Subprime financial crisis

I apologize for my lack of attention to this blog over the past week, but I’ve been extremely busy.  MD and I left one conference weekend before last, came home for a day, and left for another conference, from which we just got home last night.  During the one day we were home, we were running errands and had the clutch go out on our car in exactly the same place it went out two years ago.  We were pulling off the exit from the freeway we always use when the clutch pedal went to the floor.  We pulled to the side of the off ramp unable to move and sat waiting for help.  We got the car safely to the shop and got home, but it took a few hours out of an already busy day.  So, as Bob Cratchit said to Scrooge, I’ve been behind my time since it seems.  If you’ve had a comment languishing in awaiting moderation purgatory, mea culpa.  There are about 30, and I’ll try to get them all dealt with within the next 24 hours.  By tomorrow I should be back on my regular schedule.

I planned to put up a regular medical/nutritional post today, but in view of the financial crisis, I figured I would instead put up this video that I saw earlier this year, months before the financial crisis exploded.  These comedians were very prescient.  I find it interesting that they discuss Bear Stearns by name long before Bear Stearns bought the farm.  I’ve always found it amazing that comedy (including political cartoons) seems to be able to encapsulate a situation and present it more understandably than an in depth investigative report.

See what you think.  I’ll be happy to post all comments.

Please note: I reserve the right to delete comments that are offensive or off-topic.

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43 thoughts on “Subprime financial crisis

  1. Thanks!! This is the first real laugh I have had since this mess exploded two weeks ago. Too bad, however, that the joke is on us. The thing that really gets me foaming at the mouth is remembering all of the times I have heard people defend the indefensible salaries and “golden parachutes” by saying that without such breathtaking financial rewards, companies would not be able to get the “best people” to run them. And this is what the best minds have done for us.

    I kind of agree with you. Sort of. But, what kind of skill does it take to run a behemoth corporation with offices all over the world and thousands of employees? And what is that skill worth? And what is the worth of that skill compared to the worth of the skill of a movie actor/actress or an NFL quarterback or a star major league baseball player? People in the entertainment industry and professional sports earn huge, huge amounts of money, and no one seems to begrudge them their pay. The idea is that the market sets their worth. But let a corporate CEO earn even a fraction and it sends people over the moon. And these CEOs are doing the same thing the actors and sports professionals are doing: they are earning what the market says they’re worth. No one held a gun to anyone’s head to force the hiring of these execs – they were hired at the huge salaries because they supposedly brought value to the company. If an executive does increase the profit in a company by hundreds of millions of dollars, who says said executive isn’t worth as much as Tom Cruise or Tony Romo?

  2. Hi Dr Eades! I was under the impression that you are driving an SUV. What kind of car are you driving, if you dont mind? I love stick shift, and been driving them for years, but I do drive Honda fit, small little devil. I am relatively big guy, at 5’9 i weigh about 200 pounds, but lots of muscle and everyone was laughing at me when I bought it. However a year later I am happy i did. It is very economical, and very fast considering how small it is, yet it fits a lot.

    I’m one of those people who buys a car and drives it until the wheels fall off. MD and I get our money’s worth from any car we purchase. We have a 1998 Audi A6 that runs like a top and a 1992 Porsche 968 Cabriolet, which, aside from the occasional clutch problem, also runs like a top. We’ve had both cars forever and have no plans to upgrade anytime soon.

    Cheers–

    MRE

  3. Hm. Ask the Costco guy what he thinks of having exec salaries more than 20x what the lowest employee gets. It’s still greed on the part of the salary demander. Which the demander gets by charging such high prices for the products and services – which we are dumb enough to pay.

    Personally I’m having a blast refusing to support both entertainment zillionaires and big business zillionaires. Buying local, handmade, and watching rec softball. What a fun and cheap hobby! Very pleasant too and high quality stuff.

    The demander can only demand if the payer is willing to pay. And the payer always controls the negotiation because he is the payer. If no one is willing to pay the outrageous executive salaries, no one will get them.

  4. Ben & Jerry’s tried to prove that executives don’t have to be “overpaid” by announcing they would limit their CEO’s pay to $200,000. The result was that they couldn’t find anyone competent enough to run the company and had to quietly scuttle the plan.

    There’s a market for top executives, just like there is for any other product. You want top talent? You’ve got to out-bid your competitors … just like in sports.

  5. No. Do you think I need one?

    Michael Richards

    No. Er, I guess No. It’s not for me to say. I just can’t figure out why you wrote ‘temporarily’ above your name.

