really fair to blame one man for destroying the US economy?
not. But Alan Greenspan is still tops on our list. After all,
Greenspan "presided over the greatest expansion of speculative
finance in history, including a trillion-dollar hedge fund industry,
bloated Wall Street-firm balance sheets approaching US$2 trillion,
and a global derivatives market with notional values surpassing
an unfathomable $220 trillion." (Henry Liu, "Why the Subprime
Bust will Spread" Asia Times.)
Greenspan's also responsible for slashing the real Fed Funds Rate
so that it was negative for 31 months from 2002 to 2005. That
decision flooded the housing market with trillions of dollars
in low interest credit creating the largest equity bubble in history.
Now that that bubble is crashing; Greenspan has hit the road.
He now spends his time leap-frogging from city to city hawking
his revisionist memoirs of how he steered the ship of state through
troubled waters while fending off protectionist liberals. Look
for it in the Fiction section of your local bookstore.
we really blame "Maestro" for what appears to have been a spontaneous
flurry of "free market" speculation in real estate?
To a large
extent, yes. Apart from Greenspan's tacit endorsement of all the
dubious loans (subprime, ARMs, etc.) which flourished during his
reign; and despite his brusque rejection of the Fed's role as
regulator; the Federal Reserve's own documents ("House Prices
and Monetary Policy: A Cross-Country Study") indicate that housing
was "specifically targeted" acknowledging that it would serve
as "a key channel of monetary policy transmission".
This is not even particularly controversial any more. In fact,
we can see that this same scam has been used in England, Spain
and Ireland - all now suffering the effects of massive real estate
inflation. Low interest rates continue to be the most efficient
way of stealthily shifting wealth from one class to another while
decimating the foundations of a healthy economy.
understand the effects of cheap credit on the economy. It is branded
on their DNA.
HOUSING FALLS OFF A CLIFF
We are now
beginning to see the first signs that the listless housing bubble
has sprung a leak and is careening towards earth. This week's
news from Southern California confirms that home sales have plummeted
a whopping 48.5 per cent from the previous year. This represents
the biggest decline in home sales since the industry began keeping
records more than 20 years ago. Sales are at a standstill and
builders and homeowners have begun slashing prices in desperation.
(See youtube "Central
California Housing Crash.)
is only slightly better in the Bay Area where DataQuick reports
that "Bay Area home sales plummet amid mortgage woes":
home sales sank to their lowest level in more than two decades
in September, the result of a continuing market slowdown and borrowers'
increased difficulties in obtaining "jumbo" mortgages
of 5,014 new and resale houses and condos were sold in the nine-county
Bay Area in September. That was down 31.3 per cent from 7,299
in August, and down 40.1 per cent from 8,374 for September a year
cent year over year. That is the definition of a market collapse.
activity is at record levels."
the Fed's repos have done is buy more time for the banks
while they try to wriggle out of reporting their true
sales figures for the rest of the country are not yet available,
but what is taking place in California is what we anticipated
after the stock market "froze over" on August 16. Most people
don't understand that the market nearly crashed on that day
and that the tremors from that cataclysm changed the way the
banks do business. Many of the loans which were available just
months ago (subprime, piggyback, ARMs, "no doc", Alt-A, reverse
amortization, etc.) are either much harder to get or have been
Additionally, the banks are no longer able to bundle loans into
securities and sell them to investors. In fact, the future of
"securitization" of mortgage-debt is very much in doubt now.
An article in the Financial Times shows how this process has
slowed to a trickle:
billion of home equity loan securitizations have come to market
since July 1 - A 95 PER CENT DECLINE FROM THE $200.9 BILLION IN
THE FIRST HALF OF THIS YEAR AND A ROUGHLY 92 PER CENT DECREASE
FROM THE SAME PERIOD LAST YEAR."
Also - and
perhaps most importantly - many potential buyers are now finding
that they no longer meet the stricter standards the banks are
using to determine credit worthiness. This is especially true
for jumbo loans, that is, any home loan that exceeds $417,000.
