Monday, September 29, 2008

Homeowners, Lenders Last Line of Defense: Denial

1. Looking backward, home buyers paid too much, and lenders wrote contracts that exposed them to the homeowners’ losses. With home values declining by something like $2 trillion, we are in a mad scramble to divide the loss between homeowners, lenders and taxpayers. In the meantime, homeowners and lenders are exercising their last line of defense: denial. Many homeowners are refusing to sell their homes at prices that can attract buyers. Many lenders are refusing to sell their mortgage-backed securities at prices that can attract buyers. All this denial gets in the way of the normal price discovery process, leaving stranded assets held by owners who think they are worth more than potential buyers.

2. Nonetheless, our financial institutions are doing a pretty good job. Our financial markets are supposed tell us how wealthy we are. This year the large drop in equity valuations is sending a pretty clear message: we are not as wealthy as we thought. That seems adequately accurate; no big problem there. Our financial markets also provide credit to consumers and businesses to help grow our economy. Outside of housing the economy is doing pretty well, and there is no clear evidence of a credit crunch seriously impinging on either business spending or consumer spending even though Wall Street pundits for more than a year have been ringing out loud alarm bells about an imminent credit contraction (see
related CD post). Though business spending and consumer spending are a bit weak, that weakness properly reflects the fundamentals of the economy and is not a symptom of a credit crunch. So what’s the problem, Mr. Secretary?

3. One honest way to transfer the losses directly to the taxpayers would have the Treasury buy homes directly at inflated prices and rent them to deserving Americans. Though the Treasury Plan involves buying mortgage backed securities at inflated prices, keep in mind that foreclosures will then turn the homes over to Uncle Sam. For $700 billion, the Treasury could purchase 2.3 million homes at an average price of $300,000. That is way more than is necessary. A half a million should be enough to unclog the system. Uncle Sam could purchase foreclosed homes, mow the lawns, fix the broken windows and rent them out to deserving families. That would help the other homes in the neighborhood sell at favorable prices.

~
Edward Leamer, UCLA economics professor

12 Comments:

At 9/29/2008 10:17 PM, Anonymous Anonymous said...

You don't know what a shutdown in credit markets means. In a few weeks, companies relying on any form of credit are going to find it hard to pay payroll. This recession is going to be much more severe within weeks if the bailout doesn't pass (and it shouldn't pass because the American people rightfully oppose it).

 
At 9/30/2008 12:36 AM, Blogger randian said...

The government is a terrible landlord, that's why the "projects" are for the most part being torn down and that's why Section 8 exists.

 
At 9/30/2008 1:16 AM, Anonymous OBloodyhell said...

> (and it shouldn't pass because the American people rightfully oppose it).

This seems to make a fairly good case for why the bill should have been passed.

I think, despite the rejection, it's worth reading since the issue isn't resolved and is likely to be considered yet again.

 
At 9/30/2008 1:22 AM, Anonymous Anonymous said...

I never have worked at a company that had to borrow to make payroll.

 
At 9/30/2008 3:23 AM, Blogger juandos said...

"One honest way to transfer the losses directly to the taxpayers would have the Treasury buy homes directly at inflated prices and rent them to deserving Americans"...

Hmmmm, buggy professor, is that really you?

How many people actually pay federal income tax now a days?

Shouldn't the actual taxpayers be eligible for these houses?

"In a few weeks, companies relying on any form of credit are going to find it hard to pay payroll"...

Amen! Mom & Pop shops all over the country will feel this lack of credit in a hurry... There goes the unemployment numbers...

From IBT: Lack Of Confidence, Not Capital, Is Issue

 
At 9/30/2008 7:46 AM, Blogger Arman said...

This comment has been removed by the author.

 
At 9/30/2008 7:56 AM, Blogger Arman said...

"I never have worked at a company that had to borrow to make payroll."
You're bent. Business runs on credit. No, they don't have to go to secure loans once they've found out what their payroll is, but they almost always rely on overdraft.
"Mom & Pop shops all over the country will feel this lack of credit in a hurry."
True. When I was running my business, and the banks decided to curb their lending, my overdraft allowance was severely curbed. At the same time, my suppliers became much more demanding that my accounts get paid up, showing me that the banks were squeezing them too.
"There goes the unemployment numbers..."
No. Finance doesn't create jobs. Consumer demand, supported by the minimum wage is the foundation of the job market. This is clearly illustrated today while the finances of the country have been melting down since last September, the job markets have remained good.

 
At 9/30/2008 8:37 AM, Anonymous Anonymous said...

"Nonetheless, our financial institutions are doing a pretty good job. Our financial markets are supposed tell us how wealthy we are. This year the large drop in equity valuations is sending a pretty clear message: we are not as wealthy as we thought. That seems adequately accurate; no big problem there. Our financial markets also provide credit to consumers and businesses to help grow our economy. Outside of housing the economy is doing pretty well, and there is no clear evidence of a credit crunch seriously impinging on either business spending or consumer spending even though Wall Street pundits for more than a year have been ringing out loud alarm bells about an imminent credit contraction."


I don't see how this explains the stock market crash.

If the economy outside housing were doing well why is the stock market crashing?

Why should the stock market tell us we are poorer because the value of our homes went down?

 
At 9/30/2008 8:42 AM, Anonymous Anonymous said...

Regarding the link to why the bail out should be passed...

The linked article says the $700 billion is not paid by the taxpayers but by those who buy government bonds sold to raise the money.

But isn't it the taxpayers who pay the interest on the government bonds?

So isn't Paulson exactly right when he said the taxpayers are going to pay the $700 billion?

 
At 9/30/2008 9:34 AM, Blogger Arman said...

"If the economy outside housing were doing well why is the stock market crashing? "
It is a contraction of the money supply that was caused by the Fed cutting interest rates. The money doesn't just sit in the market. The money goes into the market and circulates from buyer to seller to seller to seller, so that just a small amount of extra cash can fuel a huge bull market. Conversely, just a small cash constriction can quickly deflate the prices on any sector it hits.

 
At 9/30/2008 5:20 PM, Anonymous BARKLEY said...

Stock valuations have a very very large psychological component which is disconnected from money supply, profits,employment or any "real" economic activity

The culprit in the stock market correction is mainly the negative press and the pessimistic economists who have been predicting a recession now for about 4 years.

 
At 10/01/2008 11:38 AM, Blogger Arman said...

"Stock valuations have a very very large psychological component which is disconnected from money supply,"
There is nothing with a price that is at all disconnected from the money supply. Comparative valuations between two similar items have a psychological component, but when valuations on whole sectors deflate, it is only about the money supply.
The money that has been taken out of real estate and stock markets so as to cause the collapse of these markets, where do you think it has gone??

 

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