Tuesday, September 30, 2008
The decision to create, market and finance ARMs turned our fortunes. Think about the brokers who sold them. Where are they now? Some could see this current crisis coming, but few were willing to openly answer the obvious questions: what happens when the rates start to adjust? As payments on these loans began to increase, so did late payments, defaults and eventually, foreclosures.
Setting that aside, lets look at the 30 year mortgage on its own. A simple calculation reveals that a mortgage paid at 7% annual interest, assuming 10% down, will more double the cost of the home you buy over 30 years.
The pattern is similar for auto financing. The interest costs are significant for autos and they can increase the cost of the car often by 50% or more over time.
Now lets look at credit cards. Some people are lucky enough to have 0% or a low 5-6% interest rate on the balance. This makes the cost seem negligible relative to the benefits and convenience of credit. If you miss a payment, however, the fine print says that your rates could go up significantly. The rates for credit cards held by teetering payers can shoot as high at 30% or more.
The bottom line is that all forms of credit make everything more expensive. Everyone has heard of inflation. We see it all the time in the news. And there are so many ways to measure it, too. Inflation is defined as an increase in the cost of goods over time. While the cost of a broom may rise over time at a constant rate, the cost of food and fuel can fluctuate wildly.
Credit is a hidden form of inflation in the sense that we aren't really trained to see how much it costs. This concept gets some lip service when we go to school. But instead of being taught how to avoid it, we're taught that the cost of credit is the cost of doing business. It's assumed to be unavoidable. This leaves an indelible impression upon a young mind.
For many Americans, credit cards have been used to maintain a standard of living. It is not unusual for people to accumulate $10-20,000 in personal debt through credit cards. This debt is often accumulated through the use of credit cards to pay for living expenses when the economy is slow. Many will use credit cards to purchase vacations and luxury items they couldn't otherwise afford. But few if any can imagine a life without using credit.
I know at least one man (whom I admire deeply for his business savvy) who doesn't need credit in the sense that most people are familiar with. He built his business on cash. He pays his invoices early for the discounts he receives from the vendors who offer early payment discounts. He owns all of his equipment, and the building from which he runs his business. And since he has no debts, he doesn't panic when the trade gets slow. He just lays people off and reduces purchasing until the level of employment and the need for materials matches the rate of business that he's doing. When business picks up again, he hires and buys.
Without loan payments to make, which are constant over time, he can adjust his cash flow with the business instead of with the bank.
Credit doesn't just make everything expensive due to the interest paid on the loan. Credit is used in this country to create artificial demand. This demand increases prices. That's why the crowd goes wild every time the Fed drops their rates. And I dare say that credit also creates a pool of cheap, skilled and willing labor, tied to the ball and chain of debt. Whichever came first is still in debate.
Let's look at the hidden costs of credit at the checkstand in simple terms: if you don't have the money, you can't buy it. But if you have credit, you can just pay it off over time. This increases demand for goods and services. And demand creates inflation.
As to the labor pool, here's the big picture: You are employed. You have a home loan, an auto loan, and maybe a few college loans, a few credit cards and a family to support. But you have no savings. A vacation is a far off fantasy without a credit card or a line of credit on your house. Worse, you can't choose the job you want or the pay that you want because you have to keep working to keep making payments.
Imagine a parallel universe where you have a year of expenses saved up. Now you can kiss your boss goodbye (ew!) on good terms, and take your time finding the job you want. Or you can take a month off to reassess your direction in life. Whatever. You have a contingency fund to handle most small emergencies, too. With a year of expenses in the bank, the bank wants you to stick around. Like I said - it's a parallel universe.
Now there's a study in contrasts. Why didn't we do this from the beginning? Maybe most Americans are masochists who need someone like a banker to help them.
Remember how much fun we were having as we watched home prices double in Southern California (and spike unreasonably fast elsewhere)? That was due to increased demand for homes created by "creative financing" mortgages. By creating easy money loans, people suddenly had the money to get into the housing market. That is the kind of demand for homes we saw then that could never have happened without ARMs.
Without ARMs, people who wanted to sell their homes would have had to either lower their prices or wait. And that is exactly what is happening now. The ARMs are gone. Prices are falling and people are waiting rather than selling.
Without easy credit, prices will have to fall. There is no way for the economy to quickly correct itself. But from a practical standpoint, we are not completely powerless over inflation. If we live within our means and buy what we need or want with cash, we can keep inflation in check. Confused? Let me explain.
