First of all, the current deal is that the holders of the MBS's (mortgage-backed securities) are being bailed out, but the shareholders of Fannie/Freddie are being stiffed. There is no (zero) effect upon the 9% of outstanding mortgages that are currently in default or foreclosure.
Without Fannie/Freddie, 60% of the mortgage industry disappears and it becomes almost impossible to get a loan. I'll point you to the repercussions of the home mortgage industry crawling to a halt. Then you have a *95%* plummet in property values, because basically you can only buy properties for cash then (the 5% average down payment on new homes). Aside from gutting the budgets of school districts and cities nationwide, anybody who currently has a mortgage will look at the fact that they're holding a $200K mortgage on a house now only worth $20K, and notice that they can buy an equal home for $20K cash that they happen to have handy, and... well, you know. The end result is that banks will lose 95 cents on the dollar for every mortgage they hold. Now, thanks to the reserve requirement and multiplier effect, that means you're going to lose *trillions* of dollars from the economy, causing galloping deflation on the scale of 1930-1932, with the same effects as 1930-1932 -- massive transfers of wealth from the middle class to the upper classes as they call in debts that are no longer payable in the now-deflated currency, social unrest, hunger on a mass scale, homelessness on a mass scale, etc.
Think about it this way. If I'd bought a house in 2005 for $500K, and defaulted on it today after paying down the principle by maybe $3,000, the bank is going to eat a $200K loss (because the house would only be worth $300K today). If you consider the fractional reserve multiplier effect of what the bank could create if they could lend out that $200K, at the current reserve requirement of 10% that means that basically $2M just disappeared out of the economy. Multiply by 9% of outstanding mortgages and you will see why the U.S. *had* to bail out Fannie/Freddie by themselves paying those losses so that the money doesn't simply disappear -- we're talking about trillions of dollars disappearing if that bailout is not done, and if Fannie/Freddie collapse and housing prices plummet by 95% rather than "just" 30%, a deflationary spiral that would overwhelm even the Fed's bottomless ability to print money.
-- Badtux the Economics Penguin
You're defending this as a necessity, BadTux, but I see it as a move to avoid taking the medicine which will ultimately fail. I keep thinking about the National Lampoon cover with the picture "Buy this magazine or we'll shoot this dog." This is similar: "Do this extremist action or your economy will collapse."
ReplyDeleteHow many "stick saves" (you know that hockey term, don't you Tux?) is the TreasyFed going to pull? Each one is larger than the last. Can they keep it up forever, just guaranteeing to bail out the favoured bagholders with piles of vapourdollars, and the Chinese/Japanese/petrokingdom overlords are going to keep accepting them? Sooner or later they're going to want to be paid with something that's REAL, like the ground beneath your feet. That, or default on the dollar, in which case the world economy goes down the rabbit hole.
There may be angles I don't understand. I didn't fully comprehend the Big Picture nature of debt deflation until your clarifying explanation. But I still don't see how the PTB can keep patching this pile of pigshit together with one bailout after another. Sooner or later, it's all gonna blow.
From under my tinfoil hat, the transmitter is saying that after Obama and the corporate Dems are allowed to win the election for president and a more massive majority in Congress, the bastards who are applying the chewing gum and gaffer tape are going to stop. Support will be withdrawn, and the freefall will commence.
The whole purpose will be to say "See what happens when you elect these people?" The economy will be destroyed, people will be jobless, homeless and hungry, cities will be burning in riots, humans will DIE, just so the "free-market" fascists can score political points.
Maybe my imagination's too fevered. It shouldn't be, because I'm relatively immune where I am, both physically and financially. But you, and your however-many readers, have to live in the middle of what seems to be coming. Aren't you scared shitless?
Bukko,
ReplyDeleteIf you really want to be scared, check out some of the financial stuff that Dark Wraith has posted online. His lectures are good, and so is his writing:
www.dark-wraith.com
Check out the categories on the left side of the page for the topic you want to see. Be warned, a stiff drink (or more) may be necessary afterwards.
It seems like to me that our economy has a fatal flaw in it if the collapse of one or two corporations will bring devestation to the economy. This is the same logic that was used for the Bear Stearns bailout. Maybe as part of this bailout, we should break these corporations into smaller pieces?
ReplyDeleteTo me, all of this has the feel of robbing Peter to pay Paul. As a taxpayer, I am not happy about the prospects of having to pay for the irresponsible practices in the mortgage market.
Also, I have to wonder if these efforts are just delaying the inevitable collapse of the house of cards.
Bukko: As a practical matter, we can print money forever. All it takes is for the U.S. Treasury to issue treasury bills, which the Federal Reserve then purchases in exchange for currency. Where does the Federal Reserve get the money to purchase those T-bills? Why, it prints it, of course. (Or, rather, moves 1's and 0's into the balance ledger of the U.S. Treasury's account records in the Federal Reserve's central computer, which has the same effect).
