The Audacity of Doing Nothing

I spent a few days recently in the company of some money managers with a total of about $2 trillion to invest, precisely the sort of folks whose confidence the government is currently trying to win.  How did they feel about all of the rule and policy changes coming out of Washington and the new more muscular government? Terrified.

The “real money” investors didn’t want to invest alongside the government.  Their concern is that if things go south, the government will take 100% of the value left in the bank or whatever and leave private investors, including recent ones, with nothing.   This is precisely what happened to recent investors in Fannie Mae.

The “real money” investors didn’t want to see judges modifying contracts, e.g., bankruptcy judges resetting mortgage payments at a lower level and reducing the principal owed.  As far as they were concerned, a central tenet of the U.S. Constitution is that people are free to make contracts.  Given how mortgages are split up among investors, a foreclosure is greatly preferable to these folks than a modification.  In a foreclosure the most senior investors get what they expected, i.e., their money back.  The holders of the most junior tranches, which carried a higher return and were known to be high risk, would get nothing.  This is also what they would have expected.  If mortgages are modified by government action, however, it is unclear how the obligations among the various private parties should be adjusted.

“What’s wrong with foreclosures?” some of these folks asked.  “The historical rate of home ownership is about 60 percent and we’re probably going to revert to that sooner or later so why slow things down?  How does it help the U.S. to have high housing prices?  Isn’t it better for housing to be affordable?  If we give a lot of money to people to prevent foreclosures in March, how is that fair people who were foreclosed on in January?”

Much of the justification for government intervention comes from the assertion that markets have failed.  One money manager scoffed at this idea.  “The markets are working fine, but they’re giving people answers that they don’t like, so people cry market failure.”  Stocks and bonds low?  That’s because investors are afraid of a prolonged depression and continued government interference.  House in a jobless region of Michigan worth almost nothing?  A place with 50% of its former jobs only needs 50% of its houses.  There are plenty of former steel towns where the price of a comfortable house stabilized at $20,000 decades ago and has barely moved since.

What did these guys want the government to do?  Nothing, basically.  “Back in the 19th Century, there were a lot of steep crashes, guys got wiped out, and the economy came back quickly.”  What’s different now?  The government is a lot bigger and more powerful.  Rich companies and people can put some of their wealth into lobbying and demand that the government prevent them from getting wiped out (or at least slow the process).

Barack Obama promised on Monday not to rest as long as this economic downturn persisted.  He promised to act decisively, change whatever had to be changed, spend whatever had to be spent.  This is precisely what worries the investors to whom I spoke.  They’d rather see the audacity of doing nothing.

61 Comments

  1. BAM

    February 15, 2009 @ 9:34 pm

    1

    Truly amazed at some of the comments on this board. People still believe goverenment is the answer to the economic problems of the country. What programs can anybody point to that are truely successes of the government?

    Good example of the government interring in the makret place is this $787 billion stimulus bill. Anybody really think its going to create a job? I own a small business. If I get a one time contract I don’t go out and hire a bunch of people and new equipment for it. I know its a one time shot so I bank the money. It is artificial demand. If I am able to get a contract with a company then I can look to build my business, purchase a new vechicle and hire people as it will be a client that will continually provide me with revenue.

    Housing prices have to come down. People knew they could not afford the houses they were living in. They were playing the game. True banks were a souce of the problem. But the government was the biggest culprit. I am a little tired of the government blaming the Republicans for deregulation and therefore we need more. What is the FDIC, SEC and Sarbanes Oxley for. Isn’t that enough regulation? They all failed miserably. The SEC was alerted several times about Madof and audited the firm multiple times and came up with nothing. But now that we have a crises we need to have more regulation-I guess that makes sense. And we will lose more jobs as bank go over seas.

    They are currently trying to prop up the housing market by freezing foreclosers and altering the terms of the loans. This will not work, it will be a total failure as housing prices will continue to go down. The govt will get into setting rates and what houses people can purchase based on there income level. Already today I heard that they want to modify loans down to 31% of homeowners income. That means the median priced home will fall to that level quickly as banks will not loan out money that does not fit this criteria.

    And finally for all of the people crying that they have upside down mortgages and are losing there homes-tough luck. You should have asked questions about the loan and should not have lived above your means. Look in the mirror and you will see the true problem. If you didn’t sign on the dotted line the country would not be in this mess.

    Before you get upset with me for this post I am the one paying for all your mistakes. I work a job and own a business. I rent a house because I used common sense and realized the market was absurdly over priced. Therefore, you should thank me for you bail out money.

  2. pmorrisonfl

    February 16, 2009 @ 4:39 am

    2

    > What programs can anybody point to that are truely successes of the government?
    How about the Internet? GPS?
    While they botch lots of things and should leave housing alone – and shouldn’t leave the big banks alone – I find it hard to read online that the government has never created value, because they helped lay the foundation for ‘online’ existing.

    We sold in 2005 because we recognized the bubble and that it was unsustainable. House prices have to match income, because that’s where people get the money to pay for them. Prices based on being able to create credit and sell the created credit upstream can’t last. I wish the FDIC would do a proper audit and take the top ~20 banks into receivership where they belong, leaving the rest of the economy and the world to recover as best it can. That doesn’t look likely.

  3. TeddyBearNeil

    February 16, 2009 @ 10:49 am

    3

    Much water has flown since the Real Estate bubble burst and as Warren Buffet said, “It is only when the tide goes out that one sees who has been swimming naked”.

    Why am I paying for my neighbors Vacation and cruise to Hawaii and Monte Carlo, their multiple trips to Vegas and the exotic chandelier and other high priced furniture in their home?

    Here is the story of a friend who bought a New home in Tracy, CA in 2004.

    The cost of the home at that time was 350K. I paid 20% down. My neighbors also bought the same model at the same time with a 3% down payment.

