Mountains, Molehills and the Government
Do we need the government to step in and regulate the subprime mortgage market? Hell no, says Ken Fisher.
Today government is about punishing the successful 90% in order to assuage the hurt feelings of the bottom 10%.
TCS: Let's talk about the current status of the subprime mortgage market. Are you worried?
KEN FISHER: The only thing I fear about the subprime mortgage market is what politicians might do, because fundamentally everyone gets this backwards.
TCS: You don't see major long-term economic consequences?
KEN FISHER: I think intuitively everybody knows that in the long term, this is not a big deal for the economy and the stock market. I don't think it's big enough to matter.
TCS: So what is the problem?
KEN FISHER: There is a different issue that is hugely important that I don't think is widely recognized. Let me walk you through this.
First, you have to understand that a subprime mortgage, from its origination, is the offering of a mortgage to someone who otherwise wouldn't qualify to buy a home.
If you look at the history of subprime loans, they tend to average about a ten percent default rate. Now we're up around 14 percent. So all this brouhaha is about the increase from that historic ten percent default rate to today's rate of 14 percent.
But a ten percent default rate means that 90 percent of the people who got these loans ended up owning homes that they wouldn't otherwise have been able to buy. The question is: Do we want more people to have homes or do we want fewer people to have homes? My view is more people owning homes is moral and good. Fewer people owning homes is immoral and bad.
We should be encouraging subprime loans. Because it's the way these people get homes.
Today government is about punishing the successful 90% in order to assuage the hurt feelings of the bottom 10%.
posted by Anonymous at 10:51 AM
14 Comments:
I personally see very little reason to do anything at all, much less panic, regarding the subprime default issue. The markets seem to agree at this point.
... but it isn't fair.
It's certainly true that the junk lenders are not big enough for the economy to notice if they disappear.
This ain't your father's economy. Continental Illinois and Chrysler bailouts are passe. I doubt there is any sector that could conceivably fail that would be a big enough proportion of the total economy to damage the whole structure.
Financially speaking, that is. (Failure of power generation would be catastrophic, physically.)
However, the problem is that the subprime stuff is interleaved with better mortgages, and nobody can tell which bundles are fairly good and which are fairly bad.
This is a setup for a panic -- one of the glories of capitalism that the Chicago Schoolboys don't talk about (see Kindleberger for an adult view).
And the bundled securities sector is big enough to do damage if it goes south.
I happened to have lunch today with two extreme free market economists, and they're worried.
Harry,
The derivatives market is a whole issue in itself. I think the problem is that the investment marketplace can't trace the convoluted trail of interdependencies that these instruments introduce. I know that Warren Buffett stated several years ago that he tried to understand all the liabilities that were involved with the derivatives in the portfolio that one of his companies held, and he could not figure it out. The theory is that derivatives spread risks out so broadly that any failure in a specific market can be absorbed, but it also links so many parties and counterparties together that it can result in domino effects when one or more fail.
The sub-prime market itself isn't to blame as much as the monetary policy that let the latest boom-bust cycle occur.
Duck wrote: "I know that Warren Buffett stated several years ago that he tried to understand all the liabilities that were involved with the derivatives in the portfolio that one of his companies held, and he could not figure it out."
Was that right before or after he got hammered shorting the dollar via currency derivatives?
Derivatives aren't a problem. The vast majority of people who use them know what they're doing. The few who don't quickly lose their shirts and exit the game. Indeed, the subprime market is a good example. Some lenders got hammered, the Fed had to loosen up for a couple of weeks, and now the problem is dissipating. No big deal.
So all this brouhaha is about the increase from that historic ten percent default rate to today's rate of 14 percent.
What Ken Fisher doesn't mention is that "today's [default] rate of 14 percent" isn't where the default rate is going to peak, not by a long shot. For instance, the vast majority of subprime adjustable-rate mortgages outstanding will reset this year and next. So if 14% of subprime mortgages are failing now, what's going to happen when the payments on those loans begin to increase every six months ?
If we speculate that the default rate in subprime will end up being one third of all such loans, then was it still a good deal for society? Where's the tipping point?
Further, putting people in homes that they can't afford under normal circumstances isn't doing them any favors. They'd have ended up much better-off financially by staying renters.
Also, as Harry notes, the problem is by no means confined to subprime. Prime and so-called "Alt-A" are going to end up having abnormally-high default rates as well, since many of those loans were made based on absurd, bubblicious market-value appraisals, now defunct.
Therefore, for at least the next five years or so, there is a great risk that anyone who loses a job, gets divorced, or otherwise becomes unable to make their mortgage payment isn't going to be able to sell their home for enough to pay off the existing loan.
...now the problem is dissipating. No big deal.
Rather, the problem is just getting started, and the worst is yet to come. No housing boom-turned-bust bottoms out in eighteen months.
NOTE: LINK FIXED.
Ken Fisher himself says that "[if] the default rate soars all the way up to 20 percent, we'd still be better off."
Not presented is what he said about a default rate of 40%, if anything, and I'm assuming that he didn't go there.
"Rather, the problem is just getting started, and the worst is yet to come."
The only problem was the potential for panic, and that is dissipating.
Bubbles themselves are rarely a big deal. See Pop!: Why Bubbles Are Great For The Economy for more info.
Only because and if there is a lender of last resort. It the Chicago Schoolboys had their way, there wouldn't be and we'd be back to the good ol' days of mass unemployment.
See Kindleberger, 'Manias, Panics and Crashes.'
On your knees and thank Franklin D. Roosevelt
The only problem was the potential for panic, and that is dissipating.
Would you like to make a small wager on that ?
What would your measure of "panic" be?
You'd have to come up with a description of what you'd be willing to wager won't happen.
We could use GDP stats, employment figures, foreclosure stats, declines in home prices...
Whatever you like.
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Oroborous, see here for a proposal.
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