The banks are getting increasing skeptical (some believe they
are hoarding capital to cover bad bets on mortgage-backed derivatives)
in determining who is a qualified mortgage applicant. Understandably,
this has thrown a wrench in sales figures and slashed the number
of September closings in half.
words, the credit meltdown on Aug 16 changed the basic dynamics
of home mortgage-lending. Decreasing demand and mushrooming inventory
are only part of a much larger problem; the financing mechanism
has completely changed. The banks don't want to lend money. And,
when banks don't lend money - bad things happen.
The economy goes into freefall. Despite the valiant efforts of
the Plunge Protection Team in engineering a late-day turnaround
to the August rout; the damage is done. Tighter lending will put
additional downward pressure on a housing market that is already
in distress speeding up an unavoidable recession. The economic
storm clouds are already visible on the horizon.
Secretary Henry Paulson has finally admitted that the slumping
housing market is now the "most significant risk to the economy".
Fed chairman Ben Bernanke agrees and adds that he believes that
housing would be a "significant drag" on GDP. The troubles at
the banks and the news from California have put the "fear of God"
in both men. But there's little they can do.
Millions of people are "in over their heads" living in homes they
clearly can't afford. They'll be forced to move in the next year
or so. Foreclosures will soar. That can't be avoided. Also, the
industry has a 10-month backlog of existing homes that must be
reduced before new sales have any chance of rebounding. That takes
time. Construction and construction-related industries will suffer
facing the banks are much more serious than anyone cares to openly
discuss. The banking system is over-extended and under-capitalized.
The Fed has provided more than $400 billion in repos since the
August meltdown, and yet, the troubles persist. The Treasury Dept
has joined with Citigroup, Bank of America and JP Morgan Chase
in an attempt to repackage bad debts and sell them to wary investors
via "Super conduit" mega fund. The desperation is palpable and
these latest shenanigans are only adding to rising stock market
Fed cannot get money to the people who need it and who
can keep the economy (which is 70 per cent dependent on
consumer spending) growing. This is a structural problem
and it cannot be resolved by merely cutting rates.
a myth that the Fed chief can wave a magic wand and make things
better. But that is not the case. Bernanke's decision to cut
the Fed's Fund Rate last month did not affect long term rates
and, therefore, did not make it cheaper to buy (or refinance)
a home. The rate-cut was really just a gift to the banks that
are currently buried under $500 billion in mortgage-backed debt
and CDO sludge.
The increase in liquidity hasn't made these toxic securities
any more sellable or solvent. Nor has it increased the banks
willingness to provide new home financing to mortgage applicants.
That process has slowed to a crawl. All the Fed's repos have
done is buy more time for the banks while they try to wriggle
out of reporting their true losses.
banks serve as a key conduit for the transferal of credit to consumers.
That conduit has turned into a chokepoint due to defaults in the
mortgage industry and the banks own humongous debt-load. The Fed
cannot get money to the people who need it and who can keep the
economy (which is 70 per cent dependent on consumer spending)
growing. This is a structural problem and it cannot be resolved
by merely cutting rates.
already begun to see signs of a slowdown in consumer spending
at Target, Lowes and Walmart. If that deceleration continues,
the economy will slip quickly into recession.
consumers have withdrawn over $9 trillion from their home equity
in the last seven years. That spending-spree has kept the economy
whirring along at a healthy clip. Now that housing prices have
stabilized - and, in many cases, gone down - that easy money is
no longer available, setting the stage for shrinking economic
growth, slower home sales, and declining demand. Deflation is
the Fed's worst nightmare and will be fought with every weapon
in their arsenal.
Bernanke does not have the tools to fix this problem and he is
likely to destroy the currency if he keeps cutting rates. The
recent cuts have already sent oil and gold to new highs while
the dollar continues to nosedive. (The euro stands at $1.42 per
dollar - up 63 per cent since Bush took office.)
