This is a wee bit of a problem:
This is the amount of debt per US family, in inflation-adjusted 2007 dollars, as according to the Federal Reserve's triennial Survey of Consumer Finances.
Per-family household debt increased by about 130% in real dollars between 1989 and 2007, from roughly $42,000 per family in 1989 to $97,000 eighteen years later. Most of that increase has come during the past six or seven years -- household debt increased by 52% between 2001 and 2007 alone.
Almost all of the debt (about 85%) falls into the category that the Fed calls "secured by residential property" -- which means mortgages and home-equity loans. Credit card debt, while having increased roughly threefold since 1989, is overall a very minor part of the problem, averaging about $3,400 per family. (We could have paid off every credit card bill in America for the cost of the TARP program.) "Other" types of debt, which I gather are mostly things like automotive loans and student financing, have also increased somewhat, but not nearly at the rate of mortgages.
All of his wasn't that much of a problem so long as the value of the housing stock was appreciating at 10 or 15% per year, keeping pace with the additional debt that households were assuming. But of course, it stopped doing so about 2-3 years ago. Translation: look out below. When people talk about the destruction of the household balance sheet, this is what they're referring to (or at least what they ought to be referring to).
The collapse of the housing bubble was obviously a very important event in precipitating the current economic crisis. There is some debate among economists about just how important it was; I tend to side with folks like Dean Baker in thinking it was a very large problem indeed.
If so, however, it makes the matter of attributing blame for the economic crisis a little bit more complicated. Clearly, for instance, credit default swaps, which bankrupted AIG, were poorly conceived of and improperly regulated instruments. But their collapse was triggered by the correction in housing prices. AIG bought into the fiction that the housing bubble wasn't really a bubble, but save for a few prescient economists like Baker, Paul Krugman and Bob Schiller, so did most everyone else.
I know it isn't in vogue to say this, but I think the manifest excesses of Wall Street have made them perhaps too easy a target in assigning blame for the economic collapse. A more appropriate focal point is probably the Federal Reserve, which many economists believe kept interest rates far lower than they ought to have been, contributing to the climate of cheap credit that triggered the housing boom (and bust). The mortgage companies themselves, of course, also exercised exceptionally poor judgment -- as did the media, with its Flip-This-House fetishism, which perpetuated the fiction that one of the biggest asset price bubbles in American history was in fact business as usual. Whether to assign any blame to the homebuyer himself is probably not important. It's tempting to say: if Joe the Homeowner had only read Schiller, none of this would have happened! But it's difficult to expect the consumer to behave rationally when they were getting such bad information from their televisions and their elected (and appointed) officials.
3.24.2009
The Mortgage Monster and the Blame Game
@ 1:01 AM
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Before the comments get overtaken by assessing blame (which, is, after all, in the title of Nate's post), I'd like to point out the graph is not necessarily showing a bad thing.
If someone who can afford it switches from paying rent to paying off a mortgage, the "blue" part of their debt will increase dramatically. Even discounting inflated prices, most houses in this country are more than $100,000. So the increase in the blue area of the graph is partially attributable to a rise in the rate of home ownership.
In the course of the past several years, people were encouraged to buy houses that were more expensive than they could safely afford. But that doesn't necessarily mean that they couldn't afford a house at all, and an $80,000 of mortgage debt per family is probably not that out of line.
The tripling of credit card balances is actually more indicative of the problem because it's not primarily due to enlarging the pool, and it's not "good" debt anyway.
SLS,
Between 1989 and 2007, the percentage of Americans with mortgage debt secured by their primary residence increased from 39.5 percent to 48.7 percent. That's not trivial, but it pales in comparison to the increase in debt per mortgageholder, which increased from $29K to $73K over the same period.
"But it's difficult to expect the consumer to behave rationally when they were getting such bad information from their televisions and from their elected (and appointed) officials."
That's bunk. The rest of your post is right on target, but give the American people a little more credit than that. People know exactly what they are doing when they sign a mortgage for a house they cannot afford. From then on, for better or for worse, it is their responsibility to pay it off as they have promised to do.
I realize that the business is full of unsavory lenders and wall street execs who make a living taking advantage of people, but to absolve the buyers of all responsibility does a disservice to those buyers who did everything right and decided to live within their means.
One more thing: The tripling in credit card debt, while a bad thing, might have more to do with the advances in technology over the last 20 years. Internet shopping has created a necessity for credit cards that wasn't there in the late 80s.
The consumers are a bit like a computer in the sense that they will do whatever they are told to do and are in themselves absurdly stupid. Therefore, to blame them is a bit like blaming your computer because you downloaded a virus when you kept opening email attachments from unknown senders claiming that yo9u have won the Nigerian Lottery. Maybe that's satisfying on some level, but it solves nothing.
A better approach would be to look at what conditions drove the consumers to do what they did. Consumerism has driven the American economy ever since the post WW2 era, and it has increased exponentially every year. This is partly by design, as the Breton Woods agreement and the GATT were drawn up in a way that woudl allow participating states (GATT became the WTO, of which now just about all the countries on earth are a member) would have their economies propelled by consumerism, particularly American consumerism, as the abolition of tariffs meant that imported goods could be bought cheaper than domestics and every country with a lower standard of living lined up to get rich by selling us their cheap shit. The US Government has historically (with the brief exception of the Carter Administration) pounded the "spend, motherfuckers, spend!!!" drum as loudly as it could. The Fed under Greenspan treated bubbles the way a drunk deals with the DTs-by pushing even greater consumption, trying to delay the inevitable in hopes the whole shithouse won't go down in flames until after you're dead. Businesses touted greed and gluttony as an integral part of the American lifestyle, quantity over quality. Gone were the family meals at home around the table, complete with socialization and conversation. Now, there was McDonalds, supersized cheap crap passing itself off as food and served in a place as conducive to family bonding and intimacy as staring at the sun is to improving one's vision. WalMart pushes the cheapest crap you can get-never mind that it falls apart two months after you buy it, or that the workers who made it are living in a sweatshop/prison in China and the local businesses are all defunct.
I pledge allegiance to the flag
of the multinational corporations,
and to the profits for which they stand,
one interlocking directorate,
under no government,
indivisible,
with monopoly and cheap labor for all.
Cheap food, cheap clothing, cheap labor, cheap lives-quality is gone from all the above. People now identify more strongly with brand names than their own family names. On rare occasions, I can find locally grown food in the grocery stores-most of the time, it's imported from another country. Or it contains ingredients I can't pronounce. We've made it so you have to buy a car-the streetcars are mostly gone, only a few lines of which still run in my city-and in most cities, they don't run at all anymore. Some places don't even have sidewalks-if you wanted to walk to get around, you'd have to wander out into the street and dodge the cars. No streetlights, either. No wonder we're all fat.
I saw a little kid couldn't have been more than 8 or 9, in a wheelchair the other day. He was so grossly fat that he couldn't walk anymore. And his parents were taking him to McDonalds. I wanted to report them for child abuse and attempted murder.
They're just doing what we programmed them to do. The clown in the yellow jumpsuit is supposed to mean family food-so they just went where the clown lead them. To their kid's funeral.
Ravi Batra has an excellent piece on Truthout http://www.truthout.org/032009R. He basically blames Reaganomics for this mess. The basic problem, production outpaced wages so the government overborrowed and then households followed. This gap has been brewing for a long time.
He mentions something that you posted last year during the election that growth DECREASED under Reagan.
Truthout interviewed him here http://www.truthout.org/031609A
I would like to see Batra as treasury secretary myself (or Krugman or the like.) It's not that I necessarily disagree with Geitner. I don't understand enough to really have an opinion. But I would feel a lot more comfortable if there was a non-Wall Street person making these decisions.
The collapse of the housing bubble was obviously a very important event in precipitating the current economic crisis.
Nah. It played a roll, but the largest factors
It was:
1. the spike in gas prices, reaching nearly $5 a gallon.
2. Overleveraged firms. Leverage killed Bear Sterns
While I can certainly agree with the cast of culprits highlighted by Nate, I think greater emphasis should be given to the mortgage lenders.
I believe that much of the buying frenzy, including the whole "flip-this-house" movement, was driven by the availability of exotic mortgage instruments that were being peddled by the lenders. Over the last decade there was an explosion in zero-down mortgages, ninja loans, liar loans, interest only loans, option ARMs, and balloon loans. Traditional ARMs, which were once rare became common place, as did the practice of bypassing mortgage insurance by simply taking out a second mortgage/line of credit at closing. Not to mention the practice of writing mortgages for more than 100% of the value of the underlying asset.
All these practices made it very inexpensive to get into the housing game, and brought down nearly all barriers so that virtually anyone could play. If you had an income of 30K a year, you could buy a 500K house. Never mind the 100K down payment that would have been required in the past.
The Fed definitely kept the market simmering nicely by providing cheap credit, but without the lax lending standards I don't think there would have ever been a stampede into the housing game.
Jenny-
Leverage only kills if there is a reversal in the underlying asset. Otherwise, leverage is a beautiful thing and generates lots and lots of money.
If the housing market would not have tanked, Bear Sterns would have been fine, along with the rest of our financial industry.
If the housing market would have simply cooled off, with prices stabilizing or declining a few percentage points, everything would have been fine as well.
$5 gas killed Detroit, but little else.
Nate,
I'm glad to see your post, as I have been thinking about similar things.
Instead of just contemplating who to blame however, I've also been thinking about who benefited, or profited.
Here, it's clear that many homeowners profited handsomely from the (artificially sustained) housing boom. Regardless of whether they were at fault, the fact of the matter is they benefited from the steep appreciation of house prices.
Some have given up their gains as the prices have come back down, but most are still far ahead overall. And needless to say, those who cashed out before the bust reaped a windfall. There's also the huge amounts of cash homeowners took out in home equity loans based on inflated house prices.
It seems a "fair" solution to the financial crisis should not just punish those responsible for causing it, but also allocate losses to those who benefited from the run-up.
@ Saint Dude: I think greater emphasis should be given to the mortgage lenders.
True, and I think Nate was saying the housing bubble/collapse was a primary cause of the economic crisis - but that bubble could not have developed without all those exotic loans which put rising prices (artificially) within reach for so many people.
Also, in response to SarahLawrenceScott: The idea that mortgage debt is “good debt” is bunk, particularly in today’s world. The actual cost of home ownership far exceeds the purchase price of a house, after factoring in mortgage interest and property taxes, insurance, maintenance, etc. It works out only if property values rise significantly over the long term. Certainly those who bought in the last seven or so years are pretty much screwed unless they intend to keep the house for the next 10-15 years, maybe longer. For all the homeowners who owe more on their houses than they're worth, it's not much different than credit card debt.
Several economists, including The Economist Magazine have seen this coming since at least 2005. It was well known, and anyone who claimed otherwise likely had an economic stake in the matter.
I see no sign of my comment after refreshing. Apologies in advance if this is a double post.
I think Nate and most of the commenters miss the real problem, as do most journalists. The Batra piece linked by iCaduceus comes closest to my view (in that it puts a spotlight on inequality of wealth and the fact that the 1920s and the last eight years both redistributed wealth upward and both led to economic collapse) but doesn't really lay out the specifics.
First, just in terms of correlations Nate would probably find it child's play to cross reference graphs of income inequality with stock market crashes and other economic indicators. Sure looks like there's a connection to me, though I'm no statistician. Much as I like Nate's blog, though, I sense that he's too much of a centrist and too sympathetic to rich people to see this as clearly as he ought to. Nate should also look at the housing bubble of the late 1920s in Florida, which also has eerie parallels with today.
My theory is that aside from the essential unfairness of a situation where the top one percent have a ridiculous lion's share of national wealth, it leads to bubbles because when people have untold millions or billions of dollars, they aren't content with sticking it in safe, staid investments like the middle class might do. They want higher returns--in fact, as inordinately wealthy people, they feel entitled to them. So the money chases investment rather than the other way around, and all kinds of bubbles get created, along with Ponzi schemes and other scams. In the quest for financial instruments that can provide the higher returns investors are insisting on, lenders look for people who will borrow money but pay a higher premium for doing so because their credit is not great.
Looked at from another angle, all that money tied up in the hands of the top one percent (who have gotten much richer while the vast majority of people saw their incomes stagnate), like water finding its level, naturally "wants" to be circulating in the economy in a more equal and sensibly distributed way. But since it is not being distributed in the form of higher wages (the rich taking greater and greater amounts of "surplus value" from their workers, a Marxian term that I have no doubt Nate shrinks from given his reflexive scorn for Marxian ideas), the wealthy feed it back to the hoi polloi in the form of debt. Sort of like a "company town" or a sharecropper setup where the capitalist charges workers every which way.
But as happened to the plantation owners when their workers got all uppity and abandoned the plantations for the North, or as happened to mining companies when the workers got fed up and went on strike (even when that meant getting shot at), the greedy rich people took it too far and their debt-ridden, leveraged house or cards collapsed--but unfortunately the collapse hurts the rest of us as well.
I see what look like a lot of right answers to the who-to-blame question, with the possible exception of YCT's.
Statler gets to the underpinnings of our problem, an arrogant, vacuous consumerist mentality that could never have been sustainable in the long run.
