It isn't facts that are important anymore, it is your Point of View.
For example, let's take mortgages and debt.
The "Progressive" point of view- Evil mortgage bankers exploited the ignorance of hard-working lower and lower middle class Americans by selling them time-bomb debt in the form of a diabolical financial instrument called an Adjustable Rate Mortgages that reset rates at a higher price than what was originally locked in. Poor folks were pushed into buying much more house than they could afford because the bankers got the fees on these mortgages. Ergo, a failure of Capitalism.
The "Free Market" point of view- Politicians, always eager to share other people's wealth, founded Fannie Mae and Freddy Mac as markets and defacto government subsidies of mortgage loans that would never have otherwise been made, since people don't risk their own money out of proportion to the risk they incur. By "de-risking" these loans, the government set up the engine for the systemic failure of the economy. Ergo, a failure of Government Interventionism.
Which side is right?
Like all things, it's somewhere between the absolutes that the rigid idealists espouse, but I think the truth is probably closer to the Free Market argument than the Evil Capitalist argument.
The "Progressive" point of view is that debt should be widely available, not just to the rich. In fact, it is the poor that need access to capital MORE than the rich. I get this idea. I actually like it.
(Digression- The very far left branch of the "Progressive" point of view; the Code Pinko Commie side, would argue that money should be given outright to the poor... screw "loaning". A clean prescription to be sure. All one has to do is convince themself and enough others that state sponsored theft of property is a-ok. In societies where there are few stakeholders and a lot of real serfs and no upward mobility or potential thereof, the marketing of this ideal has been pretty easy. In a society like ours, you have to do a lot of psychological shucking and jiving in order to make "haves" without historical antecedent feel like "have nots". Given enough time and an educational system sympathetic to such a message, it seems to work).
The "Progressives" then make laws that limit how much interest can be charged, since it looks exploitive to make the poor borrowers pay more than the rich. That the risk of`non-repayment from the poor is much higher is given lower if any consequence.
The "Free Marketeer" approach is that debt should be priced based on risk of repayment. The higher the risk, the higher the interest, because no rational person would choose to loan money for the same rate if the risk was substantively higher... in essence how many people would bet on double zero on the roulette wheel if it paid the same as Black or Red? The devil is in calculating the risk. If you manipulate the market by fixing all risks being priced the same, you will find that people will not bet on the high risk pool, so no action there at all. The unintended consequence of Usery Laws. If you make a player bet on all risks at the same price that are presented to them, then they will either not play at all or demand that the overall odds be changed to reflect a return on investment. Therefore Black and Red, and all other potential bets on the roulette wheel would be priced at 6:1 to make the overall, evenly proportioned bet slightly break even.
In our Real Life case, we got the government to guarantee payment of those loans via Fannie Mae and Freddie Mac. The loans are now either priced lower than the real risk in the interim, because the risk has been mitigated by guaranteeing the loans or the original risk was not correctly measured. Maybe, the risk was calculated all wrong in the first place, and the Government won't really have to pay out! The best of all possible outcomes, this is the "pray the bankers are stupid" scenario. Usually, when you get a choice between "the bankers are all stupid" and "the politicians don't know what they are doing when they manipulate markets", choose the outcome that depends on "the politicians don't know what they are doing" option.
Mortgages are among the easiest debt instruments to price because they have a term, and you can easily determine if the borrower income is enough to repay the loans as per the conditions. Now that we have de-risked the loans, the poor can now buy homes! Yay!
Except now they all buy homes, and the supply shrinks, and the home prices get higher because a lot of cheap capital is chasing fewer homes. That is the result of the pesky supply/demand equation, that some deny as vehemently as they accuse others of denying climate change and evolution, never mind that it has been proved in practice countless times, which does exactly what it always does. The definition of a physical law, really.
So now what? Interest rates are about as low as they can go, so lets create a mortgage that gives a nonlinear payment schedule... lower than straight interest and principal to begin with, ie "Below Market" payments for some initial period of time that resets later to an above market payment later, in hopes that your employment situation improves or your house appreciates. Or how about a simpler "interest only" note that only depends on home appreciation? And let's top it off with a Zero Down, No Equity policy? Why not? The government WANTS us to do this... everyone should have a home... and government policy is to insure that risk so the public gets what it wants.
Lower income people can have homes! Great times ahead! Progressive policies seem to be working! Homeownership is on the rise! But then...
Interest rates increase, as they always do. Or the price of homes gets so high that no amount of restructuring payment schedules can yield a defensible cash flow scenario for approving loans. Or both. Those people that had low rates to begin with are seeing them reset to higher rates They can't refinance because this is happening broadly... interest rates hit the market everywhere. Prices fall, as supply and demand dictates if no one can buy. No equity turns into negative equity. Homeowners now owe more than their house is now worth. Not a problem in the 1930's or 1940's, where people still had some integrity about their debt. A real problem today, where no shame is attached to walking away from debt, and societal scorn is instead heaped on those stupid enough to extend it to people who refuse to honor it, with the only defense offered as "I was too stupid to know what was being offered me".
The "Progressive" THEN blames the mortgage bankers for making loans that were affordable, but because of their very affordability, caused home prices to bubble. Some bankers weren't stupid. Goldman Sachs, while securitizing and selling crappy debt obligations to pension funds et al, used their fees to short these same securitized debt obligations they sold to others. They saw the big picture, even when the politicians and the dumber bankers didn't.