The weak dollar and the persistent credit problems in the markets
have sent foreign investors scampering for the exits. August was
the biggest month on record for the withdrawal of foreign capital
from US securities and Treasuries - $163 billion in capital flight.
(Japan and China led the way.) Confidence in US markets, leadership
and integrity has never been lower. Investors are voting with
their feet. They've had enough.
fleeing the country at the present pace, the US will not be able
to maintain its $800 billion current account deficit, which means
that prices will rise, the dollar will fall, and consumer spending
will dry up. No amount of financial tinkering at the Federal Reserve
will make a damn bit of difference. Barring a dramatic change
in economic policy - which seems unlikely - we appear to be quick-stepping
towards a system-wide market-busting break-down.
THAT GREENSPAN MADE
effects of Greenspan's housing bubble can't be fully appreciated
unless one spends a bit of time studying some of the charts and
graphs that are now available. These graphs are the best way to
dispel any lingering suspicion that the housing bubble may be
some a left-wing conspiracy theory. It's not, and these links
should provide ample evidence to the contrary.
(click on the charts for a better view)
graph is the ARM (adjustable rate mortgages) reset schedule -
totaling hundreds of billions of dollars in the next two years.
The next two are the interest only and negative amortization share
of total purchase mortgage originations 2000-2006. Keep in mind,
when studying the ARM reset graph that "A study commissioned by
the AFL-CIO shows that nearly half of homeowners with ARMs don't
know how their loans will adjust, and three-quarters don't know
how much their payments will increase if the loan does reset.
73 per cent of homeowners with ARM's don't even know how much
their monthly payment will increase the next time the rate goes
up." (Calculated Risk)
of the housing bubble is now beginning to show up in other areas
of the economy. Credit card debt has skyrocketed to 17 per cent
annually now that homeowners are no longer able to tap into their
vanishing home equity. Americans already owe over $500 billion
on their credit cards. Now that debt is increasing faster than
retail sales, which suggests that many people are so over-extended
they are using their cards for basic necessities and medical expenses.
Industry analysts now expect an unprecedented wave of credit card
defaults in the next six to 12 months. Unfortunately, for the
tapped-out consumer, the credit card represents his last access
to an unsecured loan.
We can also
expect the downturn in housing to swell the unemployment lines.
Oddly enough, while home sales have declined 40 per cent from
their peak in 2005, construction-related employment has only slipped
5 per cent.That is really astonishing. It could be that the BLS
is fabricating the numbers using its Birth-Death model (which
magically produces millions of fictitious jobs). But we know that
construction has accounted for two out of every five new jobs
in the US for the last six years, so we are sure to see a significant
rise in unemployment as the bubble deflates. The financial and
mortgage industries have already experienced significant layoffs.
we can expect to see substantial correction in home prices. Housing
prices typically lag six months after sales peak and inventory
rises. So far, prices have dropped a mere 3.5 per cent, whereas
inventory is at historic highs and sales have decreased 40 per
cent. It is impossible to know how low prices will go (some experts
like Robert Schiller predict 50 per cent cuts in the hotter markets)
but the downward pressure on housing prices is bound to be enormous.
Growing unemployment, 0 per cent personal savings, rising foreclosures,
the weakening dollar, and the prevailing mood of gloominess (a
recent poll showed that a majority of Americans believe we are
ALREADY in a recession!) suggest that the impending fall in home
prices will be precipitous.
a debate raging on the econo-blogs about whether the country is
headed towards hyperinflation or a deflationary cycle. The argument
for hyperinflation is compelling since the Fed has already shown
that it is prepared to savage the dollar in order to keep the
economy running. As a result, we've seen inflation is heating
up at a pace not seen in over a decade (despite the government's
mendacious figures). In September gasoline costs rose 4 per cent,
heating oil soared 9 per cent, food jumped 5 per cent, and dairy
products lurched ahead 7.5 per cent. Everything is up except the
greenback which appears to be in its death throes.
are signs that America's debt-fueled consumer economy is on its
last legs as shoppers and homeowners are increasingly forced to
accept that they have maxed-out nearly all of their available
lines of credit. They will have to curtail their spending and
live within their means. That means less growth, a continuing
decline in housing, and a sharp fall in equities prices. These
are all the harbingers of deflation.