    They refinanced with a 3/1 Arm cash out in 2005 for 500K because the value of the home had gone up. I did not do any such thing and just continued to pay my mortgage. They quickly spent the money on buying the exotic chandelier and other high priced furniture in their home and went on a Vacation to Hawaii and then on a Cruise to Monte Carlo. In between they had time to party out in glitzy Vegas.

    In 2008 their first re-set took their payment way above what they could afford and they fell behind on their payments. The current value of the home is back to what it was valued in 2004 – 350K.

    Now, per some of the advocates of foreclosure prevention, a principal write down (from 500K to 350K) is going to be handed out to my neighbor by the government using my tax dollars, so that he can continue to pay the same monthly payment as me after having run through 150K of Tax payer money! Thus forcing me to pay for my neighbor’s luxuries?

    Both of us have teenaged kids. I did not indulge in any of the splurges that my neighbor indulged in. I in fact saved up for 8 months of living expenses in case I lose my job, I put some money in a CD so that it could help pay for my kids college tuition fees!

  4. The Louman of California

    February 16, 2009 @ 12:01 pm

    4

    Look all, in regards to the audacity of Government doing nothing – If people are in need, then the ones who know them best will step up and take care of them…just like days of old.

    Look to the private sector (Churches, Synagogues, etc.), and organizations like United Way, Salvation Army, to do what the Government cannot do – take care of the people in each community.

    The Government can help by not changing the rules so quickly, invest in professionals, instead of kids, to oversee the financial sectors; and, work on macro level items. Continuation of welfare and food stamps would be a good thing, thereby leaving the individual States to take care of their own unique projects.

    By letting the people take care of their neighbors, we not only free up our Government to focus on the larger issues, we avoid growing Government to unsustainable levels ( I believe at WW2Govt was at 12% GDP – now it’s up to 40%?), and we maintain our freedoms, while not turning more personal dependency on the Government.

    E Pluribus Unum.

  5. RichTurd

    February 16, 2009 @ 5:07 pm

    5

    Lots of great posts here, from both sides of the spectrum. Healthy to hear different perspectives, even if not in agreement. Ok, heres one man’s opinion. All this talk, and looks like action soon for bailing out every hog at the trough (banks, homeowners, autos, porn industry, etc). What about the majority of taxpayers that had nothing to do with any of this? With all the so called “smart” acedemics hired to figure out this problem, why can’t the taxpayer be factored into the solution. And not some BS like “Gov’t buys crap assets from banks and resells later for a profit on behalf of taxpayers”. What about something like this.

    Gov’t allows idiot homeowners that are upside down to walk away from their mortgage. Or those who wish to remain can have the mortgage written down to market. Banks take half the hit (this assumes no taxpayer funds to banks). Shareholders/bondholders take their medicine as that is part of speculating./investing. Ok, heres the kicker part-will probably piss off some of you but hear me out. Government (taxpayers) take the hit for the other half. Market for housing is allowed to reset to where prices should be. Homeowners that are drowning are given a lifeline to get out of the debt situation and hopefully move on to a more sustainable lifestyle (lower standard of living which is what you can afford). Blah Blah tells us something new in your plan Mr. Turd that we havn’t already heard. Patience Grasshopper. I will now impart to you the wisdom from the sacred dog turd. Here goes. Any bailed out taxpayer has a liability to the government for the bailout amount, including interest until it is paid off. Wait Master, I do not understand how these people will be able to pay back such a debt. Ah, GH here is the secret of the sacred D.T. These people have until they reach retirement age to pay back these funds. if they do not, the amounts will come from their social secuurity payments that are “owed” to them. If they happen to die before the debt is paid off from ss, taxpayer is first in line when the estate is settled, including any life insurance proceeds that pay outside of the estate. So let me make sure I understand Master. Banks take a hit like they should but are not crushed, thereby supporting our financial system. Homeowners are given a chance at life but are not off the hook. And taxpayers don’t take it in the pooper. Ah-so master! (sound of gong in background)

  6. CG

    February 16, 2009 @ 6:55 pm

    6

    RichTurd you stated in the 2nd paragraph:
    “Market for housing is allowed to reset to where prices should be.”

    The problem is that sellers do not want to do this. Many homes are sitting vacant or are being rented out because sellers do not want to “give it away.” They refuse to think that they should have to take anything less than whatever percentage they planned on taking in profits on the sale of the home/property/land.

    Thus, they WANT government intervention in the housing market to act as a safety net for their “investment.” Why do you think Obama got elected?

    As I posted above, I am a renter. Recent example: My architect LL is using the rent income from this rental to support her declining business of architectural design. She recently had this rental reappraised presumably to extract more money from the bank on refi (this is her 2nd appraisal and refinancing in less than 2 years-btw, this rental should be cash-flow positive with a monthly profit of *at least* $700/mo). She and the appraiser laughed in my presence regarding “what a great rate is out there right now for refinancing. So many are refi’ing now…business is great!”

    Laughing. And here I am paying for their irresponsibility. If her business is faltering, then she needs to lay off her staff and sell the building she operates out of and work out of her home on a part-time basis as many people have to do these days. But no, she simply goes to the property ATM and extracts more cash to continue the dog and pony show.

    Are these people concerned about bringing down the country or even the entire world due to their unending greed? NO.

    What are the chances that any of them would agree to repaying bailout funds upon retirement as you suggest? NONE.

  7. RichTurd

    February 17, 2009 @ 11:08 am

    7

    CG. Some good points. The focus of my thesis is not so much whether or not housing will reset. My point is that there is a way to make (force) bailout recipients repay their debt. They would not have a choice of whether to pay back or not. Funds owed would simply be deducted from social security payments or estate settlement. Instead of taxpayