More mortgage loan problems

The financial problems caused by the subprime mortgage market is spreading. It is a big problem that is currently getting larger, and it was easily predictable. It was caused by the political manipulation of the housing and mortgage credit market to allow the Bush administration to mismanage the economy but not pay the political consequences before he ran for reelection in 2004.

The problems today were caused by Alan Greenspan, but he did it for a good cause. He knew that George Bush had to be reelected President in 2004. So what does the problem look like today?

From this morning's New York Times:

When an investment banker set out to buy a $1.5 million home on Long Island last month, his mortgage broker quoted an interest rate of 8 percent. Three days later, when the buyer said he would take the loan, the mortgage banker had bad news: the new rate was 13 percent.

“I have been in the business 20 years and I have never seen” such a big swing in interest rates, said the broker, Bob Moulton, president of the Americana Mortgage Group in Manhasset, N.Y.

“There is a lot of fear in the markets,” he added. “When there is fear, people have a tendency to overreact.”

The investment banker’s problem was that he was taking out a so-called jumbo mortgage — a loan greater than the $417,000 mortgage that can be sold to the federally chartered enterprises, Freddie Mac and Fannie Mae. The market for large mortgages has suddenly dried up.

For months after problems appeared in the subprime mortgage market — loans to customers with less-than-sterling credit — government officials and others voiced confidence that the problem could be contained to such loans. But now it has spread to other kinds of mortgages, and credit markets and stock markets around the world are showing the effects.

Those with poor credit, whether companies or individuals, are finding it much harder to borrow, if they can at all. It appears that many homeowners who want to refinance their mortgages — often because their old mortgages are about to require sharply higher monthly payments — will be unable to do so.

The problems are both with borrowers who have poor credit and with other borrowers with better credit who were sold loans which were too risky, such as Adjustable-Rate Mortgage Loans with an initial monthly mortgage payment that in some cases did not even cover the interest owed for that month. The interest was simply added to the existing loan to be paid off later.

From The Associate Press, published in the Fort Worth Star-Telegram:

So far, less than 4 percent of the option and interest-only ARMs are delinquent, well below the 14 percent rate for the subprime market, where about $1.5 trillion in home loans are still outstanding, according to data from the research firm First American LoanPerformance.

But many industry observers suspect that the biggest problems will emerge during the next 16 months as shoddily underwritten ARMs made near the real estate market's peak in 2005 and 2006 climb to higher interest rates.

The Mortgage Fondation pointed out that:

Last year, negative amortization loans accounted for 9.9 percent, or $350 billion, of all mortgages nationwide, up from just 0.4 percent as recently as 2003, according to LoanPerformance.

Thornberg said he believes that the mortgage market turmoil could lead to a recession. "This snowball is just 20 percent down the hill. It's nowhere near the bottom," he said.

The problems are not just with Adjustable-Rate Mortgages (ARM's.)Mortgage companies have also been issuing what were called "no documentation" Mortgages, those issued based on nothing more than the customer's assertion that they had a job, a given income and certain assets.

So why were these problems not stopped sooner when the damage to the American economy and the world credit markets would have been a lot less? Simple. The damage to Bush's reelection hopes in 2004 would have been tremendous.

This all goes back to the economic problems that George Bush had prior to his reelection in 2004. The Federal Reserve Chief, Alan Greenspan, told the Credit Union National Association meeting in a well publicized speech given in February 2004:

Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.

He knew what he was proposing would lead to a lot of foreclosures and personal financial tragedies when the housing bubble finally burst, but the important thing was that Bush be reelected. Credit standards and verifying documentation went out the window. He was pumping up the housing market in 2004 before the election.

In February 2005, after Bush was safely reelected, Greenspan started to slowly increase the interest rates. The effect was to stop the increased prices of homes, but it was too late. The damage was done, and to avoid the inevitable credit crunch the poor underwriting standards and risky loans were continued.

Why not? The mortgage brokers made their money up front. Any sale was a profit, and the loan was sold to a lender. Also, people do not shop for mortgages. They buy a house. The mortgage is a very complex technical document and if the mortgage broker starts to explain the real risks, the customers quickly go to someone else who assures them the loan is safe. Since both the realtor and the mortgage broker get paid only one sale of the home, any conscientious mortgage broker will quickly find no Realtors bringing him customers. The result is that most people who bought such loans did not realize the risk they were taking (nor did they know they were taking it to reelect Bush in 2004.)

The housing bubble started during the dot com boom days, but when Bush was first elected appointed President, the economy was already beginning to turn down. He couldn't afford that, so he and Greenspan did not shut down the more risky housing loans which were the only major prop under the economy.