The housing crisis seems to be just the final phase of the buy-everything-and-let-god-sort-it-out movement. Seeing that Americans were willing to go ever deeper into credit card debt over consumer goods, it was only a matter of time before someone figured out how to add houses to the list of things we could buy without knowing how we were going to pay for them.
Once it was determined that part of what it means to be an American is having the unfettered ability to come up with ever more clever ways of separating rubes from their cash, the lobbyists who helped congress rewrite the rules were on a patriotic mission.
So the rich get richer and the poor get poorer, but everybody's got big screen TV's, SUV's, and houses--for a while.
YCT
I think you, and the credit card and mortgage lenders, give the American people too much credit. You expect unqualified buyers to be able to say no to unscrupulous lenders, but why can't the government say no to them first?
If you're as smart as you claim to be, why can't you see how stupid a lot of other people are? Millions of dollars are spent on Madison Avenue, figuring out exactly what to say to get people to act against their own best interests. Hell, it's practically the only way any Republican ever gets elected!
Since when have people known exactly what they're doing? P.T.Barnum made a career out of proving otherwise. Does America have to be run like a circus?
The government can't make the world safe for people who are easily duped or wishful thinkers, but it can try to prevent the rise of institutions that are devoted to taking advantage of such people.
Congratulations on doing everything right. Now please consider how as a country we can do the right thing by people who aren't as smart as you.
Nate:
While I'm sure some of the mortgage debt increase was irrational on the part of consumers, I don't think all of it can be classified that way. Yes, people using their houses as ATM machines is irrational, and yes, in some markets, lower interest rates drive price increases in the underlying assets, as more dollars chase the same few houses, but the free market does ameliorate the increase by causing more and bigger houses to be built. (Hence the bubble, when conditions change and the market pauses to digest the existing stock.)
But not everybody uses their house as an ATM, or has a wacky variable APR or teaser rate or an even wackier negative amortization loan.
In 1986, I had an fixed rate FHA loan at 10.9%. My current loan, financed a few years ago, was a fixed rate at 5.75%, and I could refinance now for below 5%. For someone willing to go to a 15 year loan, the rate is even lower, and that's without getting into any kind of loan which may be seriously contributing to market irrationality, such as variable APR and/or teaser rates.
So, an average Joe Blow, who is not interested in flipping real estate, but who just wants to spend 'x' dollars a month for 'y' years for a house can afford to spend, not just a little more, but a LOT more, for his house now than back in the late eighties.
If Joe Blow views his house as a place to live, rather than an ATM machine or an investment, the only irrationality he exhibits by buying more house with the same number of dollars over the same time is in making the assumption that his job is as secure now as it was back then.
Maybe you could tease out the rational from the irrational by including interest rates into your calculation, and then show how much the average monthly mortgage payment has increased (or not) since 1989.
Regards,
derivative
> it's difficult to expect the consumer to behave rationally when they were getting such bad information from their televisions
I suppose that could jibe with how I was under the impression that the existence of a growing bubble in real estate, particularly residential homes, was fairly common knowledge for several years now? I haven't had TV, other than the output device for our DVD player, for well over a decade now.
On the other hand maybe my perception that it was fairly common knowledge was accurate and people were just hoping to make out like bandits while the getting was good? With a little bit of "if you wish really hard for it not to be true it won't be" and "oh sure the music is going to stop but it'll be someone else holding the hot potato/without a chair to sit on when it does? I get the distinct impression that is what was going on in financial profession circles, too.
Anyway, RufusRules it depends on where you bought your house and at what time, and if you happened to sell and when. Things have worked out very well for our family, even though we are selling now. It is actually a decent hedge against inflation, both general and localized housing inflation. When rent was really taking off around us those mortgage payments started looking really cheap.
I disagree with RufusRules with the premise that because home ownership requires property values to increase for it to pay off, a mortgage isn't a "good debt". By that reasoning, buying stock in a company is bad debt because you're requiring about 10% annual growth to get a return high enough to justify the risk. No, home ownership is an investment, and just because it's not necessarily the most advantageous investment doesn't mean it's not worthwhile.
The real benefit of home ownership is that it provides a framework for middle-class workers to pump a large amount of money into a long-term asset, that can form a basis for long terms wealth accumulation. Sure, you're probably better off renting the smallest apartment you can stomach and doing something more clever as an investment, but the tax code is structured in a way to socially engineer our behavior to make large long-term investments that we otherwise wouldn't be making (certainly not for people long ways from retirement). The various retirement and educations savings structures have the same grand purpose, but who puts as much into retirement savings as they put into their house?
The tragedy of the housing bubble and crash is that this long term goal was hijacked by a process driven by short term greed and opportunism, and many people who were doing the right thing lost far more than they thought that they were risking.
(Full disclosure: I bought a house in 2001 with a 30y-fixed mortgage, and my loan-to-equity is now about where it was then.)
Hi,
Just to give you a example to compare to:
In Italy we have 1.6 Trillion (1600billion euros ) of public debt.
We are 60 million people.
It is 26.000 euros per capita.
Considering one US $ = 0.73 Euro,it is 35.000 US $ per capita.
It is the highest in Europe,proportionally with population.
What i Just don't get in this Nate's post is the line "Per- family household",anyway in my family we are 5 people so for me it is 35.000x5 = 175.000 US $.
Am I correct ???
If yes,are we screwed ???
Meantime,enjoy and have a nice day.
:)
@ Saint Dude
Leverage is explosive in many ways.
If there is a temporary stall in a specific income asset, you'll be unable to service the debt, forcing a liquidation, often at below market prices.
Bear Stearns specifically tanked because Goldman Sachs began a creditor stampede to the exit, by declining to roll over it's credit to Bear in the repo market.
As for the gas prices, we now know the recession started in December 07, six months after the FIRST spike in Gas prices.
http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_chart.gif
matador,
The 1.6 trillion you reference is government debt in Italy, which is over 100% of Italian GDP. In the US, the public debt is about $6.5 trillion, which is roughly 45% of GDP.
Here's a great graph on the national debt as a 0/0 of GDP
http://zfacts.com/metaPage/lib/National-Debt-GDP.gif
St. Ronnie and the supply-side-snake-oil really FUCKED up our balance sheet.
And the housing bubble was about 5 years old before the Fed lowered rates to 1%. True, it kept going after that point, but it's very likely to have kept on going even with a monetary policy that was suggested by the Taylor Rule.
I agree that the Fed needs more scrutiny, the "Federal Reserve Transparency Act of 2009" intends to do just that.
There's also a petition to support co-sponsorship of the bill for anyone who is interested.
Steve said...
matador,
The 1.6 trillion you reference is government debt in Italy, which is over 100% of Italian GDP. In the US, the public debt is about $6.5 trillion, which is roughly 45% of GDP.
March 24, 2009 2:28 AM
@steve,
thank you for the aswer.
I realize right now that Nate was talking about private debt instead of public.
So the only thing I can say is that in Italy familys are doing fine.
We have an huge pubblic debt but not so much privately.
But because I can't give you a comparison up front,the only thing I can say is :
good night to you all.
I'll go back to my "read only" mode.
:)
The problem was not the collapse of the housing bubble, but the inflation of it in the first place. In 1999 the prices were close to the highest long-term sustainable multiple of incomes (about 3 times); they grew to an absurb six times incomes.
With ready access to new credit, house sellers were able to demand slightly more money for their property than their neighbours had sold for, and buyers able to bid up against each other, with basically no limits.
The governments allowed banks to create near-limitless amounts of money, by relaxing the amounts they needed to keep on reserve. The Basel accords needs a gunshot through the head, and a return to fractional reserve ratios.
Housing was not the only asset bubble - deregulation caused bubbles in oil, wheat, sugar, corn, metals (precious and industrial) and basically everything else that it was possible to buy. Open interest has been climbing again in these markets, vastly out of proportion to the actual physical hedging purpose for which they were created, and it needs to be crushed hard, and fast, to prevent another bubble. If you wondered where your bailout funds were going, here's your answer.
p.s.
@Jenny.
many thanks for the link.
:)
While it is amusing to me to think of you urging the people to "read Schiller I think you might have made a typo. Be embraced, you millions!
> it needs to be crushed hard, and fast, to prevent another bubble.
With what? How would you propose keeping the cheap credit the government is trying to put out there for consumers from getting drawn up into commodity speculation instead? Or are you thinking crushing it all and going cold turkey on the cheap credit and living with a much slower, if not at time halting, recovery?
@ MDvorak: The real benefit...is that it provides a framework for middle-class workers to pump a large amount of money into a long-term asset, that can form a basis for long terms wealth accumulation.
Funny, that's what they said about my 401k.
Many people do quite well in the housing market. For example, my parents paid around $40K in 1968 for their house, then sold it for close to a million in 1999. Pretty f'ing good for a 30-year investment. Flippers made a ton of dough during the bubble. But those days are over. None of us who bought in the last decade are going to see anywhere near that kind of value gain 30 years from now. And while I concede the many benefits and satisfactions of owning your own home, from a purely economic standpoint, the idea that mortgage debt is intrinsically "good", i.e., incurred for something that will increase or at least retain value greater than your expenditure on it over the long term, just doesn't hold water anymore.
Rufus, based on conservative current market evaluation, after deducting the interest expenses and reno costs (redid the exterior stucco a couple years ago, adding 2" of styrofoam underneath, and will replace the carpets before putting the house on the market ... kids are hard on those) we expect a roughly 200% return on the 25% down payment we made 4 1/2 years ago. That 25% down payment that was nearly all composed of profits from the house prior to that (we had bought a "fixer upper" and put in some work and investment into it).
Yes, that's better than I had ever imagined and results are going to vary. But as long as you stay prudent in your purchase and go in expecting and planning for a long term payoff rather than looking to "flip" (markets that support that definitely come and go, and you are asking for trouble trying to live in your "flip") then it's still a decent, if somewhat "boring" investment.
The one important thing about your house as part of your retirement investments is that it is ongoing "income" that isn't taxed (replacement for rent) and also represents capital gains you've made that is unlikely to be taxed until you unable to give a damn anymore.
Part of the problem is the wide-spread belief that if your own house rises in price, you have become richer. How can you spend that wealth? By moving to a big mansion? Err, no, that mansion is proportionally more expensive too. By selling and moving to Northern Alaska? No thanks.
Then there are people who see their house as a pension. Does this mean we have to struggle all of our lives with huge mortgage payments just so that when we are 85 we can sell our last house and afford a cosy nursing home for the last year of our life?
If house prices were permanently cheaper we would have more real, not borrowed, money to spend, therefore stimulating the economy. In addition, some of the money saved by not paying big mortgages would go to saving for a pension
(so we can still enjoy that cosy nursing home at the end). The only losers would be the banks and estate agents.
Do those figures adjust for the level of interest owed on the debt? Interest rates went down on mortgages, through supply and demand this drove the principle up, but the overall amount of money owed could still stay the same. Obviously that doesn't account for all of the problem, but whatever.
> Part of the problem is the wide-spread belief that if your own house rises in price, you have become richer. How can you spend that wealth? By moving to a big mansion?
In my case the plan is that when the time comes, assuming I can get the kids out the door (or maybe as part of the plan to get them out the door? ;) ), the "richer" gets used to eliminate any residual outstanding mortgage by downsizing. Or if things have gone well even have a little left over to supplement retirement funds or help out the kids or (if it's in the cards) grandkids. Or who knows what.
But there is a kernel in what you say. My wife and I thought hard a year and a half ago about selling (prices were even higher). But we weren't changing cities then and it was going to be a huge PITA to find a rental, or a suitable cheaper house, for what we had set as our family's requirements. So till selling fits whatever else you are doing in your life, or are willing to do with your life, those gains (and loses!) are somewhat ephemeral.
P.S. As much as you poke fun at Alaska, moving to realize that cash and still stay in a comparable house, albeit in a different type of location, is a very viable option for some. We've friends that have done that and it worked well for them. Unfortunately, for a number of reasons we, had ties that we just weren't going to break to do that. *shrug*
Absolutely spot on, Nate.
This is what I've been saying on here the whole time. The derivatives debacle, while very very damaging and revealing shockingly poor judgement, is just the froth on this crisis. The real problem is that we have been living way too far beyond our means for a decade or more, we are quite simply not producing anywhere near what we are consuming. We blew trillions on plasma screens from China and expensive petrol from Saudi, they gave it back to us as credit, which we then used to leverage ourselves into orbit. (Except that orbit is impossible - hence the freefall.)
Can you blame 'the ordinary Joe'? Absolutely. There is this fallacy that we are children, who need to be guided by the media in figuring out the basic lessons of life. It's not that hard, and should be drilled into every child by every parent:
Life is full of risk, and so are all - all - investments. If you take on so much debt that you can't repay it unless the weather never changes, then you are probably in trouble.
The same delusion of endless growth supported by endless house price rises was bought by everyone: central banks, speculators, consumers, house-buyers - even the creditors, who are now seeing their gains drain away as we print money. Sure, the financiers should have known better; so should all of us.
WV: oviri - latin 'to be sheeped'
Debt Is Not A Bad Thing.
Insolvency is bad. Debt is not bad. Get off your Puritan biblical high horses and get a grip on reality; debt is not, in and of itself, a bad thing.
I have been in debt for my house, for multiple cars, for my education, for my business, for my computers, and for entertainment and vacations. I paid them all off, 100%. They all made my life immeasurably better. I have spent thirty odd years borrowing and spending my way to prosperity, profitability and happiness. Half my marriage and honeymoon were paid for on credit cards.