  6. Right on Dr. Eades! Executive salaries are a drop in the bucket when it comes to a company’s expenses. However, Taxes and regulations are a huge drain on companies and our economy. It’s not capitalism that got us into this mess, it’s a lack of it. And, the only solution being offered is wholesale socialization of the financial markets!!! The government can’t tell us which, out of three nutrients, we should eat! Yet, they’re going to take over the banking and mortgage system, too (the part they didn’t already control before)? No thanks.

    Thought this summarized the situation well:

    Guy

  7. That about sums it up! That and if you are going be a failure at business it’s no good having a corner store, it has to be big enough to bring down so many other people when it fails that they can’t afford to let that happen. Then you also get a big fat bonus for your incompetence.

    If you get a chance, John Bird played a similar role opposite Stephen Fry in “Absolute Power” – a satirical look at the advertising/spin doctoring world. Well worth a look.

  8. It seems pretty elementary to me that ‘top talent’ got the economies of much of the world into this mess. Maybe they aren’t quite so talented after all?

    I think it’s a little more complex than that – at least in the US. Here political played a large role. Politicians wanted more low-income people to be able to purchase homes, so the financial institutions were basically forced to make subprime loans. These loans were then packaged and sold as investment vehicles. Once the house of cards collapsed, the same politicians who originally promoted the issue began to finger point. Had politics not been involved, it’s doubtful that any of these loans would have been made in the first place. So, it’s difficult to place total blame in this situation on the ‘top talent.’

  9. There are some differences between the overpaid movie stars and atheletes. If Tom Cruise has a few bombs, he’s not going to get as much on his next flick. In addition he’s getting money because there are many people who will part with their hard earned money to see the latest movie. A similar argument applies to athletes with the addendum that while there are soft landings as announcers and sportware design, they have a limited time as an elite athelete. Corporate presidents are paid, to use Lake Wobegon terms, as if they were all ‘above average’, that is to say they are paid pretty much the same regardless of company performance.
    They also appear to have very cozy relationships with the boards that set their pay. To be sure, if the people who actually owned the company, which is to say the stockholders (typically including you and me) made a big stink about excessive salaries this might well change.

  10. Dr. Mike, I know this doesn’t belong here, but did you ever post on minimum protein requirements to spare LBM? If not, would you please? I’ve built a lot of muscle that I want to hold onto while losing fat as quickly as possible.

    By the way, maybe we should rename carbs High Grade Insulin Promoting Leveraged Macronutrients? LOL

  11. ” Politicians wanted more low-income people to be able to purchase homes, so the financial institutions were basically forced to make subprime loans. These loans were then packaged and sold as investment vehicles.”

    While that aspect of the problem is unquestionably true, it does not mean that any investor was forced to buy those flawed investment vehicles, nor were the AIG’s of the world forced to insure them.

    If the MAJOR issue here was the issuance of bad loans as a result of poor political policy, wouldn’t the damage have started and ended with Fannie and Freddie, the quasi-political entities?

    I’m not saying that it was solely a political problem, just that politics played a large role in it. It is true that entities bought these packaged loans and others insured them and are now paying the price. I don’t see why it is incumbent upon us, the taxpayers, to bail them out.

  12. The “problem” with executive pay, IMHO, is that it is not tied to performance. A CEO can be convicted of fraud, or run the company into bankruptcy, and is till “entitled” to his bonus and severance package. To wit, the guy at WaMu, was on the job less than a month, and got several million dollars bonus and severance from a company that failed, the rank and file with years on the job will get???

    I agree that this sucks. But that’s the package these guys required to sign up. The companies are simply fulfilling their contractual obligations. I don’t blame the CEOs – I would take such a gig if I could get it, as I suspect most would. The fault lies with the people offering such ludicrous contracts.

  13. Too Funny! Much of the sub prime problem was in adjustable rate mortgages. No one informed the borrowers of the treacherous nature of interest rates on mortgage amortization. One borrower started out with a $200,000 loan at 6% which carried a month payment of $1288.60. When she paid her first payment $2000 went to interest and $288.60 went to principal. fast forward 3 years and her rate had risen to %12. Her payment was now $2106.44 with only $150 going toward principal. after 3 years of payments (about $46,000) she still owed more then $195,000. someone should have handed her a card that showed what the most her mortgage payment could rise to. and her ability to pay that amount should have been a major factor in granting or declining the loan. This is why I place the majority of blame on financial lenders rather than borrowers. having worked for a mortgage bank for 15 years I am really cynical.