Secretary Paulson's new "Master Liquidity Enhancement Conduit",
M-LEC - which allows the investment banks to delay reporting their
losses - is particularly ominous in this regard, since it was
the Japanese banks' unwillingness to write-off their bad debts
which extended their deflationary recession for 15 years. Can
the same thing happen here?
An interesting exchange took place last month between the widely-respected
economic blogger, Mike Shedlock ("Mish's Global Economic Trend
Analysis") and economist Paul L. Kasriel. The interview provides
details of the Japanese crisis which offer some striking similarities
to our present predicament. I have transcribed an extended portion
of that discussion:
Paul L. Kasriel:
Japan experienced a deflation in recent years because the bursting
of its asset-price bubble in the early 1990s created huge losses
in its banking system. The Japanese banks had financed the asset-price
bubble. When it burst, the debtors could not keep current on their
loans to the banks and therefore were forced to turn back the
collateral to the banks. The market value of the collateral, of
course, was less than the amount of the loans outstanding, thereby
inflicting huge losses of capital to the Japanese banks. With
the decline in bank capital, the Japanese banks could not extend
new credit to the private sector even though the Bank of Japan
was offering credit to the banks at very low nominal rates of
was the Japanese banks' unwillingness to write-off their
bad debts which extended their deflationary recession
for 15 years. Can the same thing happen in the United
an important transmission mechanism between the central bank
and the private economy. If the banks are unable or unwilling
to extend the cheap credit being offered to them by the central
bank, then the economy grows very slowly, if at all. This happened
in the U.S. during the early 1930s.
currently hold record amounts of mortgage-related assets on their
books. If the housing market were to go into a deep recession
resulting in massive mortgage defaults, the U.S. banking system
could sustain huge losses similar to what the Japanese banks experienced
in the 1990s. If this were to occur, the Fed could cut interest
rates to zero but it would have little positive effect on economic
activity or inflation.
the Fed depositing newly-created money directly into private sector
accounts, I suspect that a deflation would occur under these circumstances.
Again, crippled banking systems tend to bring on deflations. And
crippled banking systems seem to result from the bursting of asset
bubbles because of the sharp decline in the value of the collateral
backing bank loans."
if Bernanke cuts interest rates to 1 per cent?
In a sustained housing bust that causes banks to take a big hit
to their capital it simply will not matter. This is essentially
what happened recently in Japan and also in the US during the
Most people are not aware of actions the Fed took during the Great
Depression. Bernanke claims that the Fed did not act strong enough
during the Great Depression. This is simply not true. The Fed
slashed interest rates and injected huge sums of base money but
it did no good. More recently, Japan did the same thing. It also
did no good. If default rates get high enough, banks will simply
be unwilling to lend which will severely limit money and credit
does inflation start and end?
Inflation starts with expansion of money and credit.
ends when the central bank is no longer able or willing to extend
credit and/or when consumers and businesses are no longer willing
to borrow because further expansion and /or speculation no longer
makes any economic sense.
when does it all end?
That is extremely difficult to project. If the current housing
recession were to turn into a housing depression, leading to massive
mortgage defaults, it could end. Alternatively, if there were
a run on the dollar in the foreign exchange market, price inflation
could spike up and the Fed would have no choice but to raise interest
rates aggressively. Given the record leverage in the US economy,
the rise in interest rates would prompt large scale bankruptcies.
These are the two "checkmate" scenarios that come to mind." ("Mish's
Global Economic Trend Analysis")
scenarios". Well put. Thank you, Mish.
Mike Whitney is a well respected freelance writer living in Washington
state, interested in politics and economics from a libertarian
perspective. He can be reached at [email protected].
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