Is it really fair to blame one man for
destroying the US economy?
Probably not. But
Alan Greenspan is still tops on our list. After all, Greenspan "presided
over the greatest expansion of speculative finance in history, including a
trillion-dollar hedge fund industry, bloated Wall Street-firm balance sheets
approaching $2 trillion, and a global derivatives market with notional values
surpassing an unfathomable $220 trillion." (Henry Liu, "Why the
Subprime Bust will Spread," Asia Times) Greenspan is also responsible for
slashing the real Fed Funds Rate so that it was negative for 31 months from
2002 to 2005. That decision flooded the housing market with trillions of
dollars in low interest credit, creating the largest equity bubble in history.
Now that that bubble is crashing, Greenspan has hit the road. He now spends his
time leap-frogging from city to city, hawking his revisionist memoirs of how he
steered the ship of state through troubled waters while fending off
protectionist liberals. Look for it in the Fiction section of your local
Still, can we really
blame "Maestro" for what appears to have been a spontaneous flurry of
"free market" speculation in real estate?
To a large extent,
yes. Apart from Greenspan's tacit endorsement of all the dubious loans
(subprime, ARMs etc) which flourished during his reign, and despite his brusque
rejection of the Fed's role as regulator, the Federal Reserve's own documents
("House Prices and Monetary Policy: A Cross-Country Study") indicate
that housing was "specifically targeted," acknowledging that it would
serve as "a key channel of monetary policy transmission." This is not
even particularly controversial any more. In fact, we can see that this same
scam has been used in England, Spain and Ireland -- all now suffering the ill
effects of massive real estate inflation. Low interest rates continue to be the
most efficient way of stealthily shifting wealth from one class to another,
while decimating the foundations of a healthy economy.
Bankers fully understand the effects of cheap credit on the
economy. It is branded on their DNA.
California housing falls off a cliff
We are now beginning
to see the first signs that the listless housing bubble has sprung a leak and
is careening towards earth. Last week's news from Southern California confirms
that home sales have plummeted a whopping 48.5 percent from the previous year.
This represents the biggest decline in home sales since the industry began
keeping records more than 20 years ago. Sales are at a standstill and builders
and homeowners have begun slashing prices in desperation. (See YouTube: "Central California Housing
The news is only
slightly better in the Bay Area where DataQuick reports that "Bay Area
home sales plummet amid mortgage woes":
Area home sales sank to their lowest level in more than two decades in
September, the result of a continuing market slowdown and borrowers' increased
difficulties in obtaining "jumbo" mortgages
A total of 5,014 new and resale houses
and condos were sold in the nine-county Bay Area in September. That was down
31.3 percent from 7,299 in August, and down 40.1 percent from 8,374 for
September a year ago.
40.1 percent year over year. That is the definition of a
"Foreclosure activity is at record levels."
September sales figures for the rest of the country are not
yet available, but what is taking place in California, is what we anticipated
after the stock market "froze over" on August 16. Most people don't
understand that the market nearly crashed on that day and that the tremors from
that cataclysm changed the way the banks do business. Many of the loans which
were available just months ago (subprime, piggyback, ARMs, "no doc,"
Alt-A, reverse amortization, etc.) are either much harder to get or have been
discontinued altogether. Additionally, the banks are no longer able to bundle
loans into securities and sell them to investors. In fact, the future of
"securitization" of mortgage debt is very much in doubt now. An
article in the Financial Times shows how this process has slowed to a trickle:
"Only $9.9 billion of home equity loan securitizations have come to market
since July 1 -- A 95 PERCENT DECLINE FROM THE $200.9 BILLION IN THE FIRST HALF
OF THIS YEAR AND A ROUGHLY 92 PERCENT DECREASE FROM THE SAME PERIOD LAST
Also -- and perhaps
most importantly -- many potential buyers are now finding that they no longer
meet the stricter standards the banks are using to determine credit worthiness.