    There has to be some degree of personal responsibility, though. If I take out an adjustable-rate mortgage at 5 percent, I’ve got to know that if the interest rate goes up, my payment is going up. And I’ve got to decide if I can take the heat if and when that happens. If you’re telling me that borrowers don’t understand that such a scenario could lie in their futures, then they shouldn’t be borrowing money.

  14. I’m an MBA, and economic observer, and have a pretty good grasp on what actually happened. I don’t really see why people are so bent about Executive Pay, as these don’t really relate much to the current crunch. Yes, it’s fun for the 99% of us to bitch about the top 1%, and the 99.9% of us to bitch about the super rich in all endeavors, but we’re not talking the real problems when we do that.

    As you note, politicians wanted higher home ownership. Why? I’m not entirely clear, but that’s politicians for you. Programs with murky goals (Q.V. Iraq). But, as you note, that pushed banks to tailor financial vehicles that would work for people with murky credit, who would probably have been better off renting in the first place. Our politicians were pushing this agenda in an era of insanely inflationary home prices, fueled in part by speculation and in part by the wealth boom of the 90’s. And in part by the government, pushing more people to become home owners.

    Now, a lot of these people should have known better. A lot of these banks should have kept their due diligence strong. And the use of mortgage brokers seems almost designed to create problems, given the incentives at work (well summarized by the Long Johns in the video). Think about this: You get paid based on how many mortgages close. Not how many get paid off, but by how many close. Given a marginal loan prospect, will you a) give them a marginal rating or b) push them hard, because you get paid for their acceptance. Additionally, given a marginal loan prospect will you a) explain the loan and commitments associated with it in full to the borrower or b) be smiley and push them to sign. You get the picture. The incentives in the profession are broken to a spectacular degree.

    I want to touch on our Peerless Leader’s take on the action here. The solution proposed is that the Government is going to buy $700B worth of bad loans from financial institutions. It’s then going to sit out the “crisis” mentality and wait for things to calm down, and then it will start to sell them off, at a profit, netting the taxpayers a win. I might be missing something in the plan, but at what point do loans that aren’t likely to be repaid become good investments that people will want to buy, with their eyes opened to what they’re buying? For smart people (generally, people with a lot of money have a wee bit of savvy about how to play with it… MLB owners are obviously exempted), this happens between the pigs’ first airshow and the Winter Olympics being held in Hell. These loans, most of them, are ALWAYS going to suck. We are going to be stuck with a $700B bailout, not a buyoff and investment. I don’t think it’s wrong to be honest about this. Because it will probably work out for the better in the short term, anyway. Important for the government to keep our markets functioning and our currency viable. But to suggest it’s going to cost nothing, and even return a positive, is just lying to you.

    The other thing I want to expand on here is the role of housing speculators. You have all heard tales of people flipping houses for fun and profit. There are infomercials that sell you tricks on how to do it. There are TV shows that tell you how to flip it for the highest value. Hell, HGTV is basically a 24 hour video instruction manual on speculation in housing. And you know what the really great part of speculation is? That you can use exotic mortgages, like an interest only, balloon payment, to maximize your profit. This provided the banks with more market for these exotic mortgages, which the brokers turned around and sold as if they were as normal as any 30 fixed. But back to speculation. What does speculation in a market do? It decreases supply while increasing demand, if all other things remain equal. Now, I don’t think it’s the same as currency speculation, where a consortium of very wealthy folks can move the market, but consider the breadth of housing speculation, which in turn, drives more speculation, until the normal demand can’t play anymore. But, when the government is pushing low income people into homes and people with investment cash are upgrading houses to extract economic rents, you have supply roughly flat, maybe a little increased, and you have demand spiking. Classic economics suggests prices will rise very high, indeed. And, lo, they did.

    I’m not suggesting you curb speculation. I’m not suggesting you curb exotic mortgages. One part of a large fix to underlying market problems would be to fix the incentives of Mortgage Brokers (move payment focus from close to payment over time). Another is to fix the relationship between banks and brokers, such that brokers cannot sell mortgages without a bank doing something like due diligence. This is in the bank’s interest anyway. Another part is to have politicians who are honest (I know) about the American Dream. It may be to own a house in the suburbs and have a college degree, or even a post grad, but these things do not make economic sense for a large segment of people. And leaders who urge people to make intelligent decisions for their own benefit might not be the whole of the solution, but I think it must be part.

