would spare as many as four million households from foreclosure. On Thursday, Treasury announced that 500,000 homeowners had since had their payments lowered on a trial basis, celebrating this as a milestone.
But the report from the oversight panel directly challenged the administration’s characterizations.
Most prominently, the panel had grave uncertainty about whether large numbers of the trial loan modifications — which typically run for three months — would successfully be converted to permanent terms.
As of the beginning of September, only 1.26 percent of trial modifications that had made it through the three-month trial period had become permanent, the report found. Of course, very few of those trial loans had reached their three-month expiration because the program only recently began processing large numbers of applications. As of Sept. 1, the Obama plan had produced 1,711 permanent loan modifications.
Some homeowners complain they have received trial modifications only to have them canceled for what seem dubious reasons — checks sent but supposedly never received, documents once in the file but suddenly missing.
“We’re on the phone arguing with mortgage companies every day,” said Dan Harris, chief executive of Home Retention Group, a company that negotiates with mortgage companies for loan modifications on behalf of homeowners, adding that trial modifications for four of his clients had been canceled over the last month. “It’s incredible.”
Major mortgage companies say they have significantly increased staffing to better manage the flow of paperwork, while notifying customers of the need to send in fresh documents to make their trial modifications permanent. But the companies offer no assurances that a large number of trial modifications will indeed become permanent.
“The process is too new,” said Dan Frahm, a spokesman for Bank of America. “We don’t know the number.” He estimated that 15 percent to half of all trial modifications would fail to become permanent.
The Treasury expressed hopes that a newly streamlined process that allowed borrowers to submit documents to mortgage companies more easily would help make large numbers of trial modifications permanent.
“We are intent on working with servicers to ensure that eligible borrowers receive permanent modifications,” said the department spokesperson, Ms. Reilly.
The oversight panel’s report expressed chagrin that the vast majority of loan modifications did not lower loan balances, leaving many homeowners still “under water,” or owing more than their homes were worth.
This tends to lower all property values, the report noted, because underwater borrowers have less incentive to care for their homes, and greater reason to stop making payments and default.
An Obama administration official who spoke on condition of anonymity, citing a lack of authorization to speak publicly, said the Treasury would have preferred that the program focused more on writing down principal balances but ultimately opted against it because “that would make it significantly more expensive to the taxpayer.”
In Wauwatosa, Wis., Theresa Lutz, 47, has been seeking to lower the payments on her home for several months. She is a graphic designer whose working hours were cut last summer. In September, her employer cut her salary by 6 percent. That has made it difficult for her to pay her monthly mortgage of $1,307.
As Ms. Lutz described it, her mortgage company, Wells Fargo, initially agreed to lower her payments. But then, last week, the bank informed her that she would have to come up with a fresh $3,000 to compensate the investor who owned her loan.
A Wells Fargo spokesman, Kevin Waetke, said that information had been conveyed “in error” and “the customer has been notified that payment does not need to be made.”
As Ms. Lutz struggled to clarify her agreement with Wells Fargo, she expressed dismay at news of the oversight panel’s report, and its finding that not enough help seemed to be on the way.
“It looks to me like Wall Street is too invested in our government,” she said. “Big business is winning out over the average person.”

House price decline may not be abating

One of the recent claims is that house prices are falling less rapidly than they were before. Declining at a slower pace, is the term. We believe this is wrong. Even in the math. If zero were the base, it would be conceivable. But house prices are not going to fall to zero. They have some positive value. If this positive value is in any way significant, then the denominator of the percentage fall gets smaller faster than in the case of a zero base.

It's too damn bad the solution chosen was not an effective Home Owner's Loan Corporation or effective protection in bankruptcy. Instead it is the supply side of the market that is being salted with free money from the Fed to bring down mortgage rates. This may help those in good shape to refinance and generate some better cash flow, but that is going directly into the savings account and is not going to help demand.

Here is housing expert and noted economist Robert Shiller's take. This is the Shiller of the Case-Shiller Home Price Index.

Why Home Prices May Keep Falling,
by Robert Shiller,
Commentary, NY Times:

Home prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010.

...

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. ... If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And ... we still appear to be in a continuing price decline. ... One could easily believe that people are a little slower to sell their homes than, say, their stocks. But years slower?

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers ... have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. ... And they don’t like shifting from being owners to renters... Among couples...,... any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn. This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting...

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

Housing Bust Shatters State Migration Patterns

William H. Frey has put up a stark reminder that economic dislocation is not all about your statement of net worth.

Frey is a senior fellow at Brookings in the Metropolitan Policy Program. The link is here.

Analysis of the new Census Bureau annual estimates of state population changes for 2006-7 shows that the sinking housing market has yanked back high-flying states like Nevada and Arizona. An even bigger tug in growth occurred in Florida, another housing-boom driven state. With credit harder to get and the disappearance of housing deals, the allure of these states appears to have dimmed.

Meanwhile, the up-scale states—California, New York, New Jersey, and Massachusetts—are seeing fewer residents leave for a lower cost of living elsewhere. And those states benefiting from the previous flight to affordability—Nevada and Arizona in the west; Florida in the south; and Pennsylvania and New Hampshire in the east—have shown slower migration gains or greater declines.

Even the states surrounding Washington, D.C., another hot market, have attracted fewer migrants. Potential home buyers in the outer suburbs of Virginia and Maryland face trouble getting credit and recent buyers in the District and inner suburbs are stuck because they cannot sell.

The D.C. region has, in short, become a microcosm of the nation’s reaction to the housing bust. Like in Nevada and Arizona, the market for the region’s suburban buyers is drying up due to the credit crunch, and construction and in-migration is stalling. But the District and inner suburbs are more like coastal California, where housing-rich residents are waiting to sell in order to move to opportunities elsewhere.

In sum, there appears to be a migration correction going on. We’re at the beginning of a leveling off of migration between unaffordable and affordable America. As with the broader economy, we don’t know how much longer it will last.

Forecast and Commentary from April 2006

I've been bad about bragging without documenting the correct calls of the past. This is from my stint at the Northwest Progressive Institute. I'm dragging those posts to this site and came across it today.

One of the dreadful experiences of understanding a little economics is to watch those approaching retirement vote against schools. They have dollars in the bank, their kids are grown, Why should they worry?

Another is looking at the enormous investment in housing. Homeownership is a beautiful thing, look at the employment and tax revenue coming in, How can we lose?

The May 2006 issue of Harper's has on its cover a man carrying a house on his back. The article is entitled "The New Road to Serfdom." In it there is a graphic I pray is not correct. It identifies 90% of debt since 2000 as being mortgage debt. That would mean only 10% of debt has gone to credit cards, college loans, and oh yeah, plant and equipment.

The current debt-driven economic activity is founded on housing investment. Investment creates jobs up front. Every kind of investment. But investment in essentially passive assets, like housing, does not generate economic well being down the road like productive assets do – education and equipment and so on. It generates interest payments.

The Harper's article is instructive, if a bit pat. It's great if you like charts, because that's what it is - a dozen charts with explanatory captions. It advises of a possibility that low interest rates lure people into enormous debt loads, possibly shackling the owner to his house for decades, making payments as equity shrinks, giving lie to his hope for a valuable asset at the end of his working years.

The situation is similar to the pension crisis. (See the Seattle Times 04.04.06 article.) For dozens of years people worked, in part, for the promise of an affluent retirement funded by the company's pension. Now, one after the other, the corporation's promise has been turned over to the government for fulfilment. The "self-made" men and women wait in line to see what can be salvaged of their expectations.

Bethlehem Steel, US Airways, Kaiser Aluminum, Pan Am, and locally Consolidated Freightways, Lamonts, and Longview Aluminum, have given up their pension obligations to the federal Pension Benefit Guaranty Corporation, which now has $56 billion in assets v. $79 billion in future liabilities.

The point I want to make is that today's sure bet is tomorrow's last place finisher. Do not look at dollars. Dollars are a great medium of exchange, but a lousy store of value. They're a good way to compare goods, as in eggs are expensive, cars are cheap, but it is wrong to assume that both are being measured by a standard unit which has value in itself. They are expensive and cheap relative to each other. The dollar is simply a medium to make the comparison.

If you want your house to be worth something, or your pension to be there, or your stocks to pay off, you need to build an economy that works, with workers who will be able and willing to pay the price you want. It is their demand, not some numbers on a bank statement, that ensures value. You can lock up your greenbacks and bury them in the ground, but without that growing economy, they'll turn to dust no matter how well you wrapped them. There is no "I've got mine, now you guys fend for yourselves." You can be robbed by inflation, crashing stocks, ballooning health care, etc., etc., etc., but at its root it will always be a weakening economy that could have been floated by sound investments and reasonable trade structures.

Taxes for schools will generate economically viable citizens and reduce unnecessary drains on public coffers in the future. These are the people who will buy your house, fund your pension (including Social Security) and make your stocks worth something.

Mortgage borrowing, federal debt, everyone a millionaire... It's a hoax that is often too disturbing to contemplate, so we don't. But someday we'll have to. Our hind ends will get blasted if we keep our heads buried in the sand.