If people refused to borrow money and instead chose to save their money, what would happen to the economy? Producers and sellers would have two choices: lower their prices, or wait.
Now consider this: saving money and only using cash is not just a choice, this way of life creates choices. When you use credit, you are dependent on someone else to make the decision for you. In a credit - I mean, debt economy - the bankers make the choice for you. They decide if you will buy something or not.
But if you have the money in the bank, it's yours to spend. And the banker is going to pay you interest if he wants you to keep your money there. It's not so much that you're in control. You simply have more choices available to you. And by tempering your demand with the amount of money you have on hand instead of borrowing, you help to keep prices down.
A cash society lives on the cash they earn, and has more control over prices by controlling demand and can make spending decisions that are relatively unencumbered by the interests of bankers. Remember, a banker is only your friend to the extent that you are willing to pay him back on the loan, or to the extent he is willing to pay you interest on your deposits.
The choice is yours. Where do your interests lie? Pay or be paid?
Sunday, September 28, 2008
Here's an interesting thought experiment. The richest man in the world goes to a small town on a road trip. We'll call him Bill. Before he arrives, the whole town is abuzz about his arrival and they learn that Bill has been pushing legislation that is contrary to the interests of the town.
When Bill arrives, he checks into a hotel. He talks to the clerk and asks about a room. The clerk looks and says, "Sure we have a room for you." Bill gives the clerk his name and hands him a credit card. Suddenly, the clerk announces that there is no longer a room available, and returns the card.
Bill is surprised and suspicious. So he leaves to try another hotel. When he gets there, he encounters the same result. A room is available until he introduces himself. He repeats this until he begins to become hungry.
He heads to a local restaurant to eat. But the restaurant knows who he is. He gets a seat, sure enough and the waitress comes to him to take his order. When he finishes giving his order, the waitress asks for his credit card. Bill is surprised by this, but he complies. She comes back to say they're out of food and that he will have to eat somewhere else.
Bill repeats this a second, and a third time. He sees that he needs gas. He worries that something isn't right so instead of trying to use the ATM directly, he goes to the little snack shop to pay there. He is instantly recognized by the proprietor as word has gotten around. While other people are filling up their tanks, the proprietor announces that "We're out of gas, sorry."
Bill confronts the proprietor with this crazy-making reality. "Excuse me, but people are still pumping! I'll give you cash!"
"No you won't!" says the proprietor. Bill is flabbergasted as the proprietor points to a sign above the door. It says, "We reserver the right to refuse service to anyone".
Bill is stuck. No food, no room, no gas. Bill gets really worried when he discovers, after a few phone calls, that this isn't the only town. It's worldwide.
This is the worst possible result of the social contract. When we refuse to acknowledge a man's power by refusing his money.
When we look to our leaders and wonder why they do what they do to the rest of us, we must also look to ourselves and wonder "Did we ask for this? Did we somehow give them permission to do this?" The most probable answer is, "yes."
Tuesday, September 23, 2008
How do these bonds get paid back? With taxes. For many people the connection between the federal debt, which is now limited to around $10 Trillion, and taxes doesn't appear so easily. The government has to sell debt when it runs out of money. And that happened a long time ago, long before many of us were born. So now we live in a debt economy.
Who buys the bonds? Other than the Federal Government with more than half the outstanding debt (I know, it's weird), foreign governments are the biggest customers taken together. China and Japan come most readily to mind. And then there is the rest of us. Many people have openly questioned what will happen if China and Japan decide to unload their bonds. The net effect is a weakening of our own currency.
When our currency grows weak, foreign goods, like oil, become more expensive, even if demand is low or flat. And one thing that the Bush Administration has been consistent about is weakening our dollar. That's a big part of what makes gasoline expensive to us. And they seem to think it's a plus. When oil was selling at $140 per barrel, there was a bit of press about how high oil prices are bringing jobs home. Nice. Here's one bizarre example.
It's easy to get lost in the details of the situation. Most people are very focused on the details of the pending legislation to fix the Wall Street crisis. But the big picture looks more like this:
- If you work for someone else, you're not going to be able to charge more for your products and services like a business can when the dollar loses its value.
- If you work for someone else, you're not going to be able to use your expenses to limit your tax liability like a business can.
And that is the main problem with this proposed $700 billion bailout. The executives of Fannie Mae, Freddie Mac, AIG, Bearn Stearns, etc., all sang the song of free-market capitalism. Whether or not it's really a free market is open to question. And when it came down to owning up to their own mistakes, they want YOU to pay for it. It's only fair.
To put it another way, they privatize the benefits of capitalism while socializing the risks. Remember socialism? You know, the little brother to communism? That's what they're talking about. Big business works better if you privatize the economic benefits and socialize the risks. To put it in layman's terms: Executives keep getting paid even when you lose your job.
Since 1994, Republicans have been doing what they can to "de-regulate" the investment industry. Yeah, they de-regulated it alright. Anyone remember the failed experiment of de-regulating the power industry in California? I do. Power tripled in cost so that people like Enron executives could put their money in the Grand Cayman Islands as a safe investment.
The Bush Administration is really worried that the Democrats will load up the bill with restrictions, such as the restriction on executive pay for companies that get assistance from the government. I guess means testing is okay for poor people seeking welfare or unemployment, but for executives, that would be humiliating!
This week, they're "negotiating" on the terms of the aid. What I find interesting is that the negotiations are in secret. Why all the secrecy? It's our money too. Seems like they want to come up with a plan and spring it on the rest of. You know, like it's "now or never". At least Republicans are starting to speak up and point out alternatives other than handing the banks a big wad of money all at once. And then there is the insurance plan. Hmmm. Don't people buy mortgage insurance anyway? Now that I'm thinking about it, where are those insurance guys? The plan was submarined without informing Treasury Secretary Paulson. Some have characterized the effort behind this plan as a way to divert attention to McCain's "leadership skills".
I see also that the FBI is getting involved. It seems that there are four firms at the heart of the matter and they want to know why. And now they're letting people know that investigating the same companies for wrongdoing will be hampered when we give them a wheel barrel full of money to pay for their mistakes.
At the beginning of this week, we were talking about a huge bailout of the financial industry with almost no oversight or accountability. Democrats have been negotiating with the Bush Administration to require oversight. Many House Republicans still seem to insist that relaxing the regulations could help the situation. Even if there is some oversight, it will only be administrative oversight by unelected officials. Whether it's a handout of money, insurance or some other cooperative put together by the financial industry, one thing remains clear: control of the process is not in the hands of the people who are paying for it.
Monday, September 22, 2008
Between 2003-2006, we saw housing prices double in Southern California. Much of the rest of country saw something similar, or a serious spike in prices. During this time, people were buying houses to flip them for a tidy profit. Real estate agents were telling people that if they didn't buy now, they'd be frozen out of the market. Many people with bad credit wanted in, fearing they wouldn't be able to later. So they turned to the ARM.
Now they're wishing they hadn't. Or at least wishing their homes had increased in value. But they just couldn't go up forever, at that rate, anyway.
The Adjustable Rate Mortgage was probably the single biggest factor driving up home prices. Initially they were intended to give those who didn't have a home, a way to buy into a home.
Many economists knew this day was coming. But we really didn't see that much in the press about it. Sure Greenspan said something about it, and I'm sure people were listening intently, nodding when everyone else nodded. Unfortunately, it takes months of hard work by highly skilled technicians to parse his language into common English.
I remember reading about it in 2006 in the OC Weekly, in an article called "Welcome to Stanton!", by Rebecca Schoenkopf, aka, the Commie Girl (sorry, dead link - but I wrote to the paper to ask them to put it back). She had pointed out that even in the bad parts of Garden Grove and Santa Ana, where the doors have iron gates, and police helicopters fly nightly, houses were selling for more then $400,000. Why? ARMs. And she boldy predicted the mess we're in today.
Anyone reviewing housing prices on Zillow.com will see that housing took a wild ride during 2003-6. They have a pretty cool feature that lets you see the value history of the house over time. During that time, municipalities were basking in the glow of higher property taxes. Remember, municipalities have accountants who work for them. Surely they must've smelled the problem miles away. But strangely, they were silent. Everyone was happy as long as the housing prices continued to rise. Except for the people who wanted to buy a house.
I grew up in Manhattan Beach, California. When my parents bought a house there, they paid $50,000 for it, mumble-mumble years ago. That same house at the height of the boom in 2006 was worth nearly $2 million. In fact, most of the houses on my street where I grew up were worth close to $2 million. I talked to my sister, and she says "I wouldn't want to live there. Go down one of those streets at night, around 6-7pm. There's nobody home because they're working! Go to Sand Dune park and look at the people there: Nanny's and their kids!" It takes a lot of work to pay off a $2 million mortgage.