Without debt for a car, I never could have held my first job. Without debt for my education, I never could have interviewed for it. I would still be working my high school gigs of washing dishes and unloading 18-wheelers for retail stores.
Debt is not evil. Nor does it need to be 100% investment, debt for entertainment is a perfectly sound use of debt.
What is evil us usury; insanely high interest rates. All of my debt was in the 7%-8% range, and I stopped using debt when interest rates topped 10%; now they top 25%. That is greed run amok.
What is evil is taking on debt to gamble on something, when if you lose you cannot repay the debt. That is fraud, and the increased default rates on that fraud move rates toward 25% as well.
This chart is meaningless without some correlation to default rates. There is such a thing as good debt; in fact most of debt is a good thing.
http://www.npr.org/blogs/money/2009/02/household_debt_vs_gdp.html
This chart tracks the relationship between household debt and gross domestic product. You'll see two years when Americans' debt becomes 100 percent of GDP -- 1929 and 2007. It's the chart that made Columbia professor David Beim say:
"The problem is us. The problem is not the banks, greedy though they may be, overpaid though they may be. The problem is us... We've been living very high on the hog. Our living standard has been rising dramatically in the last 25 years. And we have been borrowing much of the money to make that prosperity happen."
Nate,
Have you been reading "The mess that greenspan made" again? ;-)
"DON'T BLAME US BLAME THE PROPAGANDA!!!!"
Born and Bred American Dopes, as Jas Jain would put it.
Quite frankly, the propaganda is no excuse for poor judgment.
The hedge funds,and their incessant need for "more profit" from everyone, deserve the blame for turning GE, GM, and most of American manufacturing into banks that happen to sell lightbulbs/cars as a legacy product
First,
This is this smartest discourse I have seen among the commenters in a while. Thanks Nate for an intersting post and thanks all for keeping it both interesting and mostly civil.
That said, I am not sure there is a clear line between good debt and bad debt when it comes to home ownership. In general I agree that it is basically good debt. That is true when the service on the debt is only marginally higher than the rent one would have paid otherwise. At the end of the day, rent never becomes equity and a home does. As such, even if there is a modest decrease in housing costs over the life of the loan, the owner has more value than having gotten no equity for the same money.
When home owners view thier house as an ATM, when they payments far exceed the rent that they might other pay or when they take non-standard (interest only, baloon, etc) loans, it becomes bad debt. These loans become much more tied to the value of the house in a short to medium term market, do not actually improve the equity stake of the home owner and lead to the bubble from which we are all suffering.
To the point that we not 'blame the homeowner', I think we all created this mess and all deserve some chastising. Certainly the Fed did not handle monitary policy well for the last five years leading to too much credit, the banks all provided to many exotic loans and some of them were down right preditory (although not all), Wall street leveraged these dubious loans through their derivities process and the home owners never really educated themselves about what it was they were borrowing or buying.
In 2000 my wife and I bought a house. We started with a 8% 30 year fixed. We refinanced twice (never taking out more value, just adjusting the rate due to market conditions) down to 5.25% on a 15 year. We always overpaid our mortgage (about $400 on a $3000 paymnent) thus shaving the capital early in the loan and collapsed the term, fully paying off the house last year.
We did the math, did not ever pull money out. Nor did read economists about the bubble. We simply knew that, although a home debt is good debt in the way we were using it, all debt is negative to the balance sheet and we should work to pay it off.
Basic home economics is lacking in this country and leads to the perfect storm we are in now.
Greenspan's free money coupled with Bush complete lack of regulation led to this. Joe Homeowner is likely still fine on his mortgage debt, but it only takes a few percent to default to mess up the whole thing - and that is happening.
This is why the man who is really fixing this is Bernanke - his buying of consumer loans and mortgages is keeping us afloat during the re-adjustment. Without him, we would be in real trouble. He did this early, and with seemingly little outside support from Paulson.
Also, the 5% mortgages are allwoing anyone with OK credit to flip to a 30 year fixed and stabilize their personal finances.
http://www.npr.org/blogs/money/2009/02/household_debt_vs_gdp.html
This chart tracks the relationship between household debt and gross domestic product. You'll see two years when Americans' debt becomes 100 percent of GDP -- 1929 and 2007. It's the chart that made Columbia professor David Beim say:
"The problem is us. The problem is not the banks, greedy though they may be, overpaid though they may be. The problem is us... We've been living very high on the hog. Our living standard has been rising dramatically in the last 25 years. And we have been borrowing much of the money to make that prosperity happen."
Go listen to these if you want finance for the layman, they are even funny:
http://www.thisamericanlife.com/Search.aspx?searchFor=mortgage
They detail Lehman and Bear and AIG insuring and selling mortgage backed securities on mortgages that the banks knew they should not fund, but would if they could sell them fast. Essentially, blame Wall Street, not Main Street.
Charles,
Guess I'm the only one who thinks investing in something that does not appreciate is a VERY DUMB investment.
Houses are such a large part of people's overall wealth... and there's really no reason for that.
1. Houses are extremely illiquid assets -- not good in a crisis, like say losing your job.
2. Because houses take up such a large portion of someone's income (say 25% of it), they don't really rise faster than wages. Buying a house is a really dumb investment.
3. Most people use space in their house extremely inefficiently (at least that's what research shows. how much marginal utility do you get out of a guest bedroom?). Therefore the rent that they'd pay would probably be for a significantly smaller place.
Take that difference, and invest it in even a moderately decent stock portfolio (aggressively conservative, say...), and you're talking about a spread of about 400 basis points. Sounds pretty decent to me!
Yes, and people take pride in their houses, they love the extrra space, they like coming home to a nice house, and they don't have to listen to neighbors flushing toilets and walking above their ceiling.
Also, most houses are maintained mush better than most apartments.
Finally, until this crisis, houses have been a good long term stable investment, rising at the rate of inflation or a bit above and were a fine place to put part of your portfolio, to offset the much more volatile stock market.
Fred, the This American Life that you speak of ends with David Beim pointing out that consumers have as much blame as Wall Street.
the "banksters" are not the only people subject to greedy and stupid risk taking.
@Charles:
"Bad Debt" is just debt you cannot pay back, or for which your ability to pay back depends too heavily upon speculation.
It is not bad debt, for example, to borrow four thousand dollars to go on a European vacation. Or to buy a home theater system. No investment, just enjoyment.
Saving money or earning money through investments should not be an end in itself; the purpose of earning the money is to spend it for personal happiness.
I borrowed for my honeymoon because saving for it was out of the question; it wouldn't be a honeymoon if it occurred three or four years after the marriage.
Borrowing for a vacation can be similarly rational; you need and want the vacation now, you are excited about it now, perhaps you have family or companions going now, or the timing is right for other reasons, such as your job situation or business situation allows the time off to do it.
There can be a huge difference between going now and going four years from now; and for some of us, the legal necessity of making the loan payment ensures it will be paid, while there is no legal necessity to save $125 a month and we may lose our resolve to continue the savings.
The line between good debt and bad debt is not strictly based on whether it can be declared an investment. When banks loaned responsibly with diligence on checking credit-worthiness, default rates were in the 2% range.
That seems about right to me: Good debt is any debt for which we are 98% certain the borrower will be able to repay it in full.
I am agnostic on how the money is spent; if it makes the borrower happy, it is really none of my business.
I don't disagree that there is alot of blame to go around, but the post above did not accept that these bad loans were being bought at a furious rate by folks like AIG - if there was no market, there would have been no loan and that is the major difference between two years ago and ten years ago. Can you really blame the guy who got a loan (but did not deserve it) and did make it through the other side to refi in a thirty year fixed and now holds an asset that did appreciate significantly? There are lots of those people, and lots more of them than the defaulters. If someone is dumb enough to give me money at rate below what I should be able to get it for I take it - who is the dumb guy in that transaction? WALL STREET!
First echo that these comments have been great. Its amazing how it works when you take partisan politics out of things. I hate that I'm late to the party. Do you guys ever sleep haha.
I agree that debt isn't bad. The problem is we had people having access to credit that they had no real option of EVER being able to afford. Forget about the housing correction for a minute.
You still had people making 30k with mortgages starting out at say 500 a month but then balloning to 1500+ a month.
So where are the failures then
1. People not realizing what they are signing up for.
2. Greed on the part of the mortgage industry
3. Lack of regulation
That was the easy part now for the solutions
1. Teaching practical personal finance/consumer math in public schools. (This one is the simplest and seems like a no brainer)
2. More focus on salary instead of commissions for sales processed and produced. (I admit thats a bit of a fantasy)
3. Increase in the amount of mortgage regulators (Costs money and would still propably barley make a drop in the bucket. Especially when just like on wall strett the salaries for the regulators is nowhere near what you can make on the other side)
Yikes these sound like liberal ideas. Where is the personal responibility and free market enterprise. My internal debate continues :-p.
Actually, this looks much better than I had feared, though I'd be interested in seeing this done as median rather than average. (It's not clear to me how the renters—zero mortgage—balance out against those holding very large mortgages.) It would also be interesting to see what the average mortgage debt is among those holding mortgages, which is really the relevant measure to assessing the large-scale debt default risk.
In any case, the debt load as portrayed here doesn't actually look out of line when compared absolutely to median household income. Median household income in 2007 was roughly $50,000. (I can't find an actual number for the average income, but it seems to be about 5% lower.) That makes the debt leverage roughly twice annual income, which would fall well within established norms for high quality mortgages. I guess what I'm saying is that it looks to me like the balance sheet of the "average" American household was actually in decent shape in 2007.
None of this is to say, however, that the trend lines are not worrisome. Also, the data does not capture the fact that it takes a relatively small number of defaults to cause major systemic problems.
Nah, all we need is the same process I just went through to refi my house at 4.4%. Lots of people checking if I really have the money and I really am a good bet - like we used to do it. The person assuming the risk is the best person to evaluate the risk, and that is the way it is supposed to be.
Hey Nate. It's Shiller, not Schiller.
Well, the real graph we need is mortgage debt vs. income - but I am not sure that data reallt exsts in the public domain.
I always thought they should be honest and do a follow up on all these flippers. Show the ones who are now living in their parents basement or on the streets after being crushed when demand dried up in Miami, Nevada, and SoCal.
I'd love to watch that show.
Tony C. -
You're certainly right that debt is not in itself a bad thing (I don't really like the use of 'an evil', to me it encodes the same Puritanism you chastise us for). Without the ability to spend future earnings now, it's very doubtful we'd have had five hundred years of rapid technological development, industrial revolutions or indeed, probably, an Enlightenment.
The problem comes when the entire country - the entire Western world - is borrowing more than it can rationally expect to pay back. This is what has happened, and the major reason for it is that rising property prices became an article of faith, leading consumers to spend too much (because the equity in their house made them feel secure), and both our own and foreign governments to pile much too much money into securities ultimately backed by property.
I think the basic crux of the problem is that human brains are faulty and contemporary economics and regulation needs to start taking this in to the calculation.
Read this blog post as a primer:
Risk as Feelings
http://scienceblogs.com/cortex/2009/03/risk_as_feelings.php
Then read Jonah Lehrer's book, "How We Decide"
I will say it again, the banksters are making the same basic mistakes that everyday workaday folks are making. everyone is just as greedy and just as arrogant, the absurd scale of wealth just magnifies the banksters sins.
As for the debate about houses as investments . . . everyone read this article:
Why Your Home Is Not the Investment You Think It Is
http://finance.yahoo.com/real-estate/article/102603/why-your-home-is-not-the-investment-you-think-it-is
from:
The Cost of Buying a House over 30 years
Purchase Price $290,000
Down payment $58,000
Principal $232,000
Interest @ 6.41; total =$291,000 (after tax: 33%) $195,000
Taxes & Insurance (6,000) $180,000
Maintenance ($300/month) $108,000
Major Repairs & Improvements $300,000
Total Costs $1,073,000
I will say it again, the banksters are making the same basic mistakes that everyday workaday folks are making. everyone is just as greedy and just as arrogant, the absurd scale of wealth just magnifies the banksters sins.
This is correct, and needs repeating on this board. It must be said, though, that bankers took some particularly silly risks given that they're supposed to be experts in the field.
Re property being a good bet or not, there's no single answer to whether it is or isn't, but it should be regarded as an investment like any other. In the US and UK it's almost as if you're considered a failure if you're not on the ladder. Whereas in France and Germany, where rent prices are tightly controlled, most people don't feel that way, probably because there's less of a feeling that rent is throwing money away.
The cost-benefit analysis of buying property, for me, looks something like this:
Pros:
Pleasure of owning your own home
Savings on rent
For many, enforced economic discipline
In many times and places, it's been a good bet in terms of appreciation
Cons:
Buying an asset via debt, ie at a hugely inflated price compared to a cash buyer
Illiquidity of asset/ lost earnings on other potential investments
If the investment goes sour, it's an immense practical and emotional upheaval (even moving house comes third after bereavement and divorce in terms of stress)
@Jon:
Your house price analysis is silly; you do not account for inflation, you do not account for present values. At 3% annual inflation, a fixed rate mortgage payment is lower every year; on average over the 30 year life of the loan, the present value of payments is about 36% less than the starting face value.
