When it comes
to the meltdown of the housing bubble, you
cannot help but wonder how fragile our system
is and how stupid our experts are. But I
guess you can't be any dumber than the person
who makes $50,000 a year and buys a $500,000
house with 0% down. Or the mortgage banker
who signed the loan papers and issued the
check. Or the smart investment banker with
a $1,000 suit that thought bundling such
mortgage programs together made it less
risky. Or the regulators who thought investment
bankers were smart and sub prime mortgages
are safe no matter how illogical.
The sub prime mortgage crisis
and its ongoing financial crisis was triggered
by a dramatic rise in mortgage delinquencies
and foreclosures of homes where the lenders
were not capable to handle the monthly payment
increases after the initial teaser rate.
Then everything else started
to unravel. High-risk mortgage loans collapsing,
inaccurate credit ratings, ineffective securitization
policies, preposterous lending practices,
absurd institutional debt levels, and general
weaknesses in the financial infrastructure
incapable of detecting flaws in the system
- all lined up in a straight, nicely-organized,
line of dominoes that only needed a little
panic to tip over. Once the confidence levels
were shattered everything started to tip
over and it reached the entire stock market
and eventually the financial system.
What is more stupid than
these high-risk loans to borrowers with
no financial ability to pay them back is
the fact that we are still building more
homes. There's about 16 months worth of
new and used homes on the market, that is
if we don't build any more homes, it would
16 months before these homes are all sold.
Add to this that there is about 15% of rental
properties and almost 7% family-owned homes
around the country that are empty. Still,
despite slowdown in the construction industry,
we are still building more homes than what
is being bought. Really smart.
The U.S. Census Bureau
released a report last week indicating that
in United States we have 128 million houses,
condos and apartments but just 112 million
households. Do the math. Isn't that ridiculous?
The report also described how we've got
large number of houses sitting in the market
but not enough that people can afford to
buy because most people that don't already
have a house are the ones with low incomes.
Increasing foreclosure rates
has increased the inventory of houses sitting
on the market. The number of new homes sold
in 2007 was 26.4% less than in 2006. In
2008, there was another 31.8% fewer houses
sold compared to 2007. By January 2008,
the inventory of unsold new homes was 9.8
times the December 2007 sales volume, the
highest value of this ratio since 1981.
By end of 2008, nearly five
million existing homes were on the market
looking for buyers, of which 3.1 million
are vacant. This overhang of unsold homes
keep lowering house prices. As prices declined,
more homeowners are at risk of default or
foreclosure because they cannot sell nor
can they re-mortgage their house to take
out equity. House prices are expected to
continue declining until this inventory
of unsold homes (an instance of excess supply)
declines to normal levels - expected to
be sometime in 2010 or 2011 or longer if
the construction pace stays ahead of demand.
Americans
at risk of default have had to keep the
lights on by using their credit cards to
buy time. And as one would expect, a growing
number of Americans are now falling behind
on their credit card bills with 60-day delinquencies
are 30% higher than one year ago, at about
8 percent. The banks can now expect more
charge-offs,
debts deemed uncollectible, and general
bad debt to exceed 15 percent in the first
half of 2009, up from current levels of
about 12 percent. Banks are keeping credit
card portfolios funded by increasing the
rates charged to cardholders in order to
stay ahead of the bad debts being incurred.
To combat the financial
risks, major credit card companies like
Bank of America, Citigroup , and American
Express are slashing credit lines and running
credit status checks each month on their
customers to evaluate their debt-to-equity
ratios. It is estimated that banks will
cancel $2 trillion of available consumer
credit throughout 2009.
To their credit, banks are
legitimately changing rates, rules, and
their terms and conditions unexpectedly
by slipping unfair and slimly changes
into the fine print and sending an
update of terms to the cardholder often
being thrown right into the trash without
review. Despite the $700-$800 billion of
your tax Dollars being used to help the
banking industry, you cannot expect any
help from them in return.