P.S. - In my last post I forgot to mention that Paul O'Neill, the former Treasury Secretary under Bush, also termed "not acceptable" W's 1990 scam with Harken Energy that we covered earlier this year. "Did I ever do an untimely filing of Form F?" O'Neill said. "No. Any other questions?"

It's timely now because W's fellow travelers at Enron are in the dock this week.

AWOL - Where is the political angst when you need it?

Listening to the first part of the House Financial Services Committee hearing on predatory lending and financial sector packaging is tedious. The consensus is, "Let's get the money flowing like it was before, but protect the borrowers from getting fleeced."

The money will not flow in a healthy mortgage sector in the same amounts, because those amounts were based on too low interest rates and packaging of mortgages to sell in shady CDOs upstream. Lots of cheap money leads directly to this kind of bubble and bust, it is the leverage that makes that kind of volatility possible.

Inflating home prices made people feel good, and lets them think that they are financial geniuses and promotes spending and so on, but in the end saddles people with debt they don't want and undermines the security of their financial assets and breaks their nest eggs.

The current hearings notwithstanding, and recognizing Chairman Franks went so far as to clear his calendar, nobody I am aware of is pressing the culpable in the recent financial sector screw-up or reforming the troops around legitimate policies.

• Bombs are dropping on middle class America with housing prices crumbling. It is not only those losing their homes, but those who are losing equity who are hurt.


• The bombers are the ludicrous mortgage peddling schemes, but they were sent into the skies by the too low for too long interest rates set by the Fed.


• Traditional defense have been sabotaged by the same bogus financial actors who force-fed the mortgage peddlers. Bad loans were packaged and gilded with spray paint and sold upstream as gold bricks.


• Yes, home buyers should have known it was too good to be true. Buyers of packaged debts should have wondered why they were so light. But even if all the naive or purposefully apathetic are punished, many millions of others are innocent victims.


• Homeowners who were led out into the open by the Fed's low interest rates are being blamed for coming under fire. It's like blaming those in the twin towers for being at work in what they knew was a terrorist target.

The problem is that the generals are chicken hawks. The Fed knows nothing other than the big red interest rate button. The "Easy" button. The Supply Side strategy of the Bush administration never worked and never can work. The SEC has political hacks rather than marshals of the market.

Were the shoe on the other foot, and a Democrat in the White House, the traveling Republican bellows would be touring the talk shows fanning the flames of crisis into full-blown panic. Look what they did with 9-11.

On the other hand, the Democrats are revealing too much about themselves when they are not on top of this. This is not a passing problem. The housing sector has saved the economy during the past six years. Debt for households, debt for government, cheap money, falling dollar.

Interest rates can be low and stable if the credit worthy are the only people able to borrow and if margin requirements on every kind of financial exchange are raised. High.

Have the Democrats bought into market rhetoric? Do they believe the architects of this falling house of cards who seem to say the Market is still prescient, but that it needs to be calmed like an hysterical matron (Jim Cramer?).

To revisit stocks: Be sure, stocks are not up because of strength in their fundamentals or faith in the economy, but because the villas of SIVs and hedge funds got washed away and all that liquidity at the top has only stocks, commodities and currency hedges to run to.

There is no strength.

The dollar has been heading south for years, fleeing Supply Side II and Greenspan Cheap. Now, with Bernanke cutting rates, it's on the run. With it goes the Chinese yuan, being pegged by its government. Look for the rest of the world to try to quarantine the US and China.

Let's put it simply:

• The Fed under Greenspan held short-term rates under water so long, they expired as a tool of economic policy. (See inverted yield curve. The back end of the yield curve is not responding.)


• The Bush tax cuts and Fed bailouts and so-called financial innovation have liquidity sloshing around at the top. This is the excess in the financial system that is the source of instability.


• Bush economic chicken hawks have spared the financial sector from even the most minimal standards. The bad apples have gotten into the barrel. Even Wall Street's less intoxicated voices can be heard calling for hedge fund disclosure and conflict of interest protections. The Bush team is in the bunker and out of earshot.
  

Dear Democrats: It's the economy, stupid.

Mortgage and predatory lending bill introduced in the House

Policy response is finally on the floor:

A House Financial Services Committee proposal goes part way to closing the barn door after the horses have been rustled.

“The Mortgage Reform and Anti-Predatory Lending Act of 2007” introduced today in the House Financial Services Committee steps up to some of the needed protections for homeowners. Still, those who were force-fed shady loans downstream from Bear Stearns will not fare so well as the befuddled buyers of them upstream. That is, the Fed is not going to bail anybody out with less than a six-figure income.