Second, you measure the cost of a house against a plausible alternative, such as living in apartments for 30 years. Apartment complexes raise their rents every year to keep pace with inflation, so the present value of 30 years of payments is just 30 times the first year's payments.
Finally, the average lifespan of a home in the USA is 80 years; and if paid off in 30 years, that leaves 50 years of economic benefit to be enjoyed for the cost of property taxes and maintenance.
In fact, buying a house before the bubble is a massive economic win. In my own case, I check when I had five years left on my mortgage and my property taxes and payments together were a sixth of the cost of renting an apartment half the size of our home.
Homes in fact are excellent investments versus apartments, which are the only plausible alternative for the benefits.
@Jon:
And honestly, $300 per month for maintenance? What are you doing, driving your motorcycle in your living room?
I've lived in my home for over 20 years, and there is no way I averaged $3600 a year on maintenance; in fact I can count the major repairs on one hand, and over 20 years they come out to well under $20K. New roof, new A/C, new water heater, and a separate $1500 plumbing issue.
@nova:
More focus on salary instead of commissions for sales processed and produced. (I admit thats a bit of a fantasy)
And misguided. Salary is certain, commissions are not. Employers should be allowed to share the risk of failure with their employees if the employees are willing, and in that case, the employees deserve more reward for accepting an uncertain income.
If we insist on salaries for all jobs, then the only people allowed to enjoy the fruits of taking risk are those rich enough to hire others. That will increase the disparity between the rich and the wage slaves.
Nate Silver said:
Between 1989 and 2007, the percentage of Americans with mortgage debt secured by their primary residence increased from 39.5 percent to 48.7 percent. That's not trivial, but it pales in comparison to the increase in debt per mortgageholder, which increased from $29K to $73K over the same period.
When percentage of people with a mortgage spikes in a short period, that means the fraction of mortgages that are early in their life also spikes. So it's not just that the percentage participating goes from 39.5 to 48.7, which is a 23% increase, it's also that the new mortgages have, on average, perhaps one-third more than the average balance, just because they're new. Put the two effects together, and they would account for an increase in the average mortgage debt of about 30%.
But that's not all. "Ordinary" inflation, irrespective of the housing bubble, would make the price of new purchases higher than mortgages that are close to being paid off. Yes, I know the chart is in "2007 dollars," but that's only for comparing year to year on the chart. A mortgage that is twenty years old was purchased at a 1989 price; the new ones are at a 2009 price. A 3.5% annual inflation rate amounts to a staggering 68% increase over fifteen years.
So let's put this all together and do a simplified calculation:
Assume there are 39.5 people out of 100 with a mortgage that is fifteen years old, and one-quarter paid off.
Assume current house values have only gone up with long-term inflation, so that they are 68% higher than they were fifteen years ago.
Assume that there are suddenly 9.2 people who buy houses at the current price.
For simplicity, take the home price fifteen years ago at $100,000 (it doesn't matter what I start it at, since I'm going to end up getting a percentage change anyway).
Old average debt: $75,000*39.5/100 = $29,600.
Average debt of those getting new mortgages: $168,000.
New average: (75,000*39.5+168,000*9.2)/100=$45,100.
That's an increase of about 50%. Admittedly, this is a bit of an overestimate of the actual situation, because the increase in ownership was spread out over a period of years. But a lot of the increase in ownership rate and a lot of the increase in debt load was in the last seven years or so, and so these frontloading effects become significant.
The actual increase, of course, was about 130%.
Does 50% (or 40%, if you figure my calculation was an overestimate) "pale in comparison" with 130%? That's a judgement call, of course. But I think it's worth pointing out.
Boing, you're pushing the standard narrative that lets the superrich off the hook. It's not true that "the entire Western world" ran up debt. Who do you think was doing the lending? Not "bankers"--they are just middlemen (middlepeople?). It is mostly the top one percent, who have become obscenely wealthy at the expense of most of the rest of us. Larry Summers laid it out quite well:
http://www.huffingtonpost.com/2008/10/16/potential-obama-treasury_n_135233.html
------------
In the last 29 years, Summers said, "you'll find that the share of income going from 80 to 99th percentiles has stayed the same. And those in top one percent have gained about $600 billion. Those in bottom 80 percent have lost about $600 billion."
Summers then calculated that this overall transfer of wealth averaged out to an additional $500,000 per year in earnings for those in the top one percent, and an $8,000 loss every year for those in the bottom 80 percent.
"If the bottom 80 percent had kept pace and earned that $8,000 ... their income growth would have been twice as high over the last generation as what we in fact observed. Think about this number: $600 billion a year. It is immense compared to any discussion of changing the tax system here or there," Summers added.
------------
Another way to put it is that if these respective shares of wealth had remained constant, average Americans could have experienced a rise in their standards of living without it being financed through borrowing. And then we wouldn't be in the pickle we're in.
For the top 1% to have more wealth than the bottom 90% is absurd and obscene. Being a billionaire should simply not be allowed. This does not have to mean uniformly distributed wealth by any means. If ordinary millionaires were still allowed--as in, you could still have maybe ten or twenty million--I'm sorry, but that's still frickin' rich. I can not muster up any pity for a billionaire being reduced to a plain old millionaire.
And while we're at it, we need to outlaw adjustable rate mortgages (either a direct scam on the consumer or a solicitation to join a pyramid scheme where someone eventually is going to be left holding the bag) and other usurious business schemes like pawn shops, check cashing joints, payday loans, "rent to own" shops, etc.
Dont worry folks. Inflation is lurking and it will solve all of our debt problems, albeit in a very painful way.
For those of you with a little gray in your beards, think back to the early 70's. You could have been double upside down on a home and walked away clean just by sitting in it until 1980.
That $20k you owe on credit cards wont amount to a hill of beans after a couple of years of double digit inflation. Your debt will be in 2009 dollars, but be paid back in future dollars.
Alan
What are you proposing then. A cap on wages? I already got chewed up a bit (my first attack from the right I think :-p) for suggesting part of the problem was too much reliance on commissions which fueled bad deals instead of salary.
Thats the problem when you are in the middle you can't please everyone :-p.
To all
I am more interested in solutions. Anyone can bemoan what has occured. The real issue is what to do moving forward.
I know it isn't in vogue to say this, but I think the manifest excesses of Wall Street have made them perhaps too easy a target in assigning blame for the economic collapse.
Are they they only ones to blame? No.
Are they responsible for the lion's share? Yes. Oh, yes.
It's pretty well-understood how the housing bubble worked (and then failed to):
1. The Fed kept interest rates very very low, such that the big money investors -- state actors, pension funds et al. -- couldn't beat inflation with Treasuries. So they needed a low-risk substitute for Treasuries.
2. Large asset managers found a way to get around the problems presented to institutional investors in investing in home loans -- the hassle of servicing the loan and the variance of risk. Outsourcing took care of the former, and tranching into securities spread the risk among many mortgages. Looked great in the models.
3. Institutional investors have a lot of money. As their demand drove home values up and interest rates stayed low, it eventually exceeded the supply of low-risk mortgage opportunities. By this time, everything about the mortgage was outsourced except the ownership, however, and the outsourcing class (and the asset managers) didn't want to go back to their old jobs, so they found ways to originate riskier mortgages, dress them up as safe, and sell them up the chain. The only people who weren't in on this, to some degree, were the ultimate bagholders -- the insitutional investors. (Except that a lot of them were, because many of the asset manager class had started partaking of the product either as an attempt to "seek alpha" or remuneration for services. Perhaps they didn't appreciate how many other people were in on the con and adding risk.)
4. Home values plateau, things fail that shouldn't fail, things fall apart, the center cannot hold, etc.
Who are the culpable parties in this story? I would rank them thusly, in ascending order of blame:
5. Homebuyers who should have known they wouldn't be able to afford the eventual monthly payment. Pressure be damned; no one's looking out for you but you, so read the contract and assume the worst.
4. Institutional investors looking for rates over inflation. They should have known something was up, but they trusted their asset managers far more than they should have.
3. The Fed. They could have taken the punchbowl away, they didn't. But I'll give Greenspan this much -- I think he chose not to act out of ideological conviction, not because he saw personal profit in it. He thought he was doing the right thing, he was just wrong.
2. Loan originators. They never had any skin in the game, so they just didn't care if Bob would default in a year or not. Many of them, though, figured the guys they were selling the loans to were doing their homework and wouldn't buy unless it was a good deal. After all, it was their money, right?
1. No, it wasn't. They were selling to the asset managers -- the Morgan Stanleys, the Goldmans, the Bank of Americas, the Countrywides and WaMus. And it was still OPM to them, too, both as individuals (as long as the annual bonus came in big, the losses on someone else's watch wouldn't matter) and institutions (as long as the house of cards didn't collapse on the client until after they had booked the fees, it didn't matter). Heck, even when the house of cards fell, it would fall on shareholders -- there weren't even any partners to take monetary losses.
The banks you're claiming are just one more casualty -- they were the asset managers. They thought up the idea, approached the institutions with it, kept it going as long as they possibly could, and would probably do it again if they had the chance, given how many millionaires it made.
To the extent that they bought the hype and started eating some of their own dog food, I'm willing to forgive them. (To they extent they want me to eat that dog food, I won't.) And you might begin divvying responsibility among the executive management (the ultimate con men, really), the board (who should have been overseeing management but figured they didn't have to, apparently) and the shareholders (who, again, should have done their homework and are apparently unwilling to shoulder the risk they undertook by buying shares in the first place).
But if it hadn't been for these banks, the party would never have gotten started. If there's a smoking gun in the room, they're holding it. Suggesting they are anything other than the most culpable party in this mess strikes me as either wishcasting or a willful misreading of the situation.
I agree, Wall Street did this - but lets add the ratings agencies to the blame game. They were rating NINJA loans as triple A + .
@akailaughingman
The only response I have to you is thus: I equate it as good debt if you are building equity in lieu of paying rent. You cannot simultaneously pay rent and buy equity with the same dollar. If your rent it is $100 versus a mortgage payement of $110, it makes more sense to pay the mortgage. You get the intrest rate deduction on your taxes making the $110 effectively $100 and you get equity while living in your home.
If you pay $100 in rent versus $500 in mortgage, then I agree with you.
If you pay $100 in rent, have a $110 mortgage payment, but pay $150, then you get back into the saving and investment game earlier with no cost to live (we currently save $3000 a month as we pay neither rent nor mortgage and were saving that in a CD until three weeks ago when we went all in on the market.
So buying versus investing, maybe invest. Buying versus renting, better to buy.
Mike in Crivitz, WI
Actually, there is some good news here. While the fallout from the decline in housing prices is massive, other forms of debt are nowhere near as large. So, waiting for other shoes to fall, like credit card debt won't be another huge shock to the economy.
That said, home prices returning to historical trend promise a decade or more of tepid economic performance. Since our recent behavior was unsustainable, that might be a good thing.
Charles,
you're missing the other counterargument to renting.
fixed rate loans make a FINE inflation hedge.
;-)
For most of the first half of your mortgage, you're paying more in interest than you are building equity.
Let's say that I live in a $900 apt (i like good maintenance). I compare that to an average house price in the same area (I like walking, and some places aren't safe to walk). [not in a bubbalicious area, so assume it's fairly accurate]. That gives me a monthly payment of 1,330, with only $163 or so going towards principal. (man having calculators on the net is handy!). I've given myself a 7% interest rate, which seems reasonable (call me on it if it's not!).
I'd say its a much better idea for me to rent than to get a mortgage. I'd be doing more investing (400 versus less than 200), and that compounds well (at an avg. rate of say 10%, which isn't too unreasonable in a bear market, we've got doubling in 7.2 years).
I don't think many people do these calculations.
In all the apartments I've lived in, I've never been able to hear other people flushing toilets.
Late night mahjong parties, yes, toilets, no.
Another drawback to owning a house is having to have the $10,000 buffer of "what if my roof comes off" money lying around.
Glad you're in the market now, and before the inflation hit the news. Good luck investing!
tony c.,
if you count maintenance as "electricity, weatherproofing, lawnmowing" and other things that a renter doesnt' have to do, 300 isn't too unreasonable (extra electricity, in this case, obviously there's some use in an apt for that!)
Alan -
I agree with your basic point - not sure I would 'ban billionaires' as such, but I would tax the living crap out of them, so that you'd have to make about 10bn to remain one. This would have the same effect as your solution - they'd all leave the country.
However, I don't think it has that much bearing on the crisis. It doesn't matter who was doing the lending - and more of it came from the Chinese and the petro states than anywhere else. The problem is borrowing.
If people can't afford the standard of living they want, they have various options, including acting to enforce redistribution of the kind you're describing, through social unrest and/or voting for people they think will achieve that (i.e. maybe not even the Democrats, and certainly not Bush, twice).
The other option is buying into the group delusion and borrowing your way to the lifestyle you crave. "We the people" chose the latter, I'm afraid, and we can't just blame the rich for that.
Boing, your post at 10:46 a.m. is equivalent to someone saying that cigarette companies' marketing had no effect on public health, nor do the stuffed crust Pizza Hut commercials. It's all well and good to say that people should resist resist all forms of marketing; but that's not the way the real world works.
I think it was a good thing that most cigarette advertising has been banned; libertarian "personal responsibility" fetishists would no doubt disagree.