This is especially true for jumbo loans, that is, any home loan that exceeds
$417,000. The banks are getting increasing skeptical (some believe they are
hoarding capital to cover bad bets on mortgage-backed derivatives) in
determining who is a qualified mortgage applicant. Understandably, this has
thrown a wrench in sales figures and slashed the number of September closings
In other words, the
credit meltdown on Aug 16 changed the basic dynamics of home mortgage lending.
Decreasing demand and mushrooming inventory are only part of a much larger
problem; the financing mechanism has completely changed. The banks don't want
to lend money. And, when banks don't lend money, bad things happen. The economy
goes into freefall. Despite the valiant efforts of the Plunge Protection Team
in engineering a late-day turnaround to the August rout, the damage is done.
Tighter lending will put additional downward pressure on a housing market that
is already in distress, speeding up an unavoidable recession. The economic
storm clouds are already visible on the horizon.
Henry Paulson has finally admitted that the slumping housing market is now the
"most significant risk to the economy." Fed chairman Ben Bernanke
agrees and adds that he believes that housing would be a "significant
drag" on GDP. The troubles at the banks and the news from California have
put the "fear of God" in both men. But there's little they can do.
Millions of people are "in over their heads" living in homes they
clearly can't afford. They'll be forced to move in the next year or so.
Foreclosures will soar. That can't be avoided. Also, the industry has a
10-month backlog of existing homes that must be reduced before new sales have
any chance of rebounding. That takes time. Construction and
construction-related industries will suffer substantial losses.
The problems facing the banks are much more serious than
anyone cares to openly discuss. The banking system is overextended and
undercapitalized. The Fed has provided more than $400 billion in repos since
the August meltdown, and yet, the troubles persist. The Treasury Dept. has
joined with Citigroup, Bank of America and JP Morgan Chase in an attempt to
repackage bad debts and sell them to wary investors via a "super
conduit" mega fund. The desperation is palpable and these latest
shenanigans are only adding to rising stock market jitters.
There's a myth that the Fed chief can wave a magic wand and
make things better. But that is not the case. Bernanke's decision to cut the
Fed's Fund Rate last month did not affect long-term rates and, therefore, did
not make it cheaper to buy (or refinance) a home. The rate-cut was really just
a gift to the banks that are currently buried under $500 billion in
mortgage-backed debt and CDO sludge. The increase in liquidity hasn't made
these toxic securities any more sellable or solvent. Nor has it increased the
banks' willingness to provide new home financing to mortgage applicants. That
process has slowed to a crawl. All the Fed's repos have done is buy more time
for the banks while they try to wriggle out of reporting their true losses.
The banks serve as a key conduit for the transferal of
credit to consumers. That conduit has turned into a chokepoint due to defaults
in the mortgage industry and the banks own humongous debt-load. The Fed cannot
get money to the people who need it and who can keep the economy (which is 70
percent dependent on consumer spending) growing. This is a structural problem
and it cannot be resolved by merely cutting rates.
We've already begun to see signs of a slowdown in consumer
spending at Target, Lowe's and Wal-Mart. If that deceleration continues, the
economy will slip quickly into recession.
American consumers have withdrawn over $9 trillion from
their home equity in the last seven years. That spending-spree has kept the
economy whirring along at a healthy clip. Now that housing prices have
stabilized and, in many cases, gone down that easy money is no longer
available, setting the stage for shrinking economic growth, slower home sales,
and declining demand. Deflation is the Fed's worst nightmare and will be fought
with every weapon in their arsenal.
Regrettably, Bernanke does not have the tools to fix this
problem and he is likely to destroy the currency if he keeps cutting rates. The
recent cuts have already sent oil and gold to new highs while the dollar
continues to nosedive. (The euro stands at $1.42 per dollar, up 63 percent
since Bush took office) The weak dollar and the persistent credit problems in
the markets, has sent foreign investors scampering for the exits. August was
the biggest month on record for the withdrawal of foreign capital from US securities
and Treasuries -- $163 billion in capital flight. (Japan and China led the
way.) Confidence in US markets, leadership and integrity has never been lower.