At least some action is being taken:

The bill will reform mortgage practices and improve consumer protection. The proposed legislation

• Calls for licensing and registration of mortgage originators, including brokers and bank loan officers. It prohibits steering, and establishes "a federal duty of care."
• Sets a minimum standard for all mortgages, including the condition that "borrowers must have a reasonable ability to repay."
• Attaches limited liability to secondary market securitizers who package and sell interest in home mortgage loans outside of these standards. (Individual investors in these securities would not be liable.)
• Expands consumer protections for “high-cost loans” under the Home Ownership and Equity Protection Act.
• Protects renters of foreclosed homes from being evicted. Lease terms must be honored. Absent a lease, renters have 90 days.
  

Sponsors are: Reps. Brad Miller (D-NC), Mel Watt (D-NC) and Barney Frank (D-MA). "This bill represents a significant step forward to clean up and prevent a number of the questionable practices that, unfortunately, took hold in the mortgage lending industry in the last several years. I hope the industry will embrace the changes and allow the bill to move forward quickly” said Watt.

This is on the table, but it will be buried under hundreds of thousands of mortgages already signed.

At a minimum, the Feds need to mandate SEC regulation of hedge funds, at least with regard to disclosure. The corrupt repackaging of securities is just part of what is a bigger mess. They have apparently infected money market funds, supposedly safe havens. The reason hundreds of billions in bad paper can be floated so easily is that practices are not open to the public.

Sure, the ratings agencies broke down, but with transparency, objective eyes -- those belonging to non-clients -- would have exposed this stuff.

See our proposals for an effective response at Demand Side Economics Policy Index.

5 Lessons and 7 Remedies for the Mortgage Meltdown and Credit Crunch

The meltdown in mortgages, overbuilding of housing stock and infestation of the world's financial markets by bogus instruments is a failure of the entire financial system: Banks, hedge funds, investment institutions of all types, rating agencies, the Federal Reserve Board and its chairman, local mortgage brokers and loan originators, state regulatory agencies, and individual home buyers. Ultimate responsibility for the order of the market lies with the Federal Reserve.

What are the lessons from the housing debacle that is now unwinding? That is, What are the lessons that should inform policy?

Too much congratulation and not enough corporal punishment is being dealt the Fed.


The need for financial markets to be regulated has been exposed by one crisis after another. The S&L bailout, the Long Term Capital Management fiasco, Enron and World Com and many more in between. Rather than set standards and hold to them, under Greenspan and Bernanke, there has been cheap money at the end. This in spite of a direct mandate from Congress.

• The Fed is not going to regulate, or indeed, set any standard at all, nor use any tool other than short-term interest rates, no matter what problem confronts it.


• The Fed is going to bail out the financial sector whenever things go bad for them. This insurance makes a mockery of the "risk" for which they compensate themselves so well. So mortgage holders should stop looking.


• No other sector will be bailed out, because the Fed is in thrall to the financial sector. When banks moved to broad services over the past four decades, they took their control of the Fed with them.


• Neither inflation nor recession is as important to the Fed as padding the financial sector. The need for "confidence" in the financial markets, which turns out to be a "confidence game," trumps both inflation and recession in the mind of the Fed. Prediction: As soon as financial firms and hedge funds signal their solvency, the Fed's practice will be to support the value of the dollar for as long as possible. This will be done for the benefit of its financial sector constituents. The announced reason will be to stem inflation pressure, but the inflation will be cost-push from higher commodities and imports, rather than demand-pull, and so higher interest will not touch it.


• The financial sector controls monetary policy and monetary policy is out of control (see inverted yield curve).

The absence of action by the Fed is the big problem. The policy response MUST do what the Fed has not done and -- of equal importance -- institute a clear civilian control of the financial sector, both in fact and in the minds of the public.

Seven Policy Remedies

1. Financial transaction tax, a .0025 tax on the value of each financial transaction. This one-quarter of one percent. This will be incidental to most transactions. 25 cents on every one hundred dollars, or 25 dollars on every ten thousand dollars. For transactions with high leverage, this tax is relatively more for the hedge fund, since they will incur the tax on the total no matter that their total is small. That is, if using a million dollars, they leverage another nine million for the transaction, the effective tax on them is 2.5 percent. If money is being moved higgley piggley to take advantage of short-term arbitrage, over a year's time it will be subject to the tax several times. The yield of such a tax would be immense. The cost to the real economy would be negligible. (This is similar to the Tobin Tax, proposed to slow down the mad rush of currency speculation around the globe.)


2. New top marginal rates on personal income tax, no income source excluded, of 50% on $1 million or more and 90% on $10 million or more. Take the reward out of high risk. Return sobriety to corporate governance. The companies of Europe are winning with executive salaries one-third of those in the U.S. Top hedge fund managers make $1 billion per year.