Point is, you can assign the blame (in a moral sense) different ways depending on your value system; but in terms of one thing leading to another thing, I think it's clear that extreme income inequality leads to bubbles and massive overextension of consumer credit (happened leading up to the Great Depression as well) due to too much money in too few hands putting pressure on investment managers for greater returns.
So, sure: if people just resisted all kinds of marketing and social pressure, all forms of predatory lending would disappear due to lack of a customer base. But that's, again, not reality. And just as we use government to set minimum wages and protect people from unscrupulous business practices in other respects, so can we do it here.
@akai:
Maybe it is a southern thing, but every apartment I've lived in has had separately metered electricity, paid for by tenants. And I have lived in at least eight; I was a contract consultant for several years.
I mow my own lawn, trim my own trees, and my wife tends her flower garden herself. The only exception is if my lawn needs mowing and one of the neighbor kids asks, I pay them to do it because I want to encourage entrepreneurship. 90% of the time I do it myself.
I haven't had a need to repair weatherproofing on my house in fifteen years. I replaced a twenty-year old fence a few years ago, but my neighbor and I did it together on five Saturdays at a total cost of less than $600 in materials.
These costs do not add up to anywhere near $300 month; anybody that thinks so either lives in a house far bigger than mine or has never owned a house.
> I've given myself a 7% interest rate, which seems reasonable (call me on it if it's not!).
That's high for even a Jumbo mortgage these days (mortgages over about a $1/2 million). If you can swing payments on a 15-year the national average is roughly 4 3/4%, if you go 30-year mortgage with fixed it averages a little over 5%
Going back to akailaughingman's comment about inefficient use of space, that is something to keep in mind when buying. Getting something that suits your needs is important, and recognize that going over that is part luxury and part contingency (like some day your parent or step-parent has to move in with you).
Luxury is, like so many things, OK in moderation and if you can truly afford it. Responsible enjoyment in the present is OK. But the first step to responsible enjoyment is accurate assessment of what is and is not a luxury.
Same with contingency, to understand what is a smart contingency and what is not you have to first understand what the contingency costs you.
Now home ownership isn't for everyone. For people that have that urge to move every year or two, or have jobs/careers that are going to push that, renting is probably a decent choice. It also depends on the market you are in at the moment. If you are moving into an area when the real estate market looks really "heated" and has been for a while you should give pause before buying right away. *shrug* But once you get to that point in your life where it looks like 5 years+ between moves is likely...
P.S. I think in the long run renting actually requires more fiscal discipline. With a house it's easier to remember to "pay yourself" at least a little a month. The bank helps remind you. :) With renting if you aren't actively investing in a balanced (not just stocks) investments to hedge against variable economic times (like the upcoming spurt of inflation we are going to see) then you are running naked compared to the homeowner down the street.
Dwight re: your P.S., I think that spending the money on things that make you happy today is underrated in the scheme of things. It's not simply a choice between investing in a house or disciplined investing in a stock portfolio or whatever (and the last few years call into question whether stocks are going to be the investment they used to be unless you time the market and buy in the troughs). Just as it is a reasonable choice (as someone else mentioned) to use credit to buy things, and it's also reasonable to salt away money in a home or other investment, there's a perfectly reasonable middle ground which is not going into debt but also not saving, and just enjoying your money from day to day.
Alan -
Again, the problem with your argument is that most of the credit didn't come from super-rich Americans, it came from super-rich Arabs and newly-rich Chinese, who needed to do something with the vast piles of cash we were giving them. That is the reality, even if it doesn't fit in so well with feelings on wealth distribution which I wholeheartedly share - and which don't need a financial collapse to validate them.
I think you credit people with too little intelligence. Most of us know what our means are and that it's not sensible to live beyond them. We just also like stuff, and think we can get laid more if we've got it, and have a tendency to live in hope that everything will work itself out.
Re cigarettes, yeah I do take the libertarian view as far as apportioning moral blame is concerned. it was different when my father started smoking - when the manufacturers actually claimed they were good for you! These days everyone knows they give you cancer, it's your choice. Should we regulate against advertising anyway? Sure, for the pragmatic reasons you invoke. Should we regulate to stop predatory lending? Sure. But that's about pragmatism rather than blame.
> Should we regulate to stop predatory lending? Sure. But that's about pragmatism rather than blame.
The wacky thing is that "predatory lending" was in theory already legislated against, to various degrees in different jurisdictions. The financial "innovation" of these various types of mortgages though were allowed to get out ahead of the regulators.
> there's a perfectly reasonable middle ground which is not going into debt but also not saving, and just enjoying your money from day to day.
As long as you are truly willing to go through periods of eating every other day. :) Living hand-to-mouth is fiscally running naked with basic needs and you know what happens to naked people, right? Sooner or later they get f*(ked. Have a large number of such people puts a huge burden on society as you go through binge and purge cycles.
Humanity turned away from that in large part 10's of thousands of years ago when we switched from hunter-gatherer to agrarian. Why? Because why "fasting" can be cathartic, being truly hungry generally sucks. :p
Because while "fasting" can be cathartic, being truly hungry generally sucks. :p
Wall Street is the easier target. Maybe people have come to realize the error of the "greed is good" mentality (which they participated in, ironically) and now they are targeting the prophets of this mentality to avoid self-reflection. I guess that, while Alan Greenspan should have known better, Wall Street actually DID know better (Jim Cramer is a good example), and so people are frustrated to see that someone used their money for their own gains although they might as well be angry at themselves, deregulation, Reagonomics or low-interest policy that lured more and more savings into the economic circulation. In addition, people are angry at Wall Street because their 401k's are losing their values.
The chart is really interesting because I had thought that credit card debt had risen much stronger. So the "greed-factor" of this economic crisis is mainly founded on the american dream of suburbia - your own house, regardless of your ability to pay for it. As a consequence, people might be going move back into the cities and rent instead of buy. And maybe people will remember that the stocks don't always climb.
Maybe people are feeling betrayed of Wall Street because the stocks had climbed for such a long period of time and thus, the stock markets looked like the most reliable way to prepare for retirement. Maybe you can attribute this the-stocks-always-climb mindset to the culture of greed, but on the other hand, noone really waved a red flag (well, noone who did so was taken seriously).
Dwight, I think you are making a bit of a straw man of my point. But fine, I suppose I should have said "from month to month" rather than "day to day". I'm talking about someone who pays their bills, stocks the cupboard and refrigerator, doesn't go into debt (I for instance don't own a credit card of any sort, though I have a VISA tied to my checking account so I can order things online and such; I also don't have a car loan or a house loan, or a 401(k) or any stocks or bonds at all, or even an interest-bearing savings account). Someone who then says "okay, looks like we've got the food shopping taken care of for this paycheck, all the bills are paid...now let's see if I have enough dough left over for that _________ I've had my eye on...or, how about I hit Priceline and take a trip to Chicago this weekend?" Stuff like that, in lieu of investing.
This also, btw, is why I lean toward the renters' argument, as I don't like the idea of having to have this contingency fund "in case the roof comes off" as someone said.
> I should have said "from month to month"
No, I assumed "from month to month". If you are living hand-to-mouth you have to be ready to lower your living standards very drastically very quickly.
I'm curious. How many weeks/months worth of food do you usually keep stocked?
@Alex S:
If run properly, stocks do in general always climb. At the root of that phenomenon is that fact that the vast majority of businesses are actually profitable; as are the vast majority of individual workers.
We should expect the vast majority of stocks to go up, as time goes by they should be creating new value which goes into their own growth or retained profits or distributed dividends. That makes them more valuable.
The source of the growth is ultimately 225M adults working an average of eight hours a day; that creates more economic value than their pay (or they wouldn't have jobs).
Oh and btw Dwight: a number of anthropologists have made compelling arguments that hunting/gathering (mostly gathering) was a healthier lifestyle that involved less work and more leisure for the average person. Basically, the agrarian thing was only really good for the elite, and pretty crappy for the vast majority who were peasants. But once population density created urbanisation, they were essentially trapped.
@Alan:
If the roof comes off, you call your home insurance company. The "contingency" fund is a $500 deductible. In my case, they will pay for me to live in a hotel while the roof is put back on.
You can also get separate home repair and major appliance insurance, for the A/C, water heater, plumbing, etc.
Tony C, you wrote: "The source of the growth is ultimately 225M adults working an average of eight hours a day; that creates more economic value than their pay (or they wouldn't have jobs)."
That last parenthetical statement is quite capitalism-centric. Why must capitalists extract surplus value for workers to have jobs? I would prefer a system where workers' pay was (at least on average) identical to the economic value they create. Then we'd have no need or use for stocks, and good riddance I say.
Dwight, your question about how much food I keep stocked betrays a very individualistic, almost survivalist mentality. As you may have picked up by now, I'm a pretty left wing, communitarian guy. If I found myself without enough income to buy food, I'd rely on food stamps without hesitation (did it before, twice, for brief periods in my twenties and early thirties).
But I should be quick to add that I *don't* believe in a welfare state in which citisens have no responsibility to give back to the communitarian pool of labour. I differ sharply with many liberal Democrats who supported the old system where someone could spend years on welfare without doing a lick of work. Instead, I believe that the government should provide jobs, New Deal style, to anyone who needs one.
The source of the growth is ultimately 225M adults working an average of eight hours a day; that creates more economic value than their pay (or they wouldn't have jobs)
It doesn't, though, create as much economic value as the pay that would support the standard of living they feel entitled to. That's the essential problem. In a globalised economy we in Europe and you in the US are no longer productive enough relative to the East, yet want to maintain the standard of living we're used to (and better). This is what's lead to the huge transfer of wealth from West to East (and the concomitant orgy of spending when they lent it back to us).
There are exceptions, like Germany, and some US states I presume. But the big, complex, expensive machines the Germans are good at making have suddenly lost value in a world too poor to buy them.
As long as we keep believing that the problem is monetary/ fiscal rather than structural, we can't start to solve it.
Tony C. re: insurance. Wouldn't you agree that, for the average person, insurance is a ripoff? Insurance companies are profit-making entities, after all (and though I don't support making all private industry government-run, insurance strikes me as one, like banking, energy, and transportation, that is just crying out to be administered by the government in a revenue-neutral way--but I digress). Seems to me that over the long run, a homeowner would be financially better off with the highest deductible insurance plan they can handle (or no policy at all if they can handle that), and to self-insure that high-deductible portion of their risk. No?
Alan, you're much more of a socialist than me, but I must say I've always agreed with your point about insurance. I think all basic insurance - life, home, car, medical, travel - should be taken on by the state. Anything beyond that would be allowed - if sports starts or musicians wanted to insure their hands and feet for millions, they could do so through private companies - because for me the point is to cover against catastrophe from the common wealth, not to punish corporations.
Incidentally, though, premiums probably wouldn't fall - at least not by much: insurers make little money from premiums - and in eventful years can often be net losers. They make their money from investing, like banks. Government wouldn't be allowed to risk your money this way in my system - it would sit in cash, if there was a big surplus some could be spent on aid if a massive disaster like the tsunami hit another country.
I'd be interested in hearing why this is a bad idea, as no-one's given me a really good reason yet.
> Dwight, your question about how much food I keep stocked betrays a very individualistic, almost survivalist mentality.
Ah, no. It was an honest question as to exactly what assets you kept.
> As you may have picked up by now, I'm a pretty left wing, communitarian guy. If I found myself without enough income to buy food, I'd rely on food stamps without hesitation (did it before, twice, for brief periods in my twenties and early thirties).
What you are doing is uploading the responsibility for maintaining a buffer to others. That goes back to exactly what I said. In relatively small numbers that is fine but if adapted large scale it becomes problematic.
As for agrarian vs hunter-gatherer do you understand how you are heavily relying on agrarian model? People aren't "trapped" in agrarian by anything more than a hunter-gatherer life is just very onerous and difficult. Unless you are very much driven to enjoy being buffeted by the elements and highly fluctuating food supplies (and some people are). Generally most people would find that the hunter-gather life truly sucks.
It isn't inherently more "healthy" than our modern living other than it didn't offer as feasible as many of the unhealthy choices of excess (sloth, glutony, etc.), and perhaps some genetic predispositions that are slowing being understood and address (as well as lessing with time). The people that did manage to survive it were in relatively good health physically but that was more a factor of survival rates being a hell of a lot lower.
> Government wouldn't be allowed to risk your money this way in my system - it would sit in cash
"Sit in cash" still represents risk, you understand? In fact it almost always represents a small real loss in value of the cash.
As for whether or not state run insurance is a bad idea or not; I'd say, having grown up with fully state run health and auto insurance, it is on option.
In some ways compulsory auto insurance, which is the norm in most of the industrialized world, is already partially state run. There are some benefits to having the edge of that compulsory nature being taken off by having a monopoly aimed with goals towards people in general rather than an effective oligopoly with self-serving goals. It provides some flexibility towards implementing the most efficient longterm solution rather than being confined to the one that generates quarter-to-quarter profit. But the devil is in the details of implementation.
Clearly, for instance, credit default swaps, which bankrupted AIG, were poorly conceived of and improperly regulated instruments.