    Well said, Max. I pretty much agree down the line. I especially agree about excess executive compensation, which has become a smoke screen laid down by the politicians to cover their own culpability in the situation. Since most people don’t make the obscene salaries many top execs do, it’s easy to hold them up to blame for a situation that wasn’t really of their creation.

    I think a better solution to the problem is to ease the credit requirements and let a lot of these people who are getting squeezed refinance with yet another exotic mortgage, but at a slightly higher rate. It’s pointless to lower interest rates if no one can get a loan, which is the situation now. Once again politicians refusing to accept any blame in this situation aimed their righteous indignation at the mortgage brokers, who now are going broke themselves right and left. And our friends in Washington have tightened the restrictions (the classic closing the gate after the horse has escaped maneuver), making loans impossible to get by anyone who doesn’t have stellar credit. If these restrictions were loosened, most of these struggling mortgagees would refinance, and most would probably end up paying their loans. Some never will, but they won’t now either, so what’s the loss? I would rather see honest people given a break than a $700B bailout of the financial institutions.

    Cheers–

    MRE

  15. The key issue I see behind the current financial meltdown is that North Americans are addicted to credit. Consumers are renting money to chase the American (and Canadian) dream, a dream which most can not afford. It was either Paulson or Berneke who recently said words to the effect that “credit is the mother’s milk of our economy”. When the flow of credit stops, the economy grinds to a halt.

    I am old enough to have grown up before the days of consumer credit and the passport to the land of debt, Visa, Mastercard and other credit card schemes. When I was a teenager I saved up cash to buy my first car and pretty much anything else I wanted. In those days one could not get a bank loan for a car or any major purchase without a lot of collateral to secure it. When credit cards and credit financed purchasing became mainstream a lot of those in my generation already had healthy savings accounts. We stuck our big toe in monthly credit card interest payments a few times and didn’t like the experience. I use credit cards. But I always pay the balance off every month.

    The generations that came after mine were born into a world where credit cards are used for everything. Today, debt has become a retail product that is packaged, marketed and sold like any other commodity. Shopping has become an occupation. Before kids are even out of high school they often have a credit card with a limit of several thousand dollars. Financial institutions not only made it easy to get credit cards with a high limit, they kept selling the idea that we can “have it all with the click of a card” and that we deserve to have it all. Most people don’t even question the insane credit card interest they are being charged for making minimal monthly payments.

    We are being marketed to on every front to indulge in debt. As Max Harris pointed out, HGTV offers 24/7 advice on how to buy homes with zero down and then flip them for huge profits. HGTV and similar home improvement channels also feature a slew of home renovation shows backed by retailers like Home Depot that have sold the perception that homes today, even brand new ones, are renovations in progress.

    Those who got themselves way over their heads in debt have to shoulder some of the blame for our current situation. But consumers did not create the sub prime mortgage schemes that lulled those with insufficient financial resources into buying homes they could not afford. The most disturbing aspect of the current financial meltdown is that the average person is so leveraged in debt that the credit engine has to be restarted in order to get the economy moving again. Just like he did after 9/11 we can expect Bush to urge people to “go to the Mall”. Except this time he will probably add ” and don’t forget to take your credit cards with you”.

    When one is ‘lulled’ in to doing something stupid, who is at fault, the lulled or the luller? I would submit that the lulled are more at fault than the luller. I suppose those who long for a nanny-state kind of society would tend to place the blame on the luller instead of the lulled, but I wouldn’t really care to live in such a society. I would much prefer to live in a society based on personal responsibility. I don’t want the government watching over my nutrition and telling me what to eat, and I don’t want it to make sure that I don’t get in debt over my head. I’ve got to take some responsibility myself.

  16. “I’m not saying that it was solely a political problem, just that politics played a large role in it. It is true that entities bought these packaged loans and others insured them and are now paying the price. I don’t see why it is incumbent upon us, the taxpayers, to bail them out.”

    I think that this crisis was brought on by a sort of “perfect storm”, politically and otherwise. It is rare for the left and right to be in complete agreement, but that was the case on mortgages (even though each side had its own very different motivations.) The lack of regulation and oversight (wanted by the right) and the easier path to homeownership (wanted by the left) were bad enough on their own, but deadly in combination.

    One thing that must return is accountability at the lending level. The ability to make a mortage loan and then sell it meant that lenders were no longer held accountable for the quality of their loans. I think it would likely be a huge mistake to stop the sale of mortgages, but lenders must not be allowed to make bad loans and then dump them (and their risk).