However, the government
is trying to get the banks to accept new
rules to stop them from continually adjusting
the rates. And consumer groups are fighting
this every step of the way and not only
wanting the passing of clearer laws to protect
consumers but also the easier enforcement
of the laws to stop banks from their increasing
rates on delinquent accounts. While banks
can still raise rates for future balances,
the new rules, which aren't expected to
take effect until 2010 however, won't allow
them in most circumstance to increase the
rates consumers pay on existing balances.
The new rules would prohibit
banks from raising rates when a customer
falls behind on other bills, say a utility
payment, not related to their credit card
account or when their credit rating is lowered
from other delinquencies.
After 2010, card
companies will have to give consumers 45
days notice of any interest rate changes,
up from the 15-day notice period currently
in force, and give them more time to make
payments. The new rules also make improvements
to disclosures by card companies. As a result
of these new rules, the Federal Reserve
estimates that credit lines could be cut
by an average of $2,000 per account, an
industry-wide reduction of nearly $1 trillion.
Among other things, the new rules will prevent
card lenders from jacking up interest rates
on existing balances, a controversial practice
that consumer advocates have long spoken
out against.
The mortgage foreclosures
in the housing crisis and the resulting
credit card delinquencies are now beginning
to affect the $92 billion student-loan market.
Student loans rising defaults and the new
law that cuts federal subsidies to student
lenders, are heavily changing the health
of the student loan industry. And to add
insult to injury, families that experiencing
higher home loan rates from their sub prime
loans and higher credit card rates are now
having dramatically harder time keeping
up with payments on student loans and all
of this is increasing the default rates
on student loans. This makes it even more
difficult to borrow for education in the
future.
Reduced federal subsidies
and anticipated lower profits have led a
number of banks and other student lenders
to stop altogether loans to borrowers, or
have discontinued discount loans, or reduced
interest rates loans that automatically
debited monthly payments from checking accounts.
What else can go wrong?
On December 1, 2008, the
National Bureau of Economic Research (NBER)
declared that the United States entered
a recession in December of 2007, citing
employment and production figures as well
as the third quarter decline in GDP. The
suffering stock market saw the Dow Jones
Industrial Average losing 679 points that
very same day. The stock market has experience
a huge loss with the Dow Jones falling from
the levels of 14,500 to levels of 8,000
between September 2007 and June 2009,
a reduction of 45%.
On September 17, 2008, Federal
Reserve chairman Ben Bernanke advised Secretary
of the Treasury Hank Paulson that a large
amount of public money would be needed to
stabilize the financial system. The government
then decided to buy mortgage-backed securities
from banks and investment houses for a staggering
amount of $700 billion ($840 billion including
all the pork barrel projects to make sure
that our honest Congress men and women can
get re-elected).
By mid-June 2009, it
was estimated that the new loans, purchases,
and liabilities of the Federal Reserve,
the US Treasury, and FDIC, brought on by
the financial crisis, totaled over $5 trillion:
$1 trillion in loans by the Fed to broker-dealers
through the emergency program, $1.8 trillion
in loans by the Fed through the Term Auction
Facility, $700 billion to be raised by the
Treasury for the Troubled Assets Relief
Program, $200 billion insurance for the
GSEs by the Treasury, and $1.5 trillion
insurance for unsecured bank debt by FDIC.
With all of this, still
the economy in recession, unemployment rising
drastically, stock market bouncing around
aimlessly, liquidity crisis continues, recession
persistent with no end in site, and confidence
in the financial and capital and global
markets shattered.
But what does
future hold?
Let's accept that China
manufactures most of what American businesses
sell to American consumers because our corporations
could never threaten their profitability
by hiring more-expensive American workers.
This mentality has precluded any common
sense that the physical location of the
factories and plants create many jobs in
the local vacinity and the factory workers
and managers spend their money here, rather
than somewhere else. Add to this, the patriot's
point of view, that manufacturing is an
essential part of national security and
our national security is being shipped away
to China.