Hey, wait a sec... Was it really the poorly conceived of CDS that bankrupted AIG? In fact, are CDS even poorly conceived of and improperly regulated? I don't know, but that's an argument for another day. But as far as AIG is concerned, I thought that the actual problem was not CDS per say (I mean, it's a bit mundane when you think about it, to say, "writing insurance was what bankrupted the insurance company"), but that because AIG had a AAA rating, it could write as much CDS protection as it wanted without posting collateral. Therefore there was no constraint (relative to capital) and consequently no restraint. Furthermore, normally a company would have to post increased collateral as their CDS position deteriorated. Because of its rating, AIG didn't have to do this, but then when it got downgraded it had to post huge piles of collateral against its CDS positions. And went boom.
I mean, WTF do I know, but it seems pretty straightforwardly the fault of AIG's crumby management combining with the dangerous benefits of being AAA rated, rather than being the fault of credit default swaps. And why is everything always the fault of credit default swaps and never, I dunno, interest rate swaps? Inquiring minds...
@Alan:
Why must capitalists extract surplus value for workers to have jobs?
This goes to the heart of why socialism fails; it runs counter to self-interest.
Why should anybody open a store if there is no excess value to reap by taking the risk? Why should anybody open a steel mill, or lumber yard, or anything else if as owners they can't make a dime doing it?
You don't seem to understand the role of risk in our system. A person that earns pay for hours worked risks essentially nothing. A business owner that is paying this worker risks misdirecting the worker to work on something that may have no ultimate value, or which they cannot sell, or which turns out to be a mistake in some other way. My son-in-law buys guitars for his store, but if he buys too many or the wrong brand he can end up taking a loss on them. He has two employees, they never risk a loss by working there: If they show up they get paid, whether they sell guitars or the place is dead.
When the employees can walk away at the end of the day poorer than when they walked in, then they are partners in some percentage and deserve a bigger share for taking that risk. Most employees prefer the security of a steady paycheck. Think of it as insurance: They premium they pay for that insurance is the difference between their paycheck and the economic value they create.
Like most insurance, on average the premiums outweigh any actual economic benefit derived, but it is purchasing peace of mind in a predictable paycheck.
I agree with an above comment that stated that the 50s home ownership dream is over, and believe that this is a critical opportunity to change habitation behavior.
Sure, having a big home is nice, yard, yadda yadda. But this is no longer environmentally sustainable. Buildings produce 40% of all emissions, double that of transportation. apartments are many times more efficient, both in terms of energy usage and the embodied energy of construction. Suburbs have to be over if we want to avoid climate catastrophe.
@Alan:
Insurance isn't a ripoff. I have health insurance; I'd rather pay twice the average cost of healthcare per US individual than play the lottery and hope my costs next year are not in the top 5%.
Being in the top 5% might bankrupt me, being at twice the average will not.
Same thing with my house. On average, people lose a few dollars in value due to house fires. But that is because only a tiny percentage of houses burn down.
I'd rather pay the premium than gamble that I will never do anything idiotic, that my neighbors understand how to use their fireplaces, and no builder ever took a shortcut or used the wrong gauge wire while building my house.
I don't mind if insurance companies make a profit, they are taking risks. They sell certainty and alleviate worry, to me that is worth something.
> "writing insurance was what bankrupted the insurance company"
Insurance without posting collateral in reserve isn't really insurance. Thus Congressman Ackerman's quip that CDS should have been sold as "I can't believe it's not insurance!"
But CDS can be a lot safer even without posting a lot of collateral, as long as you hedge to protect your downside. Which they didn't do because protecting downside, while reducing the risk, tends to reduce the upside too. So the FP division was acting like a hedge fund that wasn't hedging and an insurance company that wasn't insuring.
Yeah, hiding behind the name AIG (the middle name is "Insurance!") and the AAA rating exposed and exploited these weaknesses in the system.
But this isn't the only problem with CDS, and hedging in general. One thing with hedging, even done "safely", is that at the macro level if it becomes very prevalent you can get circular or long chains of dependancy. It's like setting up dominos and if someone, like AIG FP, that a lot of others are leaning falls without assets to back them the illusion propagates. You can get 3rd and 4th parties down the line that were acting generally in good faith that get burned hard enough to the point of going under, even companies outside the financial industries that are using derivatives for what they were initially intended for. Such as commodity producers looking to guarantee a future return for their product that they need to justify the initial investment in mining/producing their product.
How can a political blogger say that it's "unimportant" whether the consumer gets assigned some blame for this mess?
Yes Greenspan is at fault. Yes the banks were evil. Yes the lenders were predatory. But the consumer (many but not all) KNEW that borrowing money is not the same as earning money. You can't keep taking money out of your house forever. You can't keep spending more than you earn year after year after year. Consumers may not know what a CDO is, but they know they can't spend $100K a year if they only make $50K. If there is one thing Americans know, it's that there's no such thing as a free lunch.
Even as we gorged ourselves at the buffet, a tiny voice kept saying: What's the catch?
I for one think it's important that regular people realize what part they played in this ponzi scheme. Of course, no politician will dare tell the sacred constituents that they had a hand in this. But maybe an honest blogger would.
Look at from the global perspective for a second. The whole global economy has been geared toward funneling credit and consumer goods to one privileged group of people: American consumers.
It took a whole corrupt system to do that, but in the end it was the American consumer who benefited, just as much as the bankers and lenders did. They had the big house, the nice car, the European vacation, the flat screen TV, the fat 401k.
Not important? What could be more important?
You should include real income over the same period for comparison.
Well, I was being a bit glib. The point is that it's a logical fallacy akin to trying to ban cars because drunks crash them, or saying "all Muslims are terrorists", to blame CDS. Yes, literally, in a very mundane sense CDS bankrupted AIG. But it wasn't by virtue of the fact that they are inherently bad, but because AIG did bad things with them (not buying protection in order to net their trades, not posting collateral, etc). You know, that's probably the reason why CDS aren't blowing everyone else up as well. I mean, I think a clever guy like Nate would realise that this is the case if he ever sat down and thought about it. But everyone seems to have picked up on credit default swaps – I’m not sure why – and holds them to be somehow at fault for the whole crisis.
I guess you may be right about the fragility of the CDS market, but people have been going on about it for years, but it seems like the market was put under a lot of stress last year and worked pretty well:
A report earlier this month from the senior financial supervisors of the G-7 nations concluded that the credit default swap market functioned well in the second half of 2008, despite "an unprecedented 12 credit events" -- or actions that obliged the sellers of credit protection to make payments to those who had bought protection.
The credit events included the government takeover of U.S. mortgage giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), the collapse of Icelandic bank Landsbanki and, most notably, the bankruptcy of Lehman, a broker-dealer that was even bigger than Bear.
"Overall, the review confirmed the effectiveness of the existing auction-based settlement mechanism," the report said.
http://money.cnn.com/2009/03/16/markets/cds.bear.fortune/index.htm
@rexnutting:
You can't keep spending more than you earn year after year after year.
And who says they did? I think it entirely plausible that
A) Home owners simply believed their homes had appreciated in value, as everybody in the media and mortgage industry was telling them it had; and
B) Their real wages had been flat for years, and virtually everybody has a sizeable financial hole in their life (stuff they wish for and cannot afford), and
C) They listened to Countrywide or a TV commercial and found out they had tens of thousands in equity, and
D) They cashed it in.
Every expert in the country, banks, lenders, their property tax appraisal, everybody, is telling them they have $50K or $100K in equity. Well, maybe they don't care about equity. Maybe they'd rather have a less crappy car.
If you think the money is real, like everybody is saying it is, and you think the money is yours, it is your right to take it and spend it on what you want most. Isn't it? Or do we all have to be Ivy League economics professors? (Oh wait, not many of them called it either...)
Of all the posts on this subject, Mike Dimmick's hit closest to him, IMHO. I'll quote it below:
"The problem was not the collapse of the housing bubble, but the inflation of it in the first place. In 1999 the prices were close to the highest long-term sustainable multiple of incomes (about 3 times); they grew to an absurb six times incomes.
With ready access to new credit, house sellers were able to demand slightly more money for their property than their neighbours had sold for, and buyers able to bid up against each other, with basically no limits.
The governments allowed banks to create near-limitless amounts of money, by relaxing the amounts they needed to keep on reserve. The Basel accords needs a gunshot through the head, and a return to fractional reserve ratios.
Housing was not the only asset bubble - deregulation caused bubbles in oil, wheat, sugar, corn, metals (precious and industrial) and basically everything else that it was possible to buy. Open interest has been climbing again in these markets, vastly out of proportion to the actual physical hedging purpose for which they were created, and it needs to be crushed hard, and fast, to prevent another bubble. If you wondered where your bailout funds were going, here's your answer."
I especially liked his observation that it wasn't the collapse of the housing bubble that was the problem - it was the CREATION of the bubble in the first place!
Now, ask yourself when this bubble was blown, and you come up with one answer: the recession of 2001-2002. As you may recall, that was the beginning of the big tax cuts to the wealthy, and the resultant TOTAL FAILURE by Congress and the President to stimulate the economy by deficit spending. Instead, total reliance for ending the recession was dropped on the Federal Reserve, which responded in lap-dog fashion by dropping interest rates to HISTORIC LOWS, and keeping them there.
The result was a disastrous weakening of the dollar, culminating eventually in huge runups in the price of commodities such as oil and gold.
The rest, as the saying goes, is history....
> I guess you may be right about the fragility of the CDS market, but people have been going on about it for years, but it seems like the market was put under a lot of stress last year and worked pretty well.
Yes and no. It obviously has limits and "experience" is right now getting up in our grill about that limit. If Bush/Paulson/Congress had let AIG go teat's up last fall it seems extremely likely that "experience" would have been more than up in our grill about it, it would have been shoving our broken teeth down our throats.
It's like banking and loans. That system works well and is robust ... as long as you stay within reasonable fractions of leverage.
If they hadn't so heavily left themselves open they might have even pulled this off. But they just didn't leave themselves enough time, and created too big a job, to do what they are doing right now. Netting those positions.
That's why Bernnake, with Paulson, is now before Congress asking for a FDIC type system to be put in place for non-bank companies like AIG. To let the government step in with broad powers and run a specialized version of bankruptcy that isolates other companies from the damage of failure of a company that is holding a lot of hedge positions.
Really they are asking for official rules for what Congress would apparently like to do anyway, the powers that allow them to turf those much hand-wrought-over millions in bonus contracts and stuff like that.
This does tie into what Mike Dimmick was talking about way up thread. When rampant speculation gets into commodities futures, like COMEX. That bubble could be very well be real, and if it is it is very likely big enough to be seriously impacting current prices. Oil futures going a year ahead were so out of whack with the spot market that oil companies, and some traders, were selling oil they had in hand and renting tanker boats to sit with the oil till end of 2009 and even spring 2010 delivery.
He didn't answer my question about how he thought to crush that burgeoning new bubble. But I suspect what he might have in mind is to reduce the allowed leverage and/or require proof of willingness to make/take physical delivery of the oil, or at least require that for certain levels of exposure.
That gets to one key problem with CDSs. They were made completely 3rd party to the underlying asset (the loan) itself. Neither the seller nor the buyer was required to have an actual interest in the asset. That sort of arrangement breeds rampant empty speculation.
> That's why Bernnake, with Paulson, is now before Congress asking for a FDIC type system to be put in place for non-bank companies like AIG.
This isn't just for AIG, either. It's for quasi-banks like Citicorp Group where you've got this kernel portion that's a bank but it's effectively tied in with a MUCH larger entity that doesn't fall under banking regulations and is also spread across several countries, and thus falling under several international legal jurisdictions, to boot.
Here are some reasons why it's important -- not unimportant -- that we recognize that consumers share some of the blame:
We are very unlikely to adopt the right policies if we don't know what went wrong. We are very likely to conduct witch hunts that distract us from what we need to do.
Fundamental structural problems in the economy will not be addressed adequately if we ignore the root causes, because we'll say: Oh, we took care of that when we lynched a few AIG traders.
The credit boom masked significant economic problems, such as the declining value of a paycheck. Instead of working to address that problem (with education policy, tax policy, trade policy, health-care policy, infrastructure policy, regulatory policy, energy policy), we are being told that the real problem was the casino was rigged.
Blaming the casino operators is fine. The game was rigged.
But we should also realize that the casino -- even a fair one -- will never make us wealthy.
> that we recognize that consumers share some of the blame:
While there is lots of "blame" to go around, I don't think it's particularly appropriate to toss the word "blame" out there. Especially at this target. I think Sacto Joe is really getting to the heart of things. Housing prices taking off, eventually creating a full blown bubble, was an entirely logic reaction to extremely low interest rates.
While the end-game became more and more illogical, with flipping for huge profits and such, the seed of the illogical was in the monetary policy. With that genesis initiated it was really only a question of where the bubble would form. Stocks, commodities, houses, etc. As it turned out "some of all of the above", although the human face ended up more where it is logical to be. Where we come come to every day.
@rexnutting:
Blaming the consumers for wanting houses is like blaming medical fraud victims for wanting to be cured, or blaming date rape victims for agreeing to dinner without having performed a full background check on their dates.
It is simply ridiculous. The fault likes in the people committing the fraud and deception, not in the people that trusted what was obviously common wisdom at the time and got defrauded and deceived.
How, exactly, are they supposed to know they cannot afford a house? Under the paradigm that existed for their parents, you couldn't get a loan if you weren't credit worthy. Are these heretofore apartment dwellers earning median wages supposed to be real estate market experts? Are they supposed to understand economic bubbles? They are told they can afford the mortgage, it looks like they can afford the payments, and they are told that when the payments increase the house will be worth more and they can refinance at that time.