    While I do not believe that borrowers who took on foolishly risky loans deserve a free pass, I don’t think lenders do, either. Is the massive amount of misleading fine print associated with the riskier types of loans really a necessary part of the process? It goes back to accountability – how is it that some people with subprime mortgages would have qualified for prime mortgages? Perhaps because they were steered that way by an unscrupulous broker?

    It is strange that the Left and the Right are mostly in agreement about the situation. I believe that has come to pass because both are united against a common enemy: the notion that they may not be re-elected if the economy blows up.

    As near as I can figure, the Democrats were (to use a legal term) the proximate cause of the situation. The Democrats were the main pushers for the idea that lower-income and no-income people should be able to own homes. The Republicans tried to object but caved when they were beaten back by accusations that they were indulging in meanness. The Clinton administration made the situation worse by creating even more loopholes for people who were uncreditworthy to get home loans. As usual, the Republicans didn’t hold up their end of what the two-party system is supposed to do, which is to not let the other side run out of control. Once Fannie and Freddie got into the act, the Democrats pushed to let them be – the Republicans tried to exert some oversight in 2005, but were beaten back. Now the Democrats deny any culpability and the Republicans are too worried about the election to point any fingers. And it’s simply politics as usual.

  17. Thanks for your considered reply (my post at 3.21)
    Events are a little more complicated than how things have been portrayed over here in the UK.

    Have to say I find the riches enjoyed by some celebs/sports people/execs to be obscene, but i guess that’s market forces for you, but certainly don’t have any solutions, the more government regulates, the more it messes up.

    How true, how true. But that’s a lesson that’s always lost on those screaming for more regulation.

  18. I have to wonder if low-carb is the answer to this problem too. If people quit pumping their lifeblood into Big Pharma (via diabetes, heart disease, autoimmune disorders, cancer and all the other problems caused by bad diet) they’d have more money to pay off those mortgages.

    I hadn’t thought of that. Good idea. Let’s start a movement.

  19. I was the first to rail against the “fat cats” here, so let me elaborate (especially in light of Max Harris’s helpful explanation). Yelling about CEO compensation is a lot like jumping around and swearing a blue streak when you hit your thumb with a hammer. It isn’t that you really believe that the jumping and swearing will help or that you think your previous lack of profanity caused the pain you are in. It is just that jumping around and yelling is all you can think of to do for a couple of minutes. It is the flight or fight response. There is no place for most of us to run and nothing tangible to hit, so we jump up and down can call people names for a few minutes.

  20. Dr. Mike, thanks for the link. The Brits are the best at being factual and highly sarcastic at the same time. Priceless. I enjoyed it immensely!

  21. I also think the poster above has it right about “the perfect storm” hitting us. Sort of like trying to combine the high fat intake of a low carb diet with the high carb intake of a low fat diet. (How’s that for changing the subject back!)

  22. http://www.youtube.com/watch?v=vLUbb2DUYGk

    George W Bush on why old-fashioned stodgy concepts like “money down” had to go. “Everyone should own their home”. Heh.

    Of course, the Democrats were behind him every step of the way. I guess that’s what they call “bipartisanship”.

    Nice video. I hadn’t seen it. In fairness, here is the original video that inspired the one you put up.

    http://www.youtube.com/watch?v=2ewJdT_iHxU

    (Note: If you click this link and find that the video has been removed, search using the terms ‘burning down the house.’ The person who made the video used music for the background that requires licensing. As soon as a new version of the video gets posted, the various music companies get it removed. But I’ve always been able to find another.)

    George Bush is the embodiment of the old saying that the shortest route to ruin is to try to please everyone. He never met a spending bill he didn’t like and he never met a nation he didn’t want to war with. In my opinion, he is the worst of the Democrats and the Republicans all rolled into one man, who, unfortunately, has had a ton of power.

  23. Excellent comments are made above from the lender, borrower, and political points of view. From the investor viewpoint, they STILL don’t get it. Today my own excellent broker as well as the buzz on the ‘net claim we’re all hoping/dreaming that the gov’t will come up with a rescue plan and that’s why there is a rebound rally today. WRONG! I believe today’s optimism is based on the hope that there will be no plan.

    I suspect you’re correct.

  24. The thing is, for any populist style candidate, rallying the US of the 99.9% against the them of the .1% is easy money. Nearly everyone who doesn’t make CEO/Entertainer/Athlete/Investment Banker bank thinks they are overpaid. And maybe they are.