ReplyDeleteMarc: The Dark Wraith is an optimist. He believes that the American people will eventually realize, through deep national tragedy, that their sheep-like reliance upon increasingly authoritarian law-making in exchange for an illusionary "safety", an authoritarianism that has locked up an unprecedented percentage of the population behind bars, is unsustainable and that the path of freedom must be followed. He does not believe in the end game of George Orwell's novel 1984, which is a boot pressing down upon the human face, forever. I, alas, am seeing a multi-hundred year Reich as the end game, much as with the decline and fall of the Roman republic and subsequent rise of the Roman Empire.
Terrant: As I explained in my article about the Bear-Stearns bailout, the primary issue is that fiat money (the pieces of green toilet paper with pictures of dead people on them) has value only because the amount of it in circulation fairly closely matches the amount of goods and services in circulation. If the amount of toilet paper in circulation increases drastically, you get inflation -- more toilet paper than goods to buy, meaning people raise the prices of goods to match the toilet paper. This wrecks havoc with the finances of lenders who have fixed-rate obligations such as mortgages, indeed, this was the primary cause of the last collapse of the S&L industry. If the amount of toilet paper in circulation decreases drastically, you get deflation -- people no longer have the money to meet their debt obligations, and the end result is a massive transferral of wealth from those who owe money to those who have money. The ideal state of a money supply is a slow and steady inflation that very slightly outpace the growth of goods and services.
Now, the problem is that this only works if the federal government keeps tight control over all sources of money creation and destruction. And entities such as Fannie/Freddie and Bear Stearns create and destroy money via the process of fractional reserve banking -- the securities they issued were "as good as money" and could be used as collateral for further loans. Yet their creation and destruction of money was largely unregulated by the federal government.
That, then, is the cause of the fix we find ourself in. The solution is to place those entities responsible for the creation and destruction of money either under direct federal control or at least under strict government regulation. Fannie/Freddie started out as government-owned entities, and the current bailout, which places them back under government ownership, is in my opinion the correct action. We simply can no longer afford to have any of the organs of creation or destruction of money outside of tight government controls, the results if they do the wrong thing can be simply appalling insofar as the economy is concerned. Wild variations of the money supply simply are incompatible with maintaining and sustaining a viable economy because you end up not being able to lend or borrow money in any reasonable fashion. No capital = no economic activity. So it goes...
- Badtux the Economics Penguin
Tux, I know that the gubbermint and feddrzerv can print money forever. The problem becomes, who will take it?
ReplyDeleteSaudis gonna give us tankers full of oil for bullshit zeros and ones on an electronic ledger? Maybe them, because SovAmerica can threaten to roll tanks on Riyadh, or maybe just ship shiploads of high explosives to those bearded bandits in the hills down Yemen way. There was a REASON the Predators didn't kill all of them, ya know.
But will the Chinese keep sending the U.S. goods "that we can drop on our foot" (as The Economist put it in one of their clever British turns of a phrase) in exchange for crapolacurrency? Maybe for a while longer, if we keep quiet when they re-unite with that rebellious province that's been floating so temptingly offshore for the last 60 years. But after that... Well, there's always Japan to include within the Greater Asian Co-Prospherity Sphere. "Shut up while I kiss you, baby! And you, Uncle Sam -- keep your arms where I can see them!" And South Korea. But really, after THAT...
The fiat currency the U.S. creates has to have some value backing it, Tux. Endless backstopping bailouts degrades it. Maybe Americans can use toiletpaperdollars to pay the plumber who fixes the pipes on their house trailer, and for other domestic spending.
But creditors from the outside are not going to keep sending stuff to America if they're getting paid with bogusbucks. Value will have to be exchanged somehow. The U.S. is not capable of standing alone, unless it's at a 19th Century lifestyle level. It's going to come to that. Or exporting white women to Arab harems. And living space/human organs/Soylent Green to cramped/ill/hungry Hans.
There are many ways this movie can end. I'm having a hard time thinking of happy ones.
Bukko, the backing for any fiat currency is the goods and services in the economy. As long as the amount of goods and services in the economy is constant or increasing, printing money to take the place of the money disappearing due to bad loans being written off is not going to cause the sort of problem that you are talking about. The only way to devalue the dollar the way you're talking about is to issue dollars beyond what are backed by the goods and services in the economy.
ReplyDeleteNow, the U.S. government has printed a lot of money lately to cover the War on Terra. This is money not backed by goods and services within the world economy, since the whole point of buying a bomb or bullet is to blow it up or shoot it out of the barrel of a gun. It is not a good or service that stays in the economy. I.e., what I am saying is that military spending financed via printing money is inherently inflationary. But these bailouts have nothing to do with that. These bailouts are simply preventing the "un-printing" of massive amounts of already-created money (already created via fractional reserve lending using the mortgage-backed securities as collateral).
- Badtux the Monetarist Penguin
I don't want to sound like I'm quibbling; just having a discussion about Big Picture ideas on the very notion of money itself.
ReplyDeleteDoesn't the concept of the "U.S. dollar" get destroyed when so many are wished into existence at a rate far faster than they can be "repaid" with goods and services? Because ultimately, what guarantees the worth of each of those federal reserve notes is the sweat of some U.S. citizen, extracted in the form of taxes. Let me hear you say it, ComradeTux -- "Labour is the source of all wealth!"
I posit that Paulson and Bernanke have tried to replace the disappearing credit-dollars in such a way that's unsustainable. They won't even be able to keep the giant accounting game afloat, where the U.S. government increases the size of the national debt and the Treasury/Fed does the two-step paper shuffle of issuing T-Bills and FBN FRNs. (Fly-By-Night Federal-Reserve-Notes.)
They can't issue enough to fill the hole left by collapsing mortgages, mortgage bonds and the credit default swaps that the shadow banking system used to create more illusory money that it lent out. If they even tried, the interest that they'd have to pay on this national debt would dwarf the war budget. People MUST realise the U.S. is like a bad-cheque writer, since each U.S. dollar is a $1 cheque written on the account of that shady group of financiers called Teh Federal Reserve.
(I never used to focus much on banks, BTW. Now I'm getting like one of those nutters I used to snicker at. I can see why people rave about the Bilderbergers and the Jewish conspiracy. I don't think there's anything organised into a precise cabal, and I reckon there's more Protestant and Catholic greedheads than there are Jewish, simply by weight of population.)
Somebody's gotta buy those T-Bills. The Chinese, Saudis, or God forbid, even American citizens, have to give cheap plastic crap, oil, or their taxsweat, to Teh Treas. At some point, they MUST decide the currency is a Ponzi scheme. The U.S. is not producing goods and services fast enough to guarantee anything REAL with these dollars. Especially with the collapse coming from this financial panic.
The debt cannot be repaid. Am I wrong in thinking the game must soon be over, Default City, your money's no good here? Or is there a way the game continues?
This stuff matters to me in more than a conceptual way. Not only do I have piles of money to push around (not enough to retire on, but you can do the math about what would happen if someone sold a house in Latte La-la Land up the road from you at PRECISELY the right point in the market, and cashed out someone's California state pension.)
We also have to decide where to live. I love this land of happy drunks, but Mrs. Bukko detests Australia because it's full of immature drunks. So she wants to move to Vancouver, in part to be closer to her friends in San Fran.
I've been OK with that, because I think the Cheney game is to steal as much as his gang can, then let the U.S. collapse while they enjoy their riches in Dubai and Davos. That's why they'd let Obama take power, to preside over the chaos. Canada would be a good place to be in that case.
But if that they believe the game could continue, then they'd let McInsane win. And he'd start a nuclear war, and Canada would be irradiated too. In that case, I'll stay down here to die, because I'd get to watch the game unfold for at least a few months longer. I wanna see how it turns out!
What to do, wgat to do? It all depends on the nature of money...
Doesn't the concept of the "U.S. dollar" get destroyed when so many are wished into existence at a rate far faster than they can be "repaid" with goods and services?
ReplyDeleteYes, but in this case, they're getting wished into existence at a rate which is equal to the rate at which they are being wished out of existence. When a loan goes bad and gets called for a loss, that is money that is being wished out of existence, to use your terminology. By wishing money into existence to replace that being wished out of existence, as is largely guaranteed by the structure of this buyout (though it does have some deflationary component in that the stocks of Fannie/Freddie are going to lose significant value), the Treasury keeps the money supply steady and avoids the scenario you fear of printing more money than there are goods and services in the economy to "cover" them.
Regarding "when are these bonds sold to the Federal Reserve going to be repaid?" -- that might as well be "never". The "interest rate" on these bonds is basically the rate of inflation, and they simply get traded for new bonds when they expire and are "repaid". What will happen is that if at some point in the future money is getting created by banking activity (due to fractional reserve lending) faster than the supply of goods and services in the economy is increasing, thereby causing inflation, the Federal Reserve will then sell these bonds on the open market to suck some of that money back into their coffers in order to keep the supply of money relatively constant. This is sort of basic Monetary Supply 101, and what the Federal Reserve was created to do in the first place.
In short, where you see something alarming, I see the mechanisms of Treasury and Federal Reserve working as intended to keep the money supply stable and avoid the destructive cycles of deflation and re-inflation that typified the American economy prior to the creation of the Federal Reserve. Without some moderating agent insofar as the effects upon the money supply of fractional reserve banking are concerned, the result is a series of economic dislocations of dramatic severity typified by the various "Panics" of the 1800's and the first decade of the 1900's. The move to fiat money from hard money simply gives more tools for smoothing out these dislocations, though if you choose not to use these tools (as was true of Herbert Hoover in 1930-1932) they are of course no use. I'm simply gratified that there's still people in government competent enough to ignore the ideologues and do what it takes to keep the money supply stable. If only Herbert Hoover's Treasury secretary had been that smart...
- Badtux the Economics Penguin