Maybe not told this explicitly by any individual, but that was the prevailing wisdom at the time, and it is insane to blame them for accepting the paradigm that seemed to be working all around them for years on end.
They were defrauded, by the media, by the banks, by real estate brokers, and even by their government property tax bills which inflate the price every year without fail.
You are right about one thing; it is important to understand what went wrong; but blaming the victim's for not being more cautious is not the answer. What went wrong was the decoupling of risk from performance, both at AIG and at mortgage houses and banks.
With CDS and securitization without regulation, we created a system in which there was no penalty for making crappy loans, because the guys making the loans could cash them in within a few months and always make a profit.
That encouraged them to obfuscate the risks and downplay the risks to the borrowers, and it encouraged them to make the loans so complex that borrowers lacking a degree in accounting couldn't assess the risk on their own. This is effective fraud.
That is what went wrong. It wasn't a casino; most of these people did not know they were gambling at all. They were not financial sophisticates, they believed this is how it worked, and if they made their payments everything would be all right. They were robbed, and it is wrong to blame the victims of crime.
OK, slightly OT:
BTW it is starting to look like Geithner's plan to get problem loans off the books at banks is....arrrgh, all screwed up in the risk-reward category. It's starting to look like those private "partners" are going to be largely insulated from any losses, while they get a 50% cut of any realized profits. WTF? How is that suppose to create anything approximating a real value market for those loans if the private bidders don't have real skin in the purchase? It sounds like these AIG FP trader bonuses all over again. :/
OK, now I'm getting pissed. I hope Congress rips him a new gaping gash to get answers on this.
No, you've got that the wrong way round. The private money takes a hit first, like the equity tranche in a CDO. They obviously have to make a return, but I'm not sure how much that is. DeLong and the press release seem to be contradictory, and if they can't agree, what chance have I got. Anyway, if in our heuristic the private investors are making money, then isn't the plan working?
Do you think it's a coincidence that housing prices as represented by the Case Schiller index started to deviate from inflation in 1998, the year after JP Morgan invented the Credit Default Swap? CDS opened up banks' capital to allow them to make more loans. In 1998, though it took a while to catch on, Mortgage Backed Securities had been rendered theoretically risk-free as a consequence of the Gaussian Copula formula. As a result, financial "innovation" had created both the means (freed up capital) and the incentives (zero risk MBS) to write more and bigger loans.
This system of incentives led to outright fraud of which, according to the FBI, 80% was initiated by the lender. Greenspan's cheap money may have done a great deal to fuel the housing bubble, but Wall Street was already finding ways to print money on its own. Wall Street deserves a great deal of blame because they either knew or should have known that they were inflating an asset bubble and did nothing to stop it.
That said, there are tons of people to blame. Lawmakers, Bush for gutting the SEC, appraisers, Clinton for the Commoditied Future Modernization Act, regulators, free marketers, borrowers, ratings agencies, even Fannie and Freddie who were late to the securitization party and even after they dipped their toes in the water were still getting killed on market share.... and Greenspan. He should have known too. He should have used his bully pulpit along with interest rate increases to cool down the housing market.
All of those people bear blame, but they were peripheral players to the central problem. Ultimately, it's banks' fault that they were making bad loans, regardless of market conditions. They leveraged themselves thirty+ times; 56x in the case of Citi (260x if you include off balance sheet liabilities). Unlike those players who either set up conditions for excess or engaged in profit taking (and even fraud in the case of appraisers), banks were the ones writing mortgages on overvalued assets.
Remember, too, that a mortgage is a nonrecourse loan. If a lender's only security is collateral in a piece of real property, wouldn't that suggest the lender should make sure that the property is properly valued?
> Remember, too, that a mortgage is a nonrecourse loan.
Not in all states I thought? For example my understanding is that Florida is a mortgage recourse state, which is important in this case because of the large number of retirement/vacation units that have taken a complete price beatings.
I hope you are right vimothy. In truth I haven't seen the actual text of the plan myself. Even if the full private investment isn't in that frontline of losses, as long as it is the sting of a serious double digit loss to over estimate the value, that's good enough to put my mind at ease.
> Anyway, if in our heuristic the private investors are making money, then isn't the plan working?
Well yes. But theoretically the banks won't be willing to part with these if they think they are throwing a lot of value out the window. So we are going to be looking at fine lines for margins of error, I would imagine. Although I guess the threat of the FDIC pulling their over-leveraged plug if they don't shed loans, to get their leverage multiplier down, will help provide that motivation? The current stock prices make raising capital via common stock an unpleasant alternative.
Tony C., in case you do come back to read this...
First of all I really liked your post at 4:58 p.m. in reply to rexnutting. So it's ironic that we are at odds in our own little socialism tangent, since I think that was probably the best post in the whole discussion vis-a-vis the predatory lending that went on.
You make a good point that workers don't go into work taking the chance that they will go home poorer than they walk in. However, the "security of a steady paycheck" is a bit disingenuous, since if in fact the enterprise in question is losing money their jobs are far from secure.
I have a whole "manifesto" that I have developed that is too detailed to go into here. But as briefly as possible, I agree that a lack of incentive is a flaw of other socialist systems that have been tried (and BTW, to say that "socialism/communism has been tried and it doesn't work" would be akin to saying "fusion power has been tried and it doesn't work" and just throwing up our hands and giving up--these things are complex and will require many false starts before someone gets it right). It goes against human nature to have everyone make the exact same salary regardless of ability or effort.
But I don't believe we have to have extreme disparities of wealth either. A range of $10 to $50 per hour should be plenty incentive--and some of the higher paid jobs in my system would be counterintuitive (like garbage collection or meatpacking). Pseudo-capitalism would still take place, with entrepeneurial types applying to government owned banks for small business loans. Everyone working in an enterprise would take part in profit sharing but everyone (including the manager--no owner really) would also have a safety net, a floor guaranteed by the government. The benefits of competition would be preserved, although fiascoes like competing DVD formats would be avoided. If an enterprise was inefficient and lost money for more than a certain period of time, someone else would be given the chance to run it. If it still couldn't make money, it would be liquidated.
That was as short as I could present it, believe it or not.
Nate, I think you have underestimated the capacity of the investment class to understand that there was a growing housing bubble. I was aware of it well before it burst and I am not an economist or an investor. It was clear that money that had stagnated or lost value in the stock market moved to the housing market and created a bubble there. You are right that the Federal Reserve deserves the lion's share of the blame, but the deregulators (Summers, Bill Clinton, Gramm, et al) and their corporate cheerleaders are equally liable.
@Alan:
I will say again, you do not understand the value of risk, and apparently, do not understand the value of competition or self-interest.
Thank you for not publishing a manifesto.
What has been tried, and has failed, is a system in soviet russia in which labor was separated from self-interest, and coupled to state interest. They needed people to work to help everyone, and they literally did need it, and people refused.
For some moments in the heat of revolution or war people can think and act in the national interest. Then the fever fades, and they start wondering why they should work harder than the slacker, and patriotism fades and is replaced by resentment.
Your system won't work either, and the key is in your statement:
...although fiascoes like competing DVD formats would be avoided.
Those aren't "fiascos," they are the necessary and valuable competition of ideas. Who gets to decide what new product will cause a competitive "fiasco" and which are valuable new contributions? The only mechanism capable of deciding that is the market of consumerism. Is the current competition between plasma and LCD a fiasco? between HDTV and regular definition TV?
These fiascos of market competition drive down prices of both technologies. They are why you can buy a cheap TV for your dorm room for $150, and desire for a new model is why you can buy a decent used TV for $100.
Socialists routinely misunderstand that competition is the sandpaper that streamlines everything.
They also routinely commit the sin of "projection," which is the error of thinking that everybody thinks like them. Not just in terms of social justice, but in terms of what they find valuable in products.
Companies compete on four product fronts: Cost, Quality, Service, and Cachet. Different people rank these things differently; my sister is a cost diva. I am a quality wonk, I buy the highest quality I can get at the time. My brother-in-law is a cachet guy; he wants a prestigious brand name and would take it over a higher quality unknown. My wife pays more for a service warranty and only shops at stores that provide better service.
Everybody puts their own weights on these four points, and you cannot choose for them what YOU think is important and what you think they should be spending money on. This is what socialists do, they presume their weights and their prioritization are the only ones that "make sense" and all of a sudden society is crow-barred into a production system that emphasizes one thing over all others. And people are unhappy.
So no, the benefits of competition would not be preserved. If you prevent what you think is a fiasco, that implies central control over which products can and cannot be produced, and that implies control of entrepreneurship and invention. That implies micro-management of the economy by bureaucrats deciding whether they should allow a new flavor of ice cream to be tried on the market, or whether it would cause a fiasco of competition with vanilla and chocolate and harm the incomes of the vanilla and chocolate producers.
THAT is the fiasco. Because seriously, is a new DVD format any different than a new flavor of ice cream? Honestly? Nobody has to buy it, and if buy it and it turns out to be a mistake, they wasted only what they could afford, because they didn't have to buy it in the first place.
Let us turn to your limits on salaries. So, the most anyone can make is $50/hr, $100K a year. This is the salary of a typical seasoned professional with no managerial responsibilities; an architect, master programmer, professor, accountant, civil engineer and so on.
Why should anybody become a doctor? Why should anybody start a business, especially when you say nobody will own a business?
A launch pad for my own success was joining a partner, writing software for a small niche industry my partner happened to know quite well, and then selling several thousand copies of it. I spent several thousands of dollars out of my own pocket to start that company, and I ran it full time for six months for exactly zero pay, and even when I could have paid, I hired somebody instead and finished the entire first year without pay. The job I left to do this was paying $150K.
Now, in your world, what in the world would compel me to spend ten thousand dollars of my own money and leave my job and work twelve hours a day for nothing for a year?
I can tell you what compelled me then; my partner's idea blew my mind. With a family and no savings he couldn't leave his job, and he knew I could, and offered to split it with me if I financed it and worked it. So what compelled me is seeing that I could sell at least a million dollars worth of his software (and we topped that in our second year).
The crucial point is that I took a huge risk, and although it paid off, it could have failed. There is no reason to risk huge failure if there is no potential for a gigantic payoff.
The role of government is not to manage the economy; the role of government, with regard to the economy, is to keep companies on track in competing on product dimensions: cost, quality, service and cachet. The role of government regulation is to prevent companies from competing by exploiting or endangering workers, screwing investors, ripping off customers or polluting the environment.
Government should provide a safety net so that people are safe, fed, and cared for.
Government should not be in the business of managing the economy, deciding which products can be formed or can compete, or setting the maximum wages of citizenry.
Force companies to compete for customers. Efficiency of production is not the only thing that counts, there is room in the world for both $200/plate restaurants and taco joints to coexist and thrive, and I have frequented both.
Let me propose a different solution: 50/50, socialism/capitalism, so the net result of taxation is that 50% of the national income is taxed, and used for all government functions including state and local; there is no sales tax, for example, or state income taxes.
Now the tax system can be progressive, there can be a poverty cutoff, etc, but the end result is that the government's budget, which must be balanced, is 50% of national income. Period.
That 50% is used for national defense, the social safety net, infrastructure, courts and police and law enforcement, licensing and inspections such as the FDA and FAA, public schools and colleges, and all the other functions of government we need.
I would point out that 50% is about what we pay now, if you include all the revenue of the federal, state and local government: Sales taxes, federal and state income taxes, property taxes, government run water, sewage, gas and electricity income, FICA, Medicare and Medicaid deductions, licensing and inspection fees that professionals (like doctors or lawyers) and companies must pay, your car inspection sticker, tolls, etc.
My proposal is a bargain, actually, and if you get to keep 50% of your earnings you can still become a millionaire or billionaire, can still just become a well paid business owner earning $200K/yr for risking capital or pursuing a new invention, can still become a multi-millionaire actor or rock star or celebrity.
50% is plenty enough to drive self-interest; and it is the government's job to prevent the rich from gaming the system and avoiding their taxes by selling to us from overseas. The answer to that doesn't have to mean protectionism.
The 50% of income tax on a product or service should be paid wherever the product or service is sold; no matter who sells it.
So if we sell X in Germany, Germany should get 50% of the marginal income that produced for the American company that sold X, and the American company should be able to deduct that charge from their American income tax. If Germany sells us Y, the same thing in reverse; their company must pay us 50% of the marginal income produced by Y.
This system can be fair and easily protected against gaming; and it is fair to the countries involved.
If you read this far, thanks. I conclude by saying that it is possible to solve the problems of poverty, hunger, education and health care, and the symptoms of those problems such as drug use and crime. But the only way to do that is to tap into and channel the one thing that makes people work hard, take chances, defer rewards and invest time and money in things that may utterly fail: Self Interest. There must be enough chance of getting ahead or becoming wealthy, or at least more wealthy than one can get by working for others, to drive this otherwise insane behavior. I think a 50/50 solution is about right and in fact better than what we have now; people raised in such a system would understand that the government and society are their partners, in both success and failure. If they succeed, we share the profits; if they fail, we provide a safety net so their lives are not on the line. It is a fair and humane bargain.
People are missing the point, it wasn't Joe Sixpack finding new houses, or new money to buy houses.