Investors are voting with their feet. They've had enough.
With capital fleeing the
country at the present pace, the US will not be able to maintain its $800
billion current account deficit, which means that prices will rise, the dollar
will fall, and consumer spending will dry up. No amount of financial tinkering
at the Federal Reserve will make a damn bit of difference. Barring a dramatic
change in economic policy"which seems unlikely -- we appear to be
quick-stepping towards a system-wide, market-busting, breakdown.
The mess that Greenspan made
The ruinous effects of Greenspan's housing bubble can't be
fully appreciated unless one spends a bit of time studying some of the charts
and graphs that are now available. These graphs are the best way to dispel any
lingering suspicion that the housing bubble may be some left-wing conspiracy
theory. It's not, and these links should provide ample evidence to the
The first graph is the ARM (adjustable rate mortgages) reset
schedule, totaling hundreds of billions of dollars in the next two years. The
next two are the interest only and negative amortization share of total
purchase mortgage originations 2000-2006. Keep in mind, when studying the ARM
reset graph that a "study commissioned by the AFL-CIO shows that nearly
half of homeowners with ARMs don't know how their loans will adjust, and
three-quarters don't know how much their payments will increase if the loan does
reset. 73 percent of homeowners with ARM's don't even know how much their
monthly payment will increase the next time the rate goes up." (Calculated
The unwinding of the
housing bubble is now beginning to show up in other areas of the economy. Credit
card debt has skyrocketed to 17 percent annually now that homeowners are no
longer able to tap into their vanishing home equity. Americans already owe over
$500 billion on their credit cards. Now that debt is increasing faster than
retail sales, which suggests that many people are so overextended they are
using their cards for basic necessities and medical expenses. Industry analysts
now expect an unprecedented wave of credit card defaults in the next six to 12
months. Unfortunately, for the tapped-out consumer, the credit card represents
his last access to an unsecured loan.
We can also expect
the downturn in housing to swell the unemployment lines. Oddly enough, while
home sales have declined 40 percent from their peak in 2005,
construction-related employment has only slipped 5 percent. That is really
astonishing. It could be that the BLS is fabricating the numbers using its
Birth-Death model, which magically produces millions of fictitious jobs. But we
know that construction has accounted for two out of every five new jobs in the
US for the last six years, so we are sure to see a significant rise in
unemployment as the bubble deflates. The financial and mortgage industries have
already experienced significant layoffs.
Similarly, we can
expect to see substantial correction in home prices. Housing prices typically
lag six months after sales peak and inventory rises. So far, prices have
dropped a mere 3.5 percent, whereas inventory is at historic highs and sales
have decreased 40 percent. It is impossible to know how low prices will go
(some experts like Robert Schiller predict 50 percent cuts in the hotter
markets), but the downward pressure on housing prices is bound to be enormous.
Growing unemployment, zero percent personal savings, rising foreclosures, the
weakening dollar, and the prevailing mood of gloominess (a recent poll showed
that a majority of Americans believe we are ALREADY in a recession) suggest
that the impending fall in home prices will be precipitous.
Deflationary downward spiral
There is a debate raging on the econo-blogs about whether
the country is headed towards hyperinflation or a deflationary cycle. The
argument for hyperinflation is compelling since the Fed has already shown that
it is prepared to savage the dollar in order to keep the economy running. As a
result, we've seen inflation is heating up at a pace not seen in over a decade,
despite the government's mendacious figures. In September, gasoline costs rose
4 percent, heating oil soared 9 percent, food jumped 5 percent, and dairy
products lurched ahead 7.5 percent. Everything is up except the greenback,
which appears to be in its death throes.
