[Rhodes22-list] Economics - or the lack thereof

[Brad Haslett]

Robert,

Here's a trip down memory lane for you.  Yogi Berra said it best, "it's deja
vu all over again!"

Brad

--------------------
Relax, and Do Nothing *By* *John
Tamny*<http://www.realclearpolitics.com/articles/author/john_tamny/>

Calvin Coolidge once said, "If you see 10 troubles coming down the road, you
can be sure that nine will run into the ditch before they reach you." The
30th president's words are particularly prescient in light of hand-wringing
by our political class over subprime mortgages, our "problem" du jour.

Sen. Charles Schumer, New York Democrat has said, "There's going to be a
significant role for Congress" in working out the alleged subprime mess,
while Sen. Christopher Dodd, Connecticut Democrat, has suggested that
Congress should curb what he deems predatory lending. Mr. Dodd has also
spoken of finding ways to help "millions of families" facing foreclosure,
which, when translated, means Congress will seek to fleece millions of U.S.
taxpayers to bail out those who sought financing in the subprime market.
Given Congress' track record in dealing with past problems in the banking
sector, investors and taxpayers should hope any legislation is stalled in
committee. Indeed, the S&L debacle of the late 1980s should make even those
in Congress wary of wading into more banking legislation.

Nearly 30 years ago, the savings and loan (S&L) industry was on life
support. Amidst skyrocketing interest rates between 1979 and 1982, S&Ls lost
$4.6 billion in 1980, and $4.1 billion in 1981. By 1982, S&Ls had a negative
net worth of $100 billion. Rather than allow the industry to die a slow
death, Congress stepped in to save the day.

The slow death of the S&Ls began in the 1970s when interested rates
skyrocketed in response to the weak dollar. In previous decades, the S&L
sector was a prosaic one where its assets were long-term mortgages paying
higher rates, while its liabilities consisted of short-term, lower-rate
deposits. This worked well until short-term rates rose sharply. Unable due
to regulations to pay depositors more than 5-1/2 percent, S&Ls gradually
lost deposits to money-market funds paying well in excess of 51/2 percent,
while the falling dollar eroded the value of their fixed-rate mortgages.

Regulations and poor Fed policy surely hindered the S&L industry, still the
explosion of the mortgage-backed securities market and worldwide banking
competition rendered S&Ls obsolete.

But like most long-established industries in the U.S., the S&Ls had powerful
political benefactors interested in keeping them alive. Congress passed the
Depository Institutions Deregulation and Monetary Control Act of 1980, and
the Garn-St. Germain Depository Institutions Act of 1982 to keep them
afloat. Both acts served to privatize any deregulation successes, while
socializing the inevitable failures.

Whereas S&Ls were previously limited in terms of the interest rates they
could offer depositors, the aforementioned legislation removed all caps on
rates they could post to attract deposits. Capital requirements were reduced
from 5 percent to 3 percent, plus S&L loans were no longer limited to home
mortgages. To pay the high rates offered on deposits, S&Ls had the incentive
to make higher-risk loans and equity investments in areas beyond traditional
home mortgages, including commercial and construction loans. If the S&Ls had
been left to fend for themselves in this newly deregulated world, the new
legislation would have been fine.

The problem, as previously mentioned, was that Congress also chose to
socialize any failures. The Garn-St. Germain bill raised the level of
federal deposit insurance from $40,000 to $100,000. This created enormous
moral hazard in that depositors could place their funds at high rates of
interest with the S&Ls worry-free. And just the same, S&L executives could
be lax in their lending and investment standards with full knowledge that
U.S. taxpayers were on the hook if their investments soured.

Importantly, the weakest S&Ls had the greatest incentive to swing for the
fences in making loans, and this made it even more difficult for the healthy
S&Ls to compete. The rest, as they say, is history. More than 1,000 S&Ls
failed in the 1980s. The bloodbath continued into the 1990s; much of it on
the dime of U.S. taxpayers.

Returning to the existing subprime situation, according to a recent report
from Morgan Stanley, there are slightly more than $600 billion of subprime
mortgages outstanding. If there were defaults on half that (thought by many
to be the worst-case scenario), it would work out to 2 percent of the $15.7
trillion U.S. bond market. Considering how active foreign investors are in
U.S. debt, this number shrinks to 1 percent of the $33 trillion global
market. Further, $300 billion is only 1.3 percent of the U.S. housing
market, and constitutes only 0.5 percent of the $55.6 trillion net worth of
U.S. households. In short, $300 billion is pretty tiny in the big picture,
and something the markets can easily handle. And as this is public
information, stocks have already priced any presumed fallout.

Not yet priced is the governmental response to something it should best stay
out of. The Bush administration has joined the echo chamber in saying it
will vigorously prosecute any cases of predatory lending -- meaning future
homebuyers on the riskier end of the lending curve will find it tougher to
get financing in the future.

If the heads of failed subprime firms face prosecution, there will be an
even greater incentive for successful firms in the subprime space to exit
the industry. To the extent either lenders or borrowers are bailed out, U.S.
taxpayers will eventually have to pay for the inevitable carelessness that
government guarantees engender.

Still, as evidenced by the numbers involved, this is a very small problem.
To avoid making it a bigger one, Congress should let the subprime scare
slide into the ditch.
  *Page Printed from:
http://www.realclearpolitics.com/articles/2007/03/relax_and_do_nothing.html*at
March 24, 2007 - 08:29:05 AM CST


On 3/23/07, Robert Skinner <robert at squirrelhaven.com> wrote:
>
> Hank wrote:
> > How is this an issue of either political party?  It seems to me that
> this is
> > just a consequence of the free enterprise market.  Banks wanting to get
> more
> > business came up with innovative ways to provide home financing.  They
> were
> > taking a gamble that interest rates would stay low and folks could
> continue
> > to pay.  In some cases, it was a pretty dumb business decision on both
> the
> > bank's and the home buyer's part.  Now  they both will have to pay the
> > consequences.
>
> Hank, I wish you were right -- that they
> would have to pay the consequences.
>
> However, I suspect that those of us who
> are not overextended will be taxed (by
> inflation) to bail out the banks that
> can't collect.
>
> Seems that economic conservation is
> likely to be counterproductive.  But I
> still can't bring myself to spend what
> I don't have.
> --
> Robert Skinner  "Squirrel Haven"
> Gorham, Maine         04038-1331
> s/v "Little Dipper" & "Edith P."
> __________________________________________________
> Use Rhodes22-list at rhodes22.org, Help? www.rhodes22.org/list
>