It was Jane Lawyer, or Jim Realty Agent, who had money to invest, buying TWO houses, with the intent to flip one.
Think about it: if you keep on raising the price of housing, there's only a limited amount of people who can afford housing.
Most of these people were lured into "flipping" or into getting more than one house on speculation.
It worked for a while.
Yes, they deserve to suffer horribly.
Tony C.,
I did read your entire post; however, to my dismay, it appears you did not really read mine. Either that, or you just constructed a straw man. Because I thought I was clear in saying that I don't believe in a crude kind of socialism that pays everyone the same regardless of their effort, ability, or ingenuity (although it should be noted that even a crude version of this sort did not "fail" in the USSR to the extent generally stated--they went from a backward illiterate agrarian nation that got their asses handed to them in WWI to become, a couple decades later, the winner of WWII, then a nuclear power, then the first nation in space and still the nation with the most powerful rockets, and one of the best educated populations in the world).
Your rant about avoiding multiple DVD formats ignores the fact that the government has imposed a single standard on HDTV, and a deadline (now delayed) for switchover. Before that, I'm pretty sure NTSC was also a government-imposed standard (correct me if I'm wrong). Is this a travesty in your eyes?
In any event, it's a huge leap from saying that there should be a single standard for such technical platforms, to saying only one flavour of ice cream will be allowed! (Although, again, the USSR had some awesome ice cream despite the limited number of flavours.) The whole point of my idea was to allow opportunity for any entrepeneur with interesting ideas to have a crack at the capital needed to try them out--and if unsuccessful, to get out of the way and give someone else a try.
I find it hard to imagine that if $100K was the maximum anyone could make, no one would be a doctor (again, the experience of places like Cuba and the USSR would suggest otherwise). If that's how selfish and greedy doctors are, it's a sad statement on them as human beings. Personally, I will probably never even come close to making $100K a year, and I'm okay with that. But I can imagine what type of lifestyle it would bring (or for that matter, what it would be like if my wife and I each made that much), and it seems perfectly swank enough for anyone to be happy. Beyond that and you're just getting greedy, gluttonous, especially when you look at a map like this one:
http://en.wikipedia.org/wiki/File:Percentage_population_living_on_less_than_1_dollar_day_2007-2008.png
My income and standard of living, relatively meagre compared to $100K, is fabulously wealthy compared to the way most of the world lives.
@Alan:
I did read your entire post; and I used your DVD "fiasco" statement as a specific instance of a generally wrong idea. It is wrong for the government to decide a priori which products will be fiascos and which will not; that is for consumers to decide.
I find it hard to imagine that if $100K was the maximum anyone could make, no one would be a doctor...
The question isn't whether anybody would become a doctor, the question is whether fewer people would become doctors, and the answer is yes. Money motivates people. Becoming a doctor is hard, it is risky, it is insane hours.
So, say being a biologist or chemist and being a medical doctor all pay exactly the same, $100K. Do you find it hard to imagine that some people, when the going got tough, would just give up on medical school and become biologists or chemists instead? Get married? Have some kids and work the forty hour weeks? I don't find that hard to imagine at all.
And if you think that says "something about them," what it says is they aren't willing to sacrifice eight years of their life and forego their chances for romance and happiness for zero additional gain. What is says about them is what we already know about 99.999% of us, they aren't selfless martyrs doing it for the good of mankind. And anybody that claims they are that selfless, and still owns a car or a house or has money in the bank, I think is a liar.
Doctors (and I have worked with several) definitely have motives beyond greed. Most people I work with have motives beyond greed, they think they are doing moral and good things and contributing to society.
But it is human nature that if you get paid the same whether you work hard or don't, people do tend to not work very hard.
The same principle applies to ownership of companies. What is the motivation for taking risk and building a company if your maximum pay is $100K? Most professionals in the science area, where I work at least, have no problem earning $80K to $100K. What in the world is going to motivate somebody with few responsibilities and a secure future to start a new business, or spend their spare time inventing a new product, or to take a paycut to work for a new startup, or to do anything other than plod along and do the minimum necessary to keep their job?
Nothing. Self-interest rules. I am a liberal, I believe in government and I believe in the social safety net. But the chance and dream of doing better is what motivates people, and if you cap salary at $100K then motivation wanes for people as they approach the limit.
You are hurt by a $100K limit even if you never approach it yourself; because you are deprived of the benefit of the brains, dedication, and skills of people that could exceed it.
Interest rates were too low for too long. This could have been avoided if the Fed had reacted to the rise in oil prices with a raise in interest rates. As they should have! Higher interest rates would have led to less money used on credit cards, less people buying homes that could not afford them, and more people actually saving money because banks can offer decent rates on savings accounts and CD's. All of these things would have helped either lessen the severity of or altogether avoid the current economic cluster-F.
Tony C.,
Here's a fundamental difference of opinion between us that we are not likely to be able to solve. I'll allow that there's a grey area. But I feel certain that the grey is over when you get to incomes over say 300K a year. Individual exceptions notwithstanding, in the aggregate, people at that level are doing more to leech off society, more to harm it, than to "benefit" it with their "brains, dedication, and skills". Even if our overall GDP would go down somewhat without such people (and I suspect we would disagree greatly as to the extent of such a drop), I feel that the majority of people would be better off, and just as importantly the world would be a fairer place (admittedly, something like this would have to be done worldwide or people just run away to some other spot more favourable to them and their loot).
But this is so hypothetical neither of us can prove our position.
@Alan:
The data suggests your concern is misguided. Here are census bureau stats from 2007:
Income Distribution to $250K or more
What this tells us is that the mean income of people earning over $250K is about $460K. They earn 7.6% of the income in the USA, and if you cap them at $300K, they will earn 5.1% of the income; so you will have reduced net income in the USA by 2.5%.
Hooray. Implementing your plan saves one year's worth of inflation by capping the income of 0.6% of workers.
What problem do you think this solves?
Probably none, but it does create problems, because people will get around these limits in one way or another. Jobs will start including a plethora of "assistants", a boatload of perks, homes, and private jets (all corporate owned of course so they count as expenses, not as income), professionals will form corporations, of which they can be the only employee earning $300K, but charge fees and control wealth as if they earn $1M or $10M a year, while giving themselves lavish benefits, offices, a fleet of cars, vacations and more. They will go overseas, and pay themselves there. Will you outlaw Americans working for foreign corporations? Will you prevent money earned overseas from entering the USA? To plug every hole for how people can game the system and get more than $300K a year out of it, you will have to plug so many holes you will require dictatorial powers.
Of course, that is what I suspect you are proposing anyway; all to reduce national income by 2.5% and claim the system is "fair" because there is a cap, when in fact it is NOT fair because some people are simply worth more than that. For example, if you cap the pay of top-level actors at $300K, there will still be 50 times as many offers to Brad Pitt, Angelina Jolie, Julia Roberts, George Clooney, Jodie Foster and others as there are to the next tier in skill.
These people are not just genetically lucky in looks, there are a thousand prettier girls and prettier guys. They have unique abilities to inhabit characters and be believable on screen. They put butts in theater seats. The world loves them.
So we have basic economics: The demand for Jodie Foster is 50 times the demand for one of the chicks on Reno 911; and how will Jodie Foster ever decide? Maybe by the quality of the picture, but maybe she will take the five year employment guarantee that includes 12 servants, 8 cars, six houses, two private jets, one helicopter and a private island. Or maybe she will just make the picture entirely in New Zealand, or Australia, or India, or Canada, for $20M. These demands won't drive her suitors away, because Jodie already gets to pick and choose her films from studios ready and willing to pay $20M in cash. Commanding underlings to line up perks won't even make them blink.
And why? Because Jodie Foster, like Julia Roberts or Clint Eastwood, is quite literally a one-in-two-million salesperson; there are a few hundred such actors in the world, period. She sells tickets, then DVDs, then rentals, then boosts ratings on TV.
Now don't think I'm getting all gaga over Jodie or Julia, I see actors as skilled workers and have no illusions they are anything like their fictional personalities.
I am only using them as specific illustrations of an actress being worth $20M, because IF they are in the movie, they boost total net returns over the ten year economic life of a movie by $200M or more (they do still earn after that, but only a small percentage of total economic benefit is derived after the first ten years).
This has been shown statistically by comparing movies with A listers and those without.
I think this is the perfect little example. Nobody is forced to write a movie, direct one, act in one or air one. The demand for the movie is entirely voluntary, every single person that watches it would have been fine living without it. Whatever they paid they paid entirely voluntarily, and obviously thought it would be worth that, for whatever reason.
The receipts for a movie are a true reflection of the value created, and it turns out that an A-list actor's fair share of the marginal value they created through their skill is worth several million dollars.
Your assertion that nobody is worth more than $300K a year is a distortion of reality. You ignore the fact that we have 225M adults in this country, and about a billion in the first world.
There are outliers, people with literally one-in-a-million, world-class talents that really are worth millions of dollars.
And not just in acting, or sports, or music or arts. In medicine, or computer science or chemistry or research, like Edison.
I admit I am not one of them, but I recognize these outliers exist, and I do not begrudge them their income.
The ones I resent are the sociopaths that are robbing us; but it is wrong to cap the salaries of everybody, innocent of wrong-doing or not, just to keep the sociopaths from stealing 2.5% of our money. They should be stopped, but with regulation and control, not a willy-nilly salary cap born of jealousy.
Tony C.,
I enjoy a good debate, but it's really better if we both actually pay attention to each other's posts.
In your post directly above, you ask:
"They will go overseas, and pay themselves there. Will you outlaw Americans working for foreign corporations? Will you prevent money earned overseas from entering the USA?"
In my short post directly above yours, to which you were presumably responding, I noted:
"[A]dmittedly, something like this would have to be done worldwide or people [would] just run away to some other spot more favourable to them and their loot."
Doesn't that pre-empt your point?
Perhaps I need to be more clear. I'm not talking about superimposing a compensation limit on the system we have now (the providing of perqs you describe would make that difficult though perhaps not impossible just as the IRS already monitors "in kind" compensation). I'm talking about a global governmental system where private property exists only for personal possessions (I would also like to see the end of "ownership" of land, for instance, which is an absurd concept anyway when you hold it up to the light). I want to preserve enterprise, competition, ingenuity, and incentivisation, but only within allowed parameters in semi-autonomous divisions of a global "corporation" of sorts owned by the government.
So all the books would be open, all financial transactions visible, thus making large scale gaming of the system pretty difficult (small scale gaming is always going to be possible, but this is true in capitalist systems as well to the same extent).
@Alan:
Doesn't that preempt your point?
No, because my point, which either my best efforts fail to make understood or your best efforts resist addressing, is that in one way or another the unique talents WILL be compensated, or you will be running a worldwide dictatorship with everyone as your slaves. Period.
Certain people are in very high demand. Maybe 1 in 200, maybe 1 in 500. In an entertainment niche, the ratio is one in thousands, or one in millions.
One way or another, these people must find a way to prioritize the demands on their time. As in business and in life, prioritization is a way of figuring out what you are NOT going to do; because if you had the time and capital to do it all, you don't really need priorities, you just need a schedule. To understand how they will do that, look at human psychology, and sociological studies, and guess what? Self interest will rule, and one way or another they will collude and wrangle a way to get more compensation.
If we look by income, those earning $250K or more are about 1/2 of 1% of the population; 1 in 200 people.
Limiting their income is a fool's errand; this world government you propose would have to be so powerful to do it and this would cost so much that GOVERNMENT would become the problem.
And a larger point is that some of these people have talents that DESERVE the higher income.
I am not approving of executives getting pay they do not deserve and did not work for. That is fraud, or ripping off investors.
But capping salaries at $100K, or $300K, or $1M is simply dumb, and the probable cost to liberty and freedom of preventing a tiny percentage of people from getting rich is simply not worth it. At least not to me.
Since you refuse this point; all I can do is hope you fail in your bid for revolution and the enslavement of the world in order to stop something you clearly cannot comprehend.
It is not the amount of debt but debt service that counts. Debt service ratios have risen slightly but have recently fallen. They are higher now than historical averages but should decrease further as homeowners refinance at lower rates. It has been common for pundits to complain about level of debt but they always fail to note debt service burdens. They seem to always assume that a higher level of debt must mean an equal increase in claims against income. Nevertheless they are always wrong. People are rational and debt was taken on in a period of record low interest rates.
See: http://www.federalreserve.gov/releases/housedebt/default.htm
steveH,
your assertion that people are rational would seem to go against twenty plus years of behavioral economics and psychology studies.
Would you care to rethink your analysis?
unless of course you were being sarcastic, it's rather hard to tell on the net.
But it's difficult to expect the consumer to behave rationally when they were getting such bad information from their televisions and their elected (and appointed) officials.
i agree with this statement if not anything else in this post. but it will prove/is proving to be difficult to try and put a finger on what caused this economic disaster because there are so many different factors to try and comprehend that it seems nearly impossible. so Even though the housing market played a role there are way to many factors to settle on this one. Still the housing market is a vital issue that will and needs to be taken care of by the gov. because even if our economy tanks the people will need a place to live
Nate, please help me out here. Buy a house with 100% financing, then re-fi 125% of its value. Is that infinity leverage or something? In any event, the low interest rates didn't cause the problem -- it was all the easy money.
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