3. Reestablish the SEC. William Donaldson, former head of the SEC, whose appointment actually brought confidence in Wall Street back from the grave after the Enron and World Com fiascos, abandoned the post after three years. Partisan hacks returned to the posts. Donaldson has called for "getting tough" on conflict of interests, increasing oversight and closing the loophole that lets hedge funds play in the market without disclosure of their practices.


4. Windfall profits tax. There are obscene rewards to those who take a company private, do financial slicing and dicing, and sell it back to the public. These and other financial gymnastics are today's replacement for productive work. They do not have to be encouraged in the tax code.


5. No free lunch on bailouts. Companies and funds who are bailed out with cheap money from the Fed need to be identified individually and dealt with individually. Rather than this upper class welfare, there needs to be a price for liquidity, a share of the firm or specific repayment conditions, that benefit the government and the people who are footing the bill. Stiglitz seconds this suggestion in his piece:

Those in financial markets who believe in free markets have temporarily abandoned their faith. For the greater good of all (of course, it is never for their own selfish interests), they argued a bailout was necessary. While the US Treasury and the IMF warned East Asian countries facing financial crises ten years ago against the risks of bail-outs and told them not to raise their interest rates, the US ignored its own lectures about moral hazard effects, bought up billions in mortgages, and lowered interest rates.

....

It may make sense for central banks (or Fannie Mae, America's major government-sponsored mortgage company) to buy mortgage-backed securities in order to help provide market liquidity. But those from whom they buy them should provide a guarantee, so the public does not have to pay the price for their bad investment decisions. Equity owners in banks should not get a free ride.


6. Mortgage loan disclosure. Surveys, investigations and anecdotal evidence by the boxcar load have shown that many home loan purchasers do not understand the terms of their loans. This is not confined to unsophisticated subprime borrowers. A simple one-page disclosure summary is available that sets things down in black and white. It needs to be mandated for every mortgage.


7. Strict limits on the type of mortgage instruments. The ARMs promoted by Alan Greenspan are not appropriate. They are speculative instruments. Prepayment penalties are loan shark stuff. Congress must set a strict limit on the types of loan that are eligible for income tax interest deduction.

These are what could be done. The collapse in pother nations' economies undergoing similar stress in the housing sector did not happen. These countries have at least minimal standards for financial institutions and instruments. The rest of the world does not let financial markets regulate themselves.

The housing debacle

What are the lessons from the housing debacle that is now unwinding?

First and most important, we were right. We predicted the housing collapse. We'll dig up the links and enter them on the web site treatment on Friday.

We predicted that the low interest policy of the Fed would produce the bubble. Others have talked about how the leverage and corruption of the mortgage brokers was key, but the cycle begins at the beginning -- turning housing into an investment. Speculation fever follows as prices rise. Then the leverage and the corruption.

Too much congratulations and not enough corporal punishment are being dealt the Fed. Under Greenspan and Bernanke, there was low interest at the beginning and bailing out at the end, with absolutely no oversight in the middle (or anywhere, really).

Second, others predicted it as well. Dean Baker is foremost among these. Baker of CEPR and now the American Prospect used a simple historical trend analysis comparing housing rents to home prices over time. It worked. He should be on every talk show in the nation.

Third, the people who didn't see it coming are still the "experts." (Much like in another key blunder, when Thomas Friedman and even the Neocons blew the Iraq analysis, yet are still showing up as experts. Compare this to others -- George McGovern, Joseph Stiglitz -- who offered accurate analysis and peaceful, productive resolutions. They are still on the outside.)

So, fourth, the people who say, "Nobody saw it coming" were and still are listening only to each other.

This debacle continues the ballooning of the financial sector. Henry Kaufman, formerly of Salomon Brothers and now of Henry Kaufman & Co. and hardly a communist, reported that the Finance Sector is now bigger than Health Care and Energy combined. Why not? Too bad some homeowners can't get hold of that "liquidity" and out from under their ARMS. Now is the time to buy stocks in the financial sector, before everybody realizes that -- just like in 1987 and 1998 -- the Fed is bailing them out. They get a hundreds of billions of "too big to fail" insurance for free.

Upcoming we'll look closely at tool the world class analysis at the Fed is linked too. It looks a lot like a catapult. The Fed's single blunt instrument is its control over short-term interest rates. It doesn't matter how smart you are, the interest rate is (1) ineffective against inflation, (2) operates with a lag in producing growth and is wildly inferior to fiscal policy for jobs, but (3) is great at bailing out a financial sector.