In reality, if we hadn't had government policy to reduce the cost of debt below market conditions, ie had debt had been priced at market conditions, where the debt wasn't guaranteed by big bro, and the financial institutions were placed in a position to get a return on their capital, would this still happen? The answer is "Probably not to the extent it did". Yes, the securitization of the debt obligations certainly played a big part, but the risk was much more knowable. 20% down payments, plenty of equity, and not a flood of buyers bubbling up the pool to the extent it was bubbled wouldn't have happened either.
Bankers did exactly what the rules told them to do... they just had a set of risks that the government took off their hands and a system that allowed them to scale debt out like never before. Proper regulation, like not allowing a single asset to be insured for 13 times its value, would have helped a lot. Funny. I cannot insure my house for 13 times its value and then burn it down. That is called fraud. The allegorical equivalent, though, is business as usual for the insurance industry.
Want to fix it all? Don't let the government guarantee debt obligations. If you let insurance guys and bankers be paid on fees generated at closing, and not on full cycle economics, then you must escrow the amount that a full meltdown would require to fix. Let's see how that works.
Hi Choke,
Scott here. I am in Delhi, India, drilling wells in an economy with 7.9% GDP growth (2nd quarter 2009). I see Asia closing the gap on the US on many fronts, autos, steel, software..etc. There is, however, one area where the US still reigns supreme. No other country in Asia or anywhere else even comes close. That product is propaganda and I see you have bought into it again, hook line and sinker.
You seem to be concerned about the current financial crisis, and have framed it as free market conservatives vs. liberal, socialist stupid poor people. I am sure your position brings a smile to Karl Rove and Obama’s handlers. You have bought into the diversion, once again. Is it those pesky poor people that want homes, or the greedy bankers that made the loans? There is a third point of view that says it is neither. Houses have value. If every bad home loan was liquidated today it would be about a 200 billion dollar problem. Not that big of a deal in the era of the worthless dollar. The real problem is the derivatives insuring the bonds that were issued based on the bundled mortgages. One does not have to own an insurable interest to buy insurance in the world of swaps. If choke owns some bonds, and buys insurance against default, Scott and crash can buy insurance on the bonds too, so if the bonds fail, the insurance payoff can be 1000000 times the value of the insured interest. This is where the debt was created, on paper via derivatives. Oh,,I said the D word…I hope I did not offend your Rovian sensibilities. Let me rephrase in CNN and Fox Newspeak.”Toxic Assets” How Orwellian is that? Toxic Assets? Do those words go together? You see, just like war is really peace, an asset is really toxic. Fox, CNN ..etc won’t touch this subject. They will not even say the D word…you see, what we really have here are “toxic assets” and the free market vs . Socialists. Don’t even think about the fact that Wall Street wrote swaps that were leveraged to the point the system had to fail, and failure would insure a government bailout to pay off the insurance. How could they not know? They knew. The government bailout paid off the swaps, It went in the pocket of people. Oh once again I violated the rules. I talked about where the money went. Sorry choke, sean, rush and Keith…It won’t happen again. You see we are free and have a free market so we need to really need keep being free so lets talk about our freedom some more and the other arguments framed by that beautiful American propaganda machine.
Posted by: Royal Enfield | January 16, 2010 at 08:32 PM
Hey Scott... great to hear from you. Good luck in your drilling sojourn in India. I do have to ask, did you read what I wrote to the end? Did you read it thoroughly? Your response seemed very reflexive here and it really seemed to miss what I write, which is normally not the case with your responses... not that we agree often... in any case, be careful and good luck.
Posted by: Open Choke | January 16, 2010 at 09:21 PM
Choke, I do acknowledge you mentioned the “insurance” aspect at the end, but it seemed to be an afterthought in the style of the American media. The piece seemed to be centered on two opposing points of view, which were developed in great detail. I find it fascinating that the word ”derivatives” has been cleansed from the lexicon of the American media.
Wall Street created a situation that had to fail and the government had to bail them out. They knew what was going to happen. It was simply a transfer of wealth. This group purposefully sold us out, and to discuss it challenges our standards of patriotism, capitalism and government.
Equally fascinating is that nobody is talking about it. The subject is artfully diverted in to the well worn argument of socialist vs. free market. America loves this stuff and it seems we cannot get enough.
My post was intended to be a statement on American propaganda and how and why it affects our dialogue.
Thanks for your well wishes. I enjoy reading your stuff. India, as you can imagine has a serious demand for gas. There only 14000 wells in the country and none have been stimulated in earnest. There are tight gas reservoirs galore. It will get a capitalist all foamed up!!
Posted by: Royal Enfield | January 16, 2010 at 10:16 PM
Tight gas...look for ALL of the unconventional players over there real soon. Cabot, Devon, CHK, Anadark-hole, XTO. Wait, not XTO, they're dead in the water, but the rest will be there! They have to push their stock around.
Meanwhile, here's your analogy of the day (I heard this, didn't come up with it myself): I'm in the business of selling cars with faulty brakes, and I'm also in the business of selling insurance betting the car will crash, and I have a crack team of idiots telling the buyer the car CAN'T crash, while my analysts tell me when the car will crash. I'm a f'n investment banker. Oops, too many cars crashed at once and I can't cover all the losses (insurance losses) so I need the government to bail me out because if I fail, the financial world as we know it will fail!
After a short cooling off period, I will do it again. While I wait for the faulty car market to improve, I'll lobby the SEC to change the way my oil company portfolio counts its molecules of gas and further screw the unsuspecting pensioner.
Ah...America! Hey, Scott, watch out for that curry or you'll experience what I call the "ring of fire".
Posted by: Crash N. Burn | January 17, 2010 at 01:44 PM
I heard a great quote the other day.
"A Business that is "Too Big To Fail" is Too Big."
Posted by: Open Choke | January 17, 2010 at 02:02 PM