I'm sure Greenspan thought they could get the problems under control soon, but the ignored problems quickly passed into the lead-up to the 2004 election. Every President in the twentieth century who ran for reelection in a period of economic downturn lost. Rove knows that. So the government let the rotten credit conditions run until after the election.

The increased interest rate was certain to cause foreclosures, but real estate downturns take a long time to work themselves out. This one started in 2005 when the Fed started tightening the interest rates and is only now becoming really bad. There was no effort to rein in the extremely loose credit standards because that would have just made the problem worse, and I am sure Greenspan hoped the bad results of the housing bubble collapse would work themselves out relatively mildly. Obviously it hasn't happened that way.

It's not any surprise (in hindsight) that the problems have spread outside the subprime mortgage market. The entire mortgage market has been used since 2001 to prop up the largest economy in the world while the government was mismanaging taxing and spending to a degree never before seen.

The surprise is that the shaky system could have been misused by Bush and Greenspan for so long. But for all that the economists think they know, they will freely admit that the timing of macroeconomic changes is not part of it. The Fed knew that increasing the interest rate would stop the housing bubble, and that there would be associated negative results. That's why they didn't try until 2005. They didn't know how extensive the problems would be, nor how long they would take to appear.

Nor did they know, or care, how many homeowners would suffer. Why should they? They are Republicans, after all. It's all just politics to Republicans, and the wealthy aren't being hurt by this. Just the rest of us peons.

Credit crunch spreads outside U.S.subprime markets to the rest of the world.

The politically-inspired Bush-Greenspan housing bubble and the corrupt sub-prime mortgage market designed to create that bubble (and reelect Bush in 2004 along the way) has not only collapsed, it is starting to take worldwide credit markets with it. A lot of midnight oil is being burned and a lot of caffeine being drunk by very bright men and women whose personal wealth is wrapped up in the current system. If they succeed the degree of the disaster can be limited. But they won't prevent the disaster. It has already happened. At best they will keep it from spreading too much more.

So where are we now, and how did we get here? Politics was the cause. Economics is the symptom. We'll start with the symptoms and work back.

From Bloomberg this morning:

Aug. 10 (Bloomberg) -- Deutsche Bank AG's DWS unit, Germany's biggest mutual fund company, said the assets in one of its investment funds have fallen by 30 percent since the end of July as sub prime mortgage losses roiled credit markets.

Assets in the DWS ABS Fund fell to 2.1 billion euros ($2.9 billion) from 3 billion euros, mostly as a result of client redemptions, DWS spokeswoman Anke Hallmann said today. The fund, registered in Luxembourg, has no investments in U.S. subprime- related debt and hasn't halted withdrawals, she said.

Investors are shunning bonds backed by home loans after late mortgage payments by U.S. borrowers with poor credit histories rose to the highest since 2002. BNP Paribas SA, France's biggest bank, contributed to financial market turmoil yesterday by halting withdrawals from three investment funds because it couldn't value their holdings.
[Underlining mine - Editor WTF-o]

The fact that the fund has no investments in the U.S. subprime-related debt and yet has lost 30% of its value means that the problem has spread from sub-prime loans to the general credit markets. People with money to lend are delaying lending it because they are concerned about losing what they lend. Then people in the sub-prime market are having to sell investments to cover losses. This is a reasonable and expected reaction when the underlying asset (homes) is declining in value. Hedge funds which borrowed money at lower interest rates to lend in the riskier subprime markets are being battered by their leverage as they lose lots of money on the way down.

The problems in the U.S. sub-prime mortgage market are important because the amount of money involved is extremely large. The problems in the U.S. has spread world-wide. From Market Watch:

By Simon Kennedy, MarketWatch
Last Update: 10:45 AM ET Aug 10, 2007

LONDON (MarketWatch) -- Central banks in Europe, Asia and the U.S. injected billions of dollars into banking systems Friday, moving to further boost liquidity in markets suffering the ripple effect of the subprime-credit crisis and saying they stood willing to provide more cash.

The European Central Bank said it had provided 61 billion euros ($84 billion) to banks in a three-day tender offer, and the U.S. Federal Reserve carried out a $19 billion three-day repurchase agreement.

In Asia, the Bank of Japan supplied 1 trillion yen ($8.48 billion) after a rise in the overnight call rate. And The Reserve Bank of Australia added A$4.95 billion ($4.17 billion).

The Fed said it will provide reserves "as necessary" to promote trading in the federal funds market at rates close to 5.25%, the base rate. Other central banks made similar pledges about being willing to lend more.

The overnight rates at which banks lend money to each other rose again Friday, with the dollar-denominated rate hitting 5.96% from 5.86% the previous day, according to data from the British Bankers' Association.

The loans by the ECB follow the roughly 95 billion euros it handed out in its biggest-ever cash injection Thursday, in the aftermath of overnight interest rates spiking.

All of this was started by the slow (and continuing) collapse of the U.S. housing bubble. So where did the housing bubble come from?

The housing bubble was a creation of the Bush administration and Fed Chief Alan Greenspan. As I wrote previously, The Bush administration needed an adequate economy for political reasons, yet their taxing, borrowing, war spending and anti-Union policies did not provide it. The economy is run based on demand, and consumers needed money to buy the products and services produced.

The money that consumers needed to spend wasn't there in wages (there has been no increase in real wages since 2000) and in spite of the tax cuts there has been no significant increase in national investment, so where could it come from? The answer was home equity loans and real estate speculation. But this only worked if the Fed lowered interest rates a great deal and convinced banks to be willing to loan money to anyone, no matter how poor their credit was. That's what happened.

What the Bush administration has done is to deregulate home mortgages to the extent that the most recent ones are called "NINJA" mortgages. That is, a person could get one with No Income, No Job, No Assets.

That was intended to boost the economy. About two-thirds of American Gross Domestic Product is bought by consumers. Essentially the U.S. economy has operated on government spending and consumer spending since 2000, with consumer spending being the more important. Since Bush took office those consumers have not gotten an increase in after-inflation pay, but they had to get money to spend from somewhere. It has come from refinancing and second loans on the value of the homes they have title to, which required ridiculously easy lending policies and ever-increasing home prices.

This couldn't go on forever, but it really only needed to last beyond the 2004 Presidential election. It did.

By late 2004 the housing bubble was dangerously stretched. Financial bubbles break when someone seriously questions whether to gamble on buying an asset - in this case a home - at a ridiculously high price on the assumption that some greater fool will pay even more for it later, or when they can't get a loan to buy the home at the higher price. Home prices topped out after the federal reserve tried to bring the bubble down softly by a long series of small interest rate increases.

Starting about February 2005 the fed increased the federal funds interest rate by 1/4% per month for 17 months, ending at an interest rate of 5 1/4% in June of 2006 (from BBC News.) The increase in speculative housing prices could not survive this increase in interest rates. But it was more than just higher interest rates.

To get enough people to buy, sell and refinance more homes the banks needed to drop credit standards. Along with poor credit standards the mortgage industry pushed riskier types of mortgages from Adjustable Rate Mortgages with ridiculously low teaser rates at the beginning into interest only mortgages where the borrower paid only the interest and no principle. A large number of the people with poor credit who were induced to gamble in the market could not survive both the higher interest rates and a lackluster economy. People with those risky mortgages suddenly faced higher payments as the new, higher interest rates kicked in and many had to sell at a loss - if they could. An increasing number of individuals just stopped paying on houses they could no longer afford the payments for and let them be foreclosed.

When enough people have those problems then the sub-prime mortgage markets themselves became damaged seriously. It takes a lot of financially strapped people all at once to create major problems for a large market, but that point was reached and recognized in early 2007.

I am not sure exactly why the Federal Reserve started moving the interest rate back up, but the timing of their actions suggests that it probably had to do with the fact that the 2004 election was over. Greenspan worked hard to reelect Bush. At the same time the extremely low interest rates in the U.S. economy were causing the value of the dollar against the EURO, Yen and Pound to drop too much. This led to real concern that inflation would begin. The $70 per barrel price of oil has also remained consistently high and was a key element threatening new inflation. Inflation frightens the bond market. For good reason.

The Bond market had not been pricing the money they lent out to include estimated future increased inflation. Presumably they kept the interest rates they charged low because they depended on the Federal Reserve to prevent future inflation. Lenders felt that they could offer lower interest rates by eliminating the inflation premium because Greenspan promised that at any hint of inflation the Federal Reserve would step in to stop it.

If the Fed reneged on its promise to the bond market to restrict inflation, a lot of money would be lost. So the Fed had to act. It looks like the Fed did not recognize how the sub-prime mortgage market had been growing more unstable in the previous years. The instability crept up slowly as interest rates went down, credit standards were reduced and types of mortgages got more risky.

The problems did not occur overnight and without warning. But any action to stop the growth of the problems was going to cause some trouble in the markets somewhere. Bush's reelection depended on those problems not happening until he was reelected. That meant that the Fed could not act on the housing market problems before the Spring of 2005. Beginning the 17 month slow increase in interest rates in February of 2005 shows that the election was the reason for not acting sooner.

That explains how we got to the present set of financial problems. Now we have had the (long-predicted and continuing) drop in housing prices that started in 2005. Next followed the near collapse of the sub-prime mortgage market in the U.S. which became obvious late this Spring with Countrywide Mortgage Company's announcement of problems. Now we have the spread of the American sub-prime mortgage problems to the general credit markets world-wide.

Where is it going next?

Good question. No one knows. The current economic situation is one that has never occurred before. Every economic reporter I have heard in the last few days has ended his report saying something like "We expect conditions to get better tomorrow."

Even Bonddad is optimistic this morning, but his optimism is more realistic than that of most economic reporters (who, I suspect, are saying what they are told to say.) Here is what Bonddad said today:

The point is Wall Street and the central bands [banks, obviously] around the world are on the job. And these are some really smart and capable people who will get the markets through this mess. That does not mean it will be easy. In fact, the news will continue to be bad for awhile. But the markets and the economy will get through this; it will end at some point.

Bonddad recognizes that economic commentators have to appear optimistic right now but his optimism is at least realistic. He doesn't know what will happen next either, but he has faith that a lot of very smart people are working very very hard to keep disaster at bay. And what he says is true. The U.S. and the world did (finally) pull out of the Great Depression - after more than a decade of bad economic performance. If there is anything humanly possible to keep the mismanagement of the American economy by Bush and Greenspan from causing a world wide disaster, they will. That's a big IF.

The point is, none of the commentators are providing news. They are speaking optimistically in order to prop up the market long enough for something to happen to keep things from getting worse. Economic news reporters do this every time a financial market is having problems. If they don't, then there is a real danger that the market will simply stop working. Here's why. The problem is perceived risk and the behavior of lenders.

The estimate of how risky it is to lend money is subjective. If knowledgeable people don't say positive things, then that subjective estimate of the risk of loss of money will increase to where no one will dare to lend. If you have money, you lend it only to get a return on the principle. If the chances are high you will not even get the principle back, you do not rationally lend it out. You slide it under the mattress or something.

If that negative feeling takes hold, the markets themselves will collapse. No one in the financial community dares even whisper a word of negativity for fear of that collapse. A financial asset is worth only what it can be sold for, and if the market collapses, it cannot be sold. That means what was an asset becomes worthless.

I don't write this because I expect the markets to fall out of bed. I write that because no one knows what they will do. Any statements to the contrary presented as news simply ignore the fact that no one knows where the markets are going.

At the moment, prayer and good luck charms are at least as useful as knowledge of the markets.

That's why at the top of this article I emphasized that the problems in the sub-prime mortgage lending market had spread to the credit markets in general. This problem consists of the housing bubble and a myriad of bad mortgage loans, It was created by Alan Greenspan for political reasons. The economy had to be propped up to reelect Bush.

Now it has spread from the mortgage markets into the entire investment community and gone worldwide. Presently it is spreading like a forest fire and a lot of people are trying hard to put it out, but like stopping a forest fire, success is far from certain.

Politics matter, and bad politics comes back with really bad results. If you haven't suffered from the Bush-Cheney war of choice in Iraq or the Bush-FEMA failures on the Gulf Coast after Katrina-Rita hit, just wait. You will soon have a chance to suffer from the Bush-Greenspan economic mismanagement. If you aren't already.

Oh, and if you are a Republican, you are in political trouble too. The problems are hitting too soon for you to be able to blame the Democrats. You did this, and there will be political accountability.

What is the meaning of the falling dollar?

Interesting diary on the falling value of the dollar over at dKos.

The article pulls together a lot of international data. Essentially the discussion points to the fact (which we have all known for three to four years) about the fact that the Bush administration has been utterly irresponsible about borrowing money to keep the American economy afloat. This has already led to a devaluation of the dollar against the Euro, and next is going to mean devaluation against the Chinese currency. The fed has been protecting the American standard of living through financial manipulations, but this is only delaying the inevitable. Unfortunately, the process of delay will also make the inevitable worse than it had to be.

It could be better written. The overall implications aren't really clear, but a lot of useful facts are presented. I guess that's what you call a tepid recommendation [Grin] but the subject is very important.

I can't help but suspect that the Bushies are setting the economy up to where the next President will have to deal with the total mismanagement from the Bush/Cheney administration. The result will be that the next President will take the blame for what this one has done.