Outlook for the economy as housing deflates? Which economy?

• The financial sector will likely bounce back with great new investment opportunities.


• The wealthiest 20 percent will no doubt wonder what everybody is complaining about.


• The middle class will watch their home values receding in front of them as they approach retirement.


• The multiplier will bring down wages.


• The collapse of housing could create more hysteria in the immigration discussion, as migrants move out of their niche in relatively low-skill residential construction and residential support and compete for other jobs.


• A huge burden of private debt has been created, for the purpose of building an immense stock of passive housing vs. productive assets. And very little of this building was green. Both the debt and the character of the housing stock will weigh us down.

What a mess.

Forecast: Housing, pensions, disappearing dollars

One of the dreadful experiences of understanding a little economics is to watch those approaching retirement vote against schools. They have dollars in the bank, their kids are grown, Why should they worry?

Another is looking at the enormous investment in housing. Homeownership is a beautiful thing, look at the employment and tax revenue coming in, How can we lose?

The May 2006 issue of Harper's has on its cover a man carrying a house on his back. The article is entitled "The New Road to Serfdom." In it there is a graphic I pray is not correct. It identifies 90% of debt since 2000 as being mortgage debt. That would mean only 10% of debt has gone to credit cards, college loans, and oh yeah, plant and equipment.

The current debt-driven economic activity is founded on housing investment. Investment creates jobs up front. Every kind of investment. But investment in essentially passive assets, like housing, does not generate economic well being down the road like productive assets do – education and equipment and so on. It generates interest payments.

The Harper's article is instructive, if a bit pat. It's great if you like charts, because that's what it is - a dozen charts with explanatory captions. It advises of a possibility that low interest rates lure people into enormous debt loads, possibly shackling the owner to his house for decades, making payments as equity shrinks, giving lie to his hope for a valuable asset at the end of his working years.

The situation is similar to the pension crisis. (See the Seattle Times 04.04.06 article.) For dozens of years people worked, in part, for the promise of an affluent retirement funded by the company's pension. Now, one after the other, the corporation's promise has been turned over to the government for fulfilment. The "self-made" men and women wait in line to see what can be salvaged of their expectations.

Bethlehem Steel, US Airways, Kaiser Aluminum, Pan Am, and locally Consolidated Freightways, Lamonts, and Longview Aluminum, have given up their pension obligations to the federal Pension Benefit Guaranty Corporation, which now has $56 billion in assets v. $79 billion in future liabilities.

The point I want to make is that today's sure bet is tomorrow's last place finisher. Do not look at dollars. Dollars are a great medium of exchange, but a lousy store of value. They're a good way to compare goods, as in eggs are expensive, cars are cheap, but it is wrong to assume that both are being measured by a standard unit which has value in itself. They are expensive and cheap relative to each other. The dollar is simply a medium to make the comparison.

If you want your house to be worth something, or your pension to be there, or your stocks to pay off, you need to build an economy that works, with workers who will be able and willing to pay the price you want. It is their demand, not some numbers on a bank statement, that ensures value. You can lock up your greenbacks and bury them in the ground, but without that growing economy, they'll turn to dust no matter how well you wrapped them. There is no "I've got mine, now you guys fend for yourselves." You can be robbed by inflation, crashing stocks, ballooning health care, etc., etc., etc., but at its root it will always be a weakening economy that could have been floated by sound investments and reasonable trade structures.

Taxes for schools will generate economically viable citizens and reduce unnecessary drains on public coffers in the future. These are the people who will buy your house, fund your pension (including Social Security) and make your stocks worth something.

Mortgage borrowing, federal debt, everyone a millionaire... It's a hoax that is often too disturbing to contemplate, so we don't. But someday we'll have to. Our hind ends will get blasted if we keep our heads buried in the sand.


P.S. - In my last post I forgot to mention that Paul O'Neill, the former Treasury Secretary under Bush, also termed "not acceptable" W's 1990 scam with Harken Energy that we covered earlier this year. "Did I ever do an untimely filing of Form F?" O'Neill said. "No. Any other questions?"

It's timely now because W's fellow travelers at Enron are in the dock this week.

State Housing and Employment

Cheery news always sticks to the top of the Business page, while grimmer news seems to slip into the fold. Housing slows and its, "Home buyers don't have to pull the trigger as fast." An uptick in the jobless rate, "No problem... There is really no negative to put on this." (TNT) I'm here to put the negative on it. And the second Tuesday is now prediction Tuesday for state and local economic numbers.

While the overall economy in Washington will fare better than that of the rest of the country, as we enter the second dip of the Bush recession, state and local revenues will suffer, housing will suffer, and employment will suffer.