    A comment above that struck me was about credit’s evil influence. Consider the growth of prices in an environment with credit. Credit is clearly inflationary. And inflation is a key engine of growth.

    Question: How do you grow an economy where the population is basically flat?
    Answer: Charge higher prices for the same things.
    Follow up: How will they afford these higher prices?
    Answer: With credit! And with income growth, due to larger pricing on the things they work on.
    Closing question: Does it stop?
    Answer: Only when you change the rules of the game. Time + Credit = higher prices. Always.

    Here’s a nice, non-regulatory solution. Don’t worry about the rates. Let the banks be skittish about lending for a bit. Let people default on their mortgages and try to get bankruptcy protection under the leaner, meaner, Bush Financial Doctrine. This will hurt. It will hurt very bad. It will be incredibly painful in the short term. And then, miraculously, banks will have money, and they will have shareholder expectations, and they will lend again to whatever standard makes them money. Some houses will sit empty for now, but people will buy them more responsibly in the long term. Credit use will recede and we might even see some normalization of prices. This might suck for the growth measures of the economy, but do you care about the macro economy or the local economy? Do you care about the Dollar vs. the Yuen or your ability to fly somewhere and buy stuff? Do you care about national trade deficits or personal trade deficits? Generally speaking, you only feel about as bad about the economy as things are going for you and as your newscaster tells you to feel. Less TV news tends to make you feel better about the economy. Or at least more even keeled.

    In the highest of ironies, at the bottom of this, the ads are:
    Become a Homeowner Now (don’t let bad credit stop you!)
    Subprime Auto Lenders (Bad Credit, No Credit? we can help…)
    Subprime Mortgage (1 Form, 25 Questions, 4 free quotes, refi…)
    Mortgage Company Quotes (get refi quotes from top…)

    Chance is opportunity and setbacks create more opportunity. This is fun.

    Max–

    I’m surprised. You’ve got your progression out of order.

    Question: How do you grow an economy where the population is basically flat?
    Answer: Charge higher prices for the same things.
    Follow up: How will they afford these higher prices?
    Answer: With credit!

    One can’t simply charge higher prices, at least not in a competitive market. Prices go up when the demand outstrips the supply. Or, another way of saying it, when more dollars are chasing the same number of goods. If one makes obtaining credit easier, then more dollars are available because credit is just like money.

    I would set it up like this:

    Question:How do you grow an economy where the population is basically flat?
    Answer: Make credit easy to get, which will increase the number of dollars in circulation. More dollars will drive prices up. Etc., etc., etc.

    Cheers–

    MRE

  25. Hi Doc,
    Off subject but came across an interesting study:
    http://www.vrp.com/articles.aspx?utm_content=article2456&utm_source=bn20080930&utm_campaign=bn&utm_medium=email&ProdID=2456
    My question is, are you happy with the curcumin you have been using in combo with krill and have you noticed results above what you may have experienced with regular stand. 95% curcumin? I don’t like to ask this here but the information of choosing a good product that is absorbed and does all those wonderful things we read about in the literature is usually provided by the manuf. It’s good to have feedback from those who know their bodies enough to notice a difference in products.

    I’m generally not depressed, so I haven’t noticed any changes in my mood. I do like the curcumin supplement I’ve been taking.

  26. “As near as I can figure, the Democrats were (to use a legal term) the proximate cause of the situation. The Democrats were the main pushers for the idea that lower-income and no-income people should be able to own homes.”

    I think you’re casting too much relative blame on the Democrats, and the borrowers.

    1. You loan me $200,000 without figuring out whether or not I can pay you back. (In fact, you probably don’t even care all that much because you can make money either way).
    2. I take the money, even though I know (or should know) that I will eventually not be able to handle the payments. (In fact, the only reason I can even consider accepting the loan is the low teaser rate you offered me, something that any due diligence on your part would make clear).
    3. You sell the loan to a company that buys these kind of loans by the thousand and repackages them into investment products.
    4. Investors buy into these products in a huge way.
    5. Other companies wrote coverage to insure the owners of these securites.

    Sure, the Democrats had a hand in pushing home ownership and a hand in securitizing bad loans, but did they have a hand in the complete absence of due diligence on the part of lenders, investors, and insurers?

    I didn’t say that the Democrats were the main cause of it, I said that they were the proximate cause. There is a difference. If the whole shebang hadn’t been kicked off by the Dems, it wouldn’t have ever happened.

    Another example.