Still, there are signs that America's debt-fueled consumer
economy is on its last legs as shoppers and homeowners are increasingly forced
to accept that they have maxed-out nearly all of their available lines of
credit. They will have to curtail their spending and live within their means.
That means less growth, a continuing decline in housing, and a sharp fall in
equities prices. These are all the harbingers of deflation.
Treasury Secretary Paulson's new "Master Liquidity
Enhancement Conduit," (M-LEC) -- which allows the investment banks to
delay reporting their losses -- is particularly ominous in this regard, since
it was the Japanese banks' unwillingness to write-off their bad debts which
extended their deflationary recession for 15 years. Can the same thing happen
Probably. An interesting exchange took place last month
between the widely respected economic blogger, Mike Shedlock ("Mish's
Global Economic Trend Analysis") and economist Paul L. Kasriel. The
interview provides details of the Japanese crisis which offer some striking
similarities to our present predicament. I have transcribed an extended portion
of that discussion:
Paul L. Kasriel:
Japan experienced a deflation in recent years because the bursting of its
asset-price bubble in the early 1990s created huge losses in its banking
system. The Japanese banks had financed the asset-price bubble. When it burst,
the debtors could not keep current on their loans to the banks and therefore
were forced to turn back the collateral to the banks. The market value of the
collateral, of course, was less than the amount of the loans outstanding,
thereby inflicting huge losses of capital to the Japanese banks. With the
decline in bank capital, the Japanese banks could not extend new credit to the
private sector even though the Bank of Japan was offering credit to the banks
at very low nominal rates of interest.
Banks are an important transmission mechanism between the central bank and the
private economy. If the banks are unable or unwilling to extend the cheap
credit being offered to them by the central bank, then the economy grows very
slowly, if at all. This happened in the U.S. during the early 1930s.
U.S. banks currently hold record amounts of mortgage-related assets on their
books. If the housing market were to go into a deep recession resulting in
massive mortgage defaults, the U.S. banking system could sustain huge losses similar
to what the Japanese banks experienced in the 1990s. If this were to occur, the
Fed could cut interest rates to zero but it would have little positive effect
on economic activity or inflation.
Short of the Fed depositing newly-created money directly into private sector
accounts, I suspect that a deflation would occur under these circumstances.
Again, crippled banking systems tend to bring on deflations. And crippled
banking systems seem to result from the bursting of asset bubbles because of
the sharp decline in the value of the collateral backing bank loans.
Mish: What if Bernanke cuts interest rates to 1 percent?
Kasriel: In a sustained housing bust that causes banks to take a big hit to
their capital it simply will not matter. This is essentially what happened
recently in Japan and also in the US during the great depression.
Mish: Can you elaborate?
Kasriel: Most people are not aware of actions the Fed took during the Great
Depression. Bernanke claims that the Fed did not act strong enough during the
Great Depression. This is simply not true. The Fed slashed interest rates and
injected huge sums of base money but it did no good. More recently, Japan did
the same thing. It also did no good. If default rates get high enough, banks
will simply be unwilling to lend which will severely limit money and credit
Mish: How does inflation start and end?
Kasriel: Inflation starts with expansion of money and credit. Inflation ends
when the central bank is no longer able or willing to extend credit and/or when
consumers and businesses are no longer willing to borrow because further
expansion and /or speculation no longer makes any economic sense.
Mish: So when does it all end?
Kasriel: That is extremely difficult to project. If the current housing recession
were to turn into a housing depression, leading to massive mortgage defaults,
it could end. Alternatively, if there were a run on the dollar in the foreign
exchange market, price inflation could spike up and the Fed would have no
choice but to raise interest rates aggressively. Given the record leverage in
the U.S. economy, the rise in interest rates would prompt large-scale
bankruptcies. These are the two "checkmate" scenarios that come to
Well put. Thank you, Mish.
Mike Whitney lives in
Washington state. He
can be reached at email@example.com.