Housing

Home sales in most of the state have reached their peak. King County's will top out pretty soon. By this time next year (end of February reports), home prices will be down 5 to 10 percent in King County and 10-20 percent elsewhere in the state. Here are our benchmarks.

Actual February 2006 median home sale prices

King County - $345,000
Pierce County - $250,000
17-County Area * - $283,000
(*covered by Multiple Listing Service)

Predicted February 2007 median home sale prices

King County - $325,000
Pierce County - $220,000
17-County Area - $250,000

Picking the peak of a trend is the most difficult. Things tend to trend over long time periods. Can't find anybody else making predictions about housing. If you see some, drop us a line.

Employment

Employment growth will be nonexistent in Washington over the coming year. That is, zero job growth. I am not going to predict the unemployment rate, because it's been boogered by the Bush team and I haven't got a handle on it.

Background from economist John Williams:

"Richard Nixon had a highly publicized war with the Bureau of Labor Statistics on the unemployment data. Nixon wanted to report the unemployment rate as the lower of the seasonally adjusted or unadjusted number, at any given time, but not specify same to the public. While that approach was unconscionable at the time and never used, basically the same methodology was introduced in 2004 as "state-of-the-art" by the current Bush administration."

I just played with some employment growth v. employment rate figures from the 2006 Economic Report of the President. Clinton added 18.4 million jobs in his eight years. The unemployment rate dropped from 6.9 to 4.0. Bush added a total of 4.8 million jobs in five years, and the unemployment rate rose only to 5.1. Supposedly its down to 4.7 now. Something is very funky. I'll give you a chart next week.

State Revenue

Tax revenue growth has been set at 5% by OFM's chief forecaster Irv Lefberg. I've tried to budge him, but he's sticking to it. (Actually official baseline growth is only 2.2% next year, but it jumps to 5.7 in 2008 and continues at about 5 percent thereafter.) Barring legislative action, revenue will grow substantially slower -- 1.1% short term and 3.0% long term.

Economy on meth, but it's smiling

The difficulty in communicating the true condition of our economy to the larger public lies in the fact that the rotting walls are concealed behind flowery wallpaper. Enormous federal and private borrowing have created an artificial demand which obscures the decay. It won't take much of a tremor to severely damage the structure. Even the current tepid situation cannot be sustained, much less built upon. But there is demand, and the house hasn't fallen apart yet.

Because many on the left are convinced of the underlying weakness of the Bush economy, we sometimes fudge the numbers to show it. An EPI snapshot last week compared productivity to income and net worth. The period 1998-2001 was compared with the next three year period 2001-2004. Not surprisingly the boom years of the late 1990s treated people better than the best years following Bush's tax breaks for the rich. But it looks suspicious when we cherry pick the time periods.

I won't reproduce the chart for fear of copyright infringement, but the sums are Productivity 8.2% v. 11.7%, first period v. second, and Median Family Income 9.5% v. 1.6%. A bit more ambiguity occurs if you look at the stream of productivity vs. real hourly compensation, as below.


The underlying point is valid. Under Bush and the corporate domination of government and the economy, the fruit of productivity increases has been stolen from working people. Ravi Batra has made the wage-productivity gap a cornerstone of his analysis. This is an intriguing if not completely convincing tack, and certainly points in the inevitable direction. One should also note that productivity can be got by several means, one of which is cutting hours and producing the same product. Hours suffered under the Bush regime.

Economic understanding is at a postwar low, however, and even after six years of bullshit and spin, with massive deficits and little to show for it, Bush has not needed to change his line. His doofus economics still gets a hearing.

"Losing jobs is painful, so let's make sure people are educated so they can find – fill the jobs of the 21st century. And let's make sure there's pro-growth economic policies in place. What does that mean? That means low taxes; it means less regulation; it means fewer lawsuits; it means wise energy policy."

... pitiful.

Economic prognosis from the state's forecaster

I watched Victor Moore and ChangMook Sohn in front of the Senate Ways & Means committee Wednesday. Moore is head of the Office of Financial Management and was outlining the governor's budget. Dr. Sohn is head of the Office of Forecast Council, and he was there to predict revenues and economic events.

Moore did a good job, but I've covered the budget elsewhere.

One Note: Low-income heating assistance has already passed both houses and been signed by the governor. The Guv had called for speedy action. She got it. Kudos.

Quite a difference from the disgrace in the other Washington, where in an apparent fit of pique over losing drilling rights in ANWR, Republicans took federal low-income heating assistance off the table. It had lost its meaning as a bargaining chip. See December 27, NPI "Payback ..." post or CBPP.