    A guy brings a caged lion into a town. The cage is totally secure with thick steel bars, chains wrapped around it, and multiple locks. A bunch of kids get a blow torch and cut through the chains, then they cut through the bars, and the lion gets loose and eats one of the kids. Who is at fault? The kids obviously let the lion out and would bear some blame, but the proximate cause is that the guy brought the lion into town in the first place. Had he never brought the lion to town, the kids wouldn’t have been tempted, and the whole affair would never had occurred.

    It’s the same with the Democrats and the current meltdown. They are the proximate cause.

  27. On one of the talk shows last night someone said the gov’t should, instead of bailing out the corporations, give $1,000,000 to every citizen and they could pay their mortgage and spend some money and get the economy running again. There has to be something wrong with that but I can’t see what.

    The bailout will supposedly cost $900B. Giving every adult citizen $1M would end up costing about $200 trillion, a substantial difference. If the gov’t were to distribute the $900B amongst the adult citizenry it would come to about $300 per head.

  28. “It’s the same with the Democrats and the current meltdown. They are the proximate cause.”

    I would say the ability of a lender to issue a mortgage and then sell it (thereby removing his financial incentive to only loan money to those who can pay) is the caged lion in your example. And the Democrats and investors both are the kids with the blowtorch.

    If there had been some mechanism by which lenders were held accountable for bad loans, this mess couldn’t have happened.

    The lending institutions were forced by the politicians to make substandard loans in an effort to ensure that anyone who wanted home ownership could get it whether able to afford it or not. The politicians are the ones who brought the caged lion to town; the institutions who bought the large packages of these substandard notes are the kids with the blowtorches.

    I guess a more accurate example would be that a man with a gun (the government) forced the man with the lion to leave it caged in town. In that case, the proximate cause would be the man with the gun.

  29. When we bought our (small) house in 2001, we had bankers talk up those adjustable mortgages, explaining how we could buy a bigger house for the same initial mortgage payment. Since I’m 1) good at math and 2) not an imbecile, I went with a standard fixed mortgage instead of hoping and praying that my income would somehow double by the time the higher rates kicked in.

    My reward for being fiscally responsible is that I now get to watch my tax dollars help bail out people who bought bigger homes than I did. (And I’m just talking about the earlier homeowner-bailout bill, never mind the monstrosity they want to pass now.)

    Is this a great country, or what?

    Yeah, it’s a great deal for all.

  30. 1. $900 Billion/300 Million Citizens = $3,000/head, not $300
    2. In the lion cage example, I believe the kid’s break-in is the proximate cause.

    You’re right. I missed a decimal point.
    You’re wrong about the proximate cause. It’s the guy who brought the lion to town.

  31. Nonegiven : they’d pay their mortgage all right, but the value of the USD would plummet instantly. All financial instruments valued in dollars would be worth nothing (including everyone’s pension plan, 401K and stocks) and the economy would crumble under triple digits inflation. We Canadians and foreigners (especially Chinese) would buy your entire country’s assets and own you as slaves for the rest of your lives.

    🙂

  32. Hi Dr. Mike–great post and discussion. I called my congresscritter and urged him to vote against the bailout (he did so, bless him). I am against any sort of rescue or bailout. For once, I am proud that a majority of reps refused to drink the Kool Aid.

    1. It is fundamentally unfair and would be the largest heist in the history of the world.

    2. Where are we going to find a trillion dollars? (Don’t believe the $700B figure–government programs ALWAYS cost more than their proponents say they will.) Either we increase the deficit further (which is unacceptable, especially when we get hit with the unfunded liabilities of Social Security and Medicare coverage for all the baby boomers set to retire in the next decade or so), we just print more money (hello, inflation!) or we tax each man, woman, and child in the U.S. an extra $3000.

    3. There is no assurance this will work. What if we jump off the debt cliff and the economy collapses anyway?

    4. The big factor in this downward spiral (aside from governmental incompetence and private-sector malfeasance) is artificially inflated housing prices. For years, housing prices have headed toward the stratosphere, driven by ever-increasing demand, which in turn was driven by increasing availability of bizarre financing schemes, which made more and more people eiligible to buy homes they really couldn’t afford. More and more demand and a fixed supply equals higher prices. Now, in many areas, the average person (or even many with an above-average income) simply cannot afford to buy a home with a fixed-rate mortgage. Bailing out homeowners who really could not afford their homes in the first place is unfair to responsible renters who are saving to buy a home they CAN afford, because it props up artificially high housing prices. Housing prices need to keep falling and it escapes me why everyone should be a homeowner. There is no shame in renting–if someone can pay an interest-only mortgage they can afford rent on an apartment.

    All valid arguments. I hope the congress can man up to the task. But somehow I doubt it.

  33. “When one is ‘lulled’ in to doing something stupid, who is at fault, the lulled or the luller? I would submit that the lulled are more at fault than the luller.”

    I completely agree with you. The problem is that a lot of people are apparently willing to be lulled. When the sub prime mortgages first appeared it was apparent to me at least that the outcome would be disastrous. In the absence of some miraculous event what happened was completely predictable. Yet even today I still see schemes being advertised for homes with special promotional interest rates well below prime for the first 6 or 12 months after which they go into space orbit or financing schemes where one does not pay until 2020. Right! Read the fine print and see what happens if you are one second late with a payment.

    The hope is that the lulled will benefit from the experience only if they are allowed to suffer from it. If they are bailed out, that sets expectations that such a bailout will happen again. And, consequently, the lulled never learn from their experience. They are like the people who continually build houses in flood plains and on areas of the beach that are hammered with storms and expect government insurance (read: you and I) to bail them out when the inevitable happens. Then they rebuild and wait for the next disaster. I can assure you that if these folks lost the value of their homes just one time due to a storm or a flood, they wouldn’t rebuild in the same place. Once burned, twice shy. But if never really burned, never really shy. I think these people should be made to pay for their folly – I don’t think the rest of us should pay for their folly because odds are we’ll be paying for it again down the road if these folks never learn.

  34. ” I think these people should be made to pay for their folly – I don’t think the rest of us should pay for their folly because odds are we’ll be paying for it again down the road if these folks never learn.”

    You don’t think we’re ALL going to pay, one way or another? Everyone who uses credit, responsibly or not, will be hurt to some degree.

  35. Good discussion.

    If it’s been said and I missed it, I apologize, but Thomas Sowell made a good point about the “golden parachute” stuff:

    ” What really sets some people off is the fact that a CEO who has mismanaged some corporation into losing billions of dollars is rewarded with a severance package worth millions.

    Think about it. If the CEO’s decisions are costing the company billions, it is a bargain to get him out the door immediately for millions, rather than having his departure delayed by either internal struggles or battles in the courts.”

    Sowell is right, I suppose. I guess it’s one of those things where you’ve just got to hold your nose and do it.

    Years ago in our clinic in Little Rock we found that one of our nurses had been stealing drugs from our locked drug cabinet. The day before we discovered the theft, she had announced that she was pregnant. Upon the discovery, we confronted her with the evidence, she admitted to it, and we fired her. A few days later we got a letter from a labor attorney telling us that our drug-stealing nurse was planning on suing us for terminating her because she was pregnant, and that she would not sue us if we would give her $10,000 severance pay. As you might imagine, I went ballistic. I told our own attorney that I would rather pay $20,000 fighting it than to give this woman a nickel. He pointed out to me that a) it would cost a whole lot more than $20,000 to fight it even if we won (which wasn’t a guarantee given the wrong jury, etc.) and b) that we could probably settle it for $5,000. He said that we should simply consider the $5,000 as a cost of doing business. So, we held our noses and paid.

    When you have a contract with a big-time exec, it usually gives you an out if the exec commits fraud or does something unlawful but doesn’t usually give you an out for sheer incompetence. So if the contract is for 5 years and after 2 you realize the exec is costing the company a fortune, it’s best to pay him/her off and be done with it. God only knows what the cost would be to keep him/her around another 3 years. The thing that I can’t understand is why these people keep getting rehired after such horrible performance, but they do. And the cycle begins again.

    It’s like NFL coaches. There are a bunch who are perennial losers. They coach a team, the team doesn’t do squat, the coach gets fired. Then he gets hired by another team and the cycle starts anew.

  36. Dr. Eades:
    “The thing that I can’t understand is why these people keep getting rehired after such horrible performance, but they do. And the cycle begins again.

    It’s like NFL coaches. There are a bunch who are perennial losers. They coach a team, the team doesn’t do squat, the coach gets fired. Then he gets hired by another team and the cycle starts anew. ”

    Same reason people still keep electing these bozos in Congress (both R and D) and still listen to Jimmy Carter. I don’t know what that reason is…unless it’s that they are familiar and it’s easy.

    Can you believe how they’re patting themselves on the back today for “saving” us?

    It truly beggars belief.