Now that we've watched the biggest investment banks fall, Bear Stearns and Lehman Brothers, and AIG get a nice helping hand of $85 Billion, and Fannie Mae and Freddie Mac get nationalized, where are we? We have a Republican administration pushing a bill that would give omnipotent authority to the Treasury Secretary to buy bad mortgages. Oh, and don't forget, we don't want the courts to get involved. We can't have pesky judges get in the way while we help our friends and allies in Wall Street.
So are we willing to spend $800 Billion to help the investment industry save their posteriors? I see that the Democrats are speaking up about the golden parachutes of the people who ran these firms into the ground. So how about it, CEO of Fannie Mae? Now that you've decimated your company's stock, are you going to give back? Oh, wait. You still need to be able to send your kids to a private school, live in a gated community, take the family on vacation in Europe twice a year and make payments on 3 cars? No can do, my friend. You have to come down here, with the rest of us if you want to get back up again. Oh no! He flew to Barbados! Sigh. Easy come, easy go.
A recession is what happens when the middle class cannot afford, or is unwilling to work for what the upper class is willing to pay. That is what we have here. The lower classes couldn't afford to get a home on what the upper classes were willing to pay. Notice that upper class is still not willing to pay. They're really worried that they won't have enough money for when Jesus returns.
Howcome I don't hear anyone talking about "infrastructure"? Well, I heard Obama talking about it, but only briefly. The point is this: we could spend $800 Billion to save the people who got us here, or we could do a Roosevelt and start building roads. Remember the bridge collapse in Minnesota? Michael Heller says that we could eliminate delays at airports if we built 25 new runways at our busiest airports. But that would be too expensive (there are easement issues, too, but that's another article).
How about communications? Check out this website by the Communications Workers of America. Seems they have noticed that Japan has internet access we could only dream of. They get 61 Mbs on average. That kind of money could light up all the dark fiber laying around in this country, too.
Infrastructure is what made this coutnry great. Without all the freeways, airports, plumbing, wiring and communications, we couldn't live the way we live now. But all of that takes maintenance. Maintenance that the billionaires in Dana Point and Beverly Hills weren't willing to pay for with taxes. Perhaps they'd rather go to war.
I moved from California to Utah. Life is pretty nice here. But one thing I've noticed is that they're really busy with the infrastructure. It's hard to drive down a major road without seeing some sort of construction going on. They may be paving the road, laying pipe, or just fixing it up. But the're always working on something. They get it that infrastructure is important.
That might explain their low unemployment rate of 3.8%, relative to the rest of the country, which now stands around 6.1%. I'm sure there are other factors at work here, no pun intended. But the bottom line shows up in the infrastructure.
Building infrastructure would add more value to homes, a lasting value I might add, than bailing out executives who wanted to fleece people who wanted a home to live in. Talk to your friends and politicians about it. Get the message out.
I rest my fingers.
Sunday, September 14, 2008
Over the last week or so, I've become more and more alarmed about Governor Palin. Yes, I say Governor, and I will not refer to her as "Sarah Palin". That would be sexist. And, as Willie Brown points out, it lends a familiarity with her that Democrats do not really enjoy. He's a little bit pompous, but he does make a good point here.
The New York Times is running an article (you'll get 4 1/2 pages, and then you must subscribe) that describes in detail a history of Palin that shows an extreme concern for secrecy. Like intending to use private emails on private devices to conduct government business so that the records of the email cannot be reviewed under open government laws, as an example. We've already seen this in the Bush Administration, too. Remember the lost emails?
Very scary. The Democrats have their own issues to be sure, and many of us can remember secrecy in the Clinton administration. But this, and potentially the next administration have taken secrecy to new extremes. And Palin seems intent on continuing that philosophy.
To illustrate the difference, let me give you an example. A number of sources have noticed a change in the way the Freedom of Information Act and the Privacy Act have been enforced and administered. During the Clinton years, the executive branch agencies erred on the side of disclosure. But during the Bush II years, they erred on the far side of withholding documents.
I can remember when I was a young man, how the Republicans proudly stood for freedom. But now, as an older man, I see that they live in constant fear of being exposed. The war on terrorism is a convenient cover for the need for secrecy and it will only be more so under Palin. I don't think the Republicans stand for freedom anymore. In fact, I'm not really sure what they stand for. It's a secret.