On the revenue side, Sohn's revenue update for January 10 shows another increase to the surplus. Real Estate Excise taxes were up 6.5% and Revenue Act taxes (retail sales, B&O, utility, mostly) were up 4.1%, netting a neat $27.8 million. The update displays a drop in school levy collections without explanation, and what is likely to be a continuing disappointment in cigarette taxes (as smokers avoid the tax by stopping or smuggling).

To the committee, Sohn was slow in his delivery, but he was pointed on one topic. He said that while the acceleration of housing activity would level off, the sector would continue to be strong, and would not collapse. This and continuing higher oil prices were the two primary economic determinants for the coming year.

When asked about interest rates, Sohn pointed to the rise in short-term rates due to Fed action, probably to 4.75% later this month, while long-term rates seem to be stuck at 4.5%. The good doctor did not fret, as some others have, about the so-called interest rate "inversion," (although it was covered in his November forecast). Short-term interest rates should always be lower than long-term rates, because of the risk premium.

Interest rates are a poser. As Sohn points out, short-term rates are rising. Long-term rates ought to be rising, too. But they're not. Is this a good thing? Or does it indicate basic weakness? (Or maybe strength? There are many who see it this way. Imagine stable, low interest rates as far as the eye can see. It's a worthy goal, but this is not how you do it. I am reminded of Dow 36,000 and the "New Economy" of the late 1990s, an economy which had finally outrun recessions.)

Long-term rates should be rising not only to reflect short-term rates plus risk premium, but because mortgages and federal debt are stoking demand, while at the same time the weakness of the U.S. trade situation should be weakening the dollar.

The fact that long-term rates are not rising means to me that there is plenty of supply. Which means investors want safety over return. Not a good sign. Boomers are scared out of the stock market. Asian countries are flush with the booty of huge trade surpluses and are stashing dollars. Wealthy individuals have tax cuts they don't know what to do with. It certainly ain't coming from working families, since household debt has increased markedly since Bush got in, and net savings went negative for the first time in history according to a December report by EPI.

A creative alternative explanation is available at the Economist's View blog. (Please keep in mind when reading this stuff that inflation has been dormant since the early 1990s, and Greenspan gets the credit no matter what he does, raise the rate to 7% or lower it to zero. Please review my previous takes on Maestro Magoo, and discard the idea that the market has confidence in the Fed.)

(The Economist's View blog and this one would be useful to compare over a period of time. The author believes housing is poised to take off again. I do not.

An end to the bubble or no?

Predicting an end is not so difficult. The alternative is to forecast a boom that goes on forever, like the .... Well, I guess we haven't had one. If it's a bubble, it will burst. This is my opinion. When houses stop appreciating, things will not flatten out, as Dr. Sohn predicts. They will begin to descend, because the speculative motive will have disappeared. Dean Baker of the Center for Economic Policy Research has shown that house prices are already well outside their historic relationship with the rental market. It is by no means the case that houses are being bought exclusively by first-time homebuyer. Quite the contrary. Prices are often outside the range of this group, except with the off-the-wall mortgage instruments.

Dr. Sohn's view is that this is not a bubble, but a run-up in housing that will level off benignly. Thee are plenty of folks who present this view. I hope so. Though if you've made your money, you might want to get out of the market now, just to be safe. You could always put your gains in ... government bonds.

Housing weakness portends economic bad times

The AP reports that mortgage lenders are seeing a slowdown in re-fi's and home buying. This is bad news for Washington's economy, as well as for the whole country. Residential construction, remodels, and attendant purchases have floated the economy for the past four years. Re-fi's have brought equity out of houses and into the consumption economy. It had to end. The question is, How hard will we fall?

The economy of Western Washington ought to be rising with its big exporters like Boeing, Microsoft and Paccar. Instead, we like the rest of the country, have been floating on the sea of red ink in residential construction and housing-related activities. (The red ink from the Feds, funneled into the pockets of the rich and into the war in Iraq, doesn't do much for the economy.)

The state's chief forecaster Chang Mook Sohn has been warning for some time that the improvement in the state's finances he projects depends on housing, and when it falls, it could take the state down with it.

Historical trends analysis developed by Dean Baker of the Center for Economic and Policy Research (www.cepr.net) says the correction could be sharp. Baker was one of the few economists to call the stock market bubble bursting while others were blithely predicting the New Economy would carry us up to Dow 36,000. For the past several years he has predicted a similar bursting of the housing bubble.

When it happens it will kill the jobs picture here in Washington and will absolutely crunch the revenue situation for all levels of government. With the Rube Goldberg revenue archetecture we've got, and the general ignorance purveyed by the anti-tax right wing, the outcome is not pretty to contemplate.