It's a good thing Henry "Hank" Paulson wasn't
around in 1929 or we'd all be hawking apples on a street corner.
Paulson is currently on a losing-streak that would have been
the envy of Marvelous "Marv" Thorneberry and the '67 Mets. In the
last three months, he's put together three new programs to deal with the
subprime crisis that have fizzled out in a matter of weeks. First, he tried to
entice struggling investment banks to put their mortgage-backed bonds in a
Super SIV (structured investment vehicle) to see if it would help off-load
billions of dollars of down-graded junk onto unsuspecting investors.
That flopped. Then he brokered "Hope Now"
(1-888-995-HOPE) which was designed to help the banks and homeowners work out
the details for a rate freeze on mortgage resets. Paulson assured the public
that 500,000 homeowners would take advantage of the program, which would dramatically
reduce rate of foreclosures. So far, the Hope Now hotline has provided
counseling to just 36,000 borrowers. Representatives have suggested loan
workouts for fewer than 10,000 of them, a small fraction of borrowers in
need." [Earlier Subprime Rescue Falters; Wall Street Journal)] Only 10,000
homeowners; and Paulson promised 500,000? Another slight miscalculation.
This week, Paulson announced another new program,
"Project Lifeline," which targets homeowners who are delinquent 90
days or more on their mortgages.
Here's a rundown of how it works (thanks to Calculated
risk): "Project Lifeline involves servicers sending letters to borrowers
-- prime, Alt-A, or subprime, we're past pretense on that part -- who are very
seriously delinquent (90 days or three payments down or more). The letter says
that if the borrower contacts the servicer within ten days, agrees to homeowner
counseling, and provides sufficient financial documentation that the servicer
can consider a case-by-case, deep-analysis style modification of the mortgage
terms, the servicer will agree to put the foreclosure process on hold for 30
days while the workout is considered. If the borrower fails to respond to the
letter, foreclosure proceeds."
At the very best, the program just buys a little more time
for the homeowner to pick out a nice rental where he and is family can live
after the bank repos his home.
So far, all of Paulson's solutions have been nothing more
than "business-friendly" Band-Aids which fail to address the core
issues of rising foreclosures, falling home prices, skyrocketing inventory, and
Last week, at a press conference in Washington, Paulson made
this shocking admission in response to a reporter's question.
Reporter: "Sir, is the worst over, yet? Will 2008 have
Secretary of the Treasury Paulson: "In terms of
subprime and the resets, the worst isn't over. The worst is just beginning. . .
. There's close to 2 million adjustable rate mortgages where the rate is going
to be reset over the next couple of years. These loans are of a vintage where
there was the most lax underwriting. So, this is the biggest challenge and this
is why this is so important."
Paulson is right; it is important. So, why is he wasting
time with these bogus public relations gambits when he should be making serious
Paulson's so called "mortgage modifications" just
don't cut it. They're pointless. They just put off foreclosure until a later
date. The only real solution to the problem is renegotiating the mortgages with
the lenders so that people with negative equity have an incentive to continue
making their monthly payments. Otherwise, the number of walk aways will
mushroom and wreak havoc on the entire industry.
Last week's housing stats from California illustrate how
desperate the situation really is. DataQuick Information Systems said Wednesday
a total of 9,983 homes were sold in Los Angeles, Orange, San Diego, Riverside,
San Bernardino and Ventura counties last month, a drop of nearly 50 percent
from January last year.
Fifty percent. That is unprecedented. California is in a
housing depression. Is a 30-day grace period really the best that Paulson can
come up with?
That's nuts. California is a vital part of the US economy.
In fact, California and Florida combined represent two-fifths of the nations'
GDP. Is Paulson planning to let California go the way of New Orleans?
For the last four months, housing sales in California have
plummeted 40 percent (year over year) At the same time, prices in Southern California
have dipped 16.7 percent. The market is freefalling. So far, the only analyst
to come up with a reasonable solution is Professor Nouriel Roubini who suggests
a three-year rate-freeze and a reduction of the face value of the mortgages by
Of course, the banks will scream bloody murder, but it's the
only way to stem the tide of foreclosures and prevent a crisis that could suck
the rest of the economy down a black hole.
And, for those who still doubt that a collapse in housing
will batter the broader economy, listen to Yale economist Robert Schiller. He
predicted the dot-com bust in 2000 and is widely respected for his analysis of
the real estate bubble.
"We are in a historic housing bust comparable to that
of the Great Depression. Prior to the Depression, housing prices only rose 19
percent (between 1921 to 1925) and then fell 30 percent The cycle we are going
through now, is a unique cycle; it will go down as the subprime cycle. The
excitement in housing was unprecedented and the unraveling of that [bubble]
will have unpredictable consequences. . . . Real estate owned by households is
roughly $20 trillion and we've already seen an 8 percent decline which means a
loss of $2 trillion. That has a powerful impact on the economy . . . The losses
are throwing people's balance sheets off. So now household balance sheets are
in bad shape. People who used to be able to borrow against their house are
facing new constraints. This is an ongoing thing that will last for more than a
year. So we have unfolding problems to forward to.
"We should be thankful that we have Ben Bernanke, who
is an expert about the Great Depression at the helm. I don't think he will make
the same mistakes that the Fed made that last time around . . . On the other
hand, it [the bubble] is a major misalignment and cutting rates -- when homes
prices have doubled in the last decade -- won't change that. The correction [in
home prices] is not going to be stopped by the Fed.
"If this isn't handled right, this could be a serious
Notice how Schiller dismisses inflation as a major concern
and emphasizes the potential dangers of a deflationary downturn. It's clear
that he would prefer to see Bush increase the $168 billion than face an economy
that is stuck in neutral. In other words, he anticipates a collapse in consumer
Schiller continues, "I am a big believer that
'confidence matters.' What is happening now, is that people are getting a
succession of scare stories and personal savings are down . . . If you look at
what happened before the Great Depression . . . there was evidence of a sudden
and sharp drop in consumer confidence and people pulled back and stopped
spending. And we are seeing consumer confidence falling and I expect that it
could take a much bigger tumble if we don't do something."
Are you listening, Hank Paulson?
Consumer spending is down (excluding food and fuel) and
consumer confidence is falling at the fastest pace since the 1990-91 recession.
Also, $2 trillion has been wiped out by falling home prices and another $600
billion will vanish this year from mortgage equity withdrawals (MEWs). Traffic
to the shopping malls has slowed to a crawl and retail shops had their worst
January on record. Homeowners are hoarding their earnings to cover basic expenses
and to make up for their lack of personal savings. The spending spigot has been
turned off. America's consumer culture is in full retreat.
Everything Schiller said is taking place right now. So,
where's the political leadership? Does anyone in Washington even have a game
In the fourth quarter of 2007, new foreclosures averaged
2,939 a day, double the pace of a year earlier. Business inventories are on the
rise. Last week's release of the Institute for Supply Management's
Non-Manufacturing Index (ISM) showed steep declines in all areas of the
nation's service sector -- including banks, travel companies, contractors,
retail stores etc. The Business Activity Index, the New Orders Index, the
Employment Index, and the Supplier Delivery Index have all contracted at a
These are the classic signs of overproduction. The next shoe
to drop will be rising unemployment. Layoff notices have already gone out in
new construction, retail, car manufacturing and financial services. This is all
the predictable outcome of low interest" bubble-making. It invariably ends
in a painful deflationary spiral.
"Confidence matters," Schiller warns.
Yes, it does. But the American people lost confidence in
their leaders long ago. So -- like Paulson says -- the worst is probably just
Whitney lives in Washington state. He can be reached at firstname.lastname@example.org.