So now we find ourselves
in very precarious predicament. More than
one million U.S. jobs were cut in 2008 by
AT&T, Bank of America, General Electric,
Citigroup, Cisco, US Airways, and a range
of employers in the retailing, construction,
and manufacturing industry. Refrigerators
are empty and hope is lost to find a new
job with 3 people unemployed for each job
that is advertised.
Since credit markets are
driven with cheap-money policy of the Federal
Reserve it effects other economies in the
world that are also dependent upon the cheap
money policies of the Fed. This is partly
because the rest of the world has grown
increasingly dependent upon the rising trade
surplus with America created by the excess
demand in America as a result of the downward
pressure on the Dollar created by the low
interest rates. Other countries' central
banks emulate the cheap money policy of
the Fed in order to prevent their currencies
from rising too rapidly in value against
the dollar. Moreover, world economic growth
is also dragged down by structural problems
in United States.
Therefore, we move from
a solid manufacturing and industrial complex
into printing money and living off of hype.
And the hype created overconfidence in the
U.S. economy's excessive dependency on cheap
credit. In 2000, the U.S. experienced its
largest stock price bubble since the 1920s
with valuations of technology stocks set
at ludicrously high levels. This bubble
was driven by rapid money supply growth
and was accompanied by a sharp increase
in the private sector debt burden and current
account deficit, both of whom reached new
record levels.
The private sector financial
savings rate usually fluctuating between
a surplus of roughly 5% of GDP during recessions
and around zero during good times, is now
in negative territory at –6% of GDP.
When the bubble burst in the spring of 2000,
a severe recession was avoided by a combination
of tax cuts and spending increases, and
the fastest and largest interest rate cuts
ever in American history, with real interest
rates being pushed into negative territory
for the first time since the 1970s.
But this successful avoidance
of a deep recession came at the price of
preserving and indeed aggravating the creation
of another, even bigger bubble, this time
in housing which quickly spread to all of
the credit markets. Normally during recessions
the private sector debt burden falls and
household and corporate balance sheets are
restored through high net savings. But while
corporate balance sheets have been repaired
as a result of a sharp decline in business
investments and record corporate profits,
households have been on an unprecedented
spending spree, households are more indebted
than ever before with millions in negative
home equity, as mentioned above, due to
collapsing house prices.
As a result of the household
spending spree and the budget deficit, this
time contrary to the normal developments
during a recession, the current account
deficit increased to new record levels.
And since the economy recovered from the
recession of 2000-2001 quickly, the build-up
in debt levels have of course continued
to increase.
Many people see this recession
to be a long recession, may be even 3 years
- later to be named the 2008-2010 recession.
A long recession forces people to become
more realistic and prudent and frugal -
but mostly to invest for the rainy day.
As we have seen from the
reduced price of gasoline due to cut backs
in consumption, we shall soon see cut backs
in the consumer spending which will help
our economy to pull out of recession.
The longer this recession
lasts, the better the years that will proceed
it. As Americans we need to understand that
we do need to have more savings and we cannot
have a strong economy if 95% of our population
go from paycheck to paycheck with no savings
in the bank hopeful that there is always
a job waiting for them despite their lack
of constant re-investment in further education
and training for more productive and higher
paid jobs. This instant gratification society
needs to wake up and be wiser with its budget.
Looking at all the reports
from Department of Commerce and other publishers
regarding the current pains of the U.S.
economy I can only assume that just about
every American is seeing the errors of our
ways in the last 10 years and the longer
this economic crisis lasts the more enduring
the growth years that will follow it.
Although this may not be
much comfort to many people in America facing
hardship today, the years between 2011 and
2006 will be very prosperous in U.S. and
the rest of the world. Let's hope that as
a country we take this opportunity to fix
many of the ills of our current situation,
such as loan risk analysis, accounting principles
and practices, credit rating inefficiencies,
and politically charged securities and financial
management laws and practices. The future
will be much rosier than it appears today.
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