Friday, November 27, 2009

Mortimer B. Zuckerman

Get Ready for a Second Obama Economic Stimulus Program

The Obama administration needs to start working on contingency plans

Posted March 2, 2009

The queen of England asked a good question: "Why did no one see this coming?" She was talking, of course, about the world financial crisis. The answer is that nothing like this has ever happened before. Totally unprecedented, it was therefore unpredictable.

Mort Zuckerman
Mort Zuckerman

It came upon us at the speed of an avalanche, wiping out one third of the world's net equity, or $30 trillion, the largest peacetime destruction of wealth. The American financial system, considered the most sophisticated and developed in the world, is now seen as a casino game in which highly paid participants mismanaged risk and highly respected regulators cheered them on.

Looking back, the big question is how the financial brains could have been so blind to the risks in gambling that $1 of equity could support $30 of lending. The public had no idea that the traditional ratio of $12 of debt for every $1 of equity had been recklessly exceeded. But it seemed to be raining money, and the public naturally took advantage of that. Easy money tempted people to buy homes they couldn't afford. Some did so by lying about their assets—if anyone even asked them!—while others grabbed teaser loans with no down payments and low rates that eventually ballooned unbearably. Millions of other homeowners refinanced their mortgages to sustain consumption.

Everybody seemed to think that trees would grow to the sky. It is understandable how ordinary people made that mistake. It is unforgivable that the computer models of the agencies that rated risk were not programmed for a fall in prices. That was the agencies' job, and, impelled by greed, they screwed up big time. So, when people started defaulting on their mortgage payments, homes were foreclosed and home prices began to fall. At that point, the leverage began to work in reverse, generating a credit crisis that was crippling in scope and global in reach.

The Obama administration now has come forth with a series of programs. The administration is offering various incentives to encourage lenders to lower mortgage payments to affordable levels so people can stay in their homes. That's sensible. It is more profitable for lenders than foreclosures—especially since foreclosures tend to accelerate the decline in the value of homes.

But that's a plan that goes only so far. It's available only for mortgages that are not more than 5 percent in excess of the current value of a home. It thus would help perhaps fewer than a million of the 14 million homeowners who are now "under water." To protect the rest, the program will have to find a way to lower the principal owed by homeowners who have larger negative equity, i.e., whose home values have fallen below what they owe on their mortgage. The vast majority of these owners still are likely to go into foreclosure if prices fall more, since they will have no motive to continue making mortgage payments.

The program also would allow millions of homeowners to qualify for refinancing. And, if nothing else works, the administration wants Congress to give bankruptcy judges the power to change the terms of mortgages and reduce monthly payments.

The banking bust that continues to cripple the economy and devastate the stock market is a direct result of the collateral damage of mortgage foreclosures. The decline in the value of mortgage-backed securities, catastrophic for the overleveraged system, has been aggravated by hundreds of billions of dollars of other illiquid and complex assets. The result has been the deterioration in banks' balance sheets that has led them to make a drastic reduction in lending, a deleveraging that, in turn, has produced a sharp decline in economic activity.

The largest component of the credit bust came from the disappearance of the "securitization market"—the packaging and selling of bundles of debt from mortgages, credit cards, auto loans, etc., that made up more than $2.5 trillion, or about 50 percent, of total financing in 2007. Today, that number has gone down to virtually zero: The credit rating system that made these bonds salable to investors has proved to be so unreliable that the market is moribund. Even if the banks were all solvent, they couldn't make up this drastic shortfall of credit. Securitization enabled the banks to roll over loans into securities, which they sold. The banks used the money raised to relend for a second and third time.

Reader Comments

stimuli bull

I think his ideal is the dumbest he is sitting inthe white house padding his packets with our money .He could send it to people who need it.What about the people who don't have a job and need money to feed their kids. what then ,he just going to sit back and watch us rot

Obamaa banking stimulus package

Obama has inherited an absolute mess from Bush and his nefarious gang. Not only did they "take a weed eater" to banking regulations they gave 350B to friends and relatives in the waning days of their adminitration. They've fought for the big guys against the rest of us for so long they think it's their right. Now the democrats have to fix it and its going to take a lot of work and a lot of money.

Tell the Queen: some people DID see it coming!!

Mort, come on. Lots of people saw it coming but most of us wouldn't listen. One of the most prescient was Michael Hudson's May 2006 Harper's Magazine cover story entitled "The New Road to Economic Serfdom: Ahn Illustrated Guilde to the Coming Housing Collapse". http://www.insurgentamerican.net/download/MichaelHudson/Hudson_RoadToSerfdom.pdf

And how about Nouriel Roubini, Hency C. K. Liu, Mike Whitney, Dean Baker Steve Randy Waldman, Jim Wille, Meredith Whitney, Yves Smith and even big names like Floyd Norris, John Authers and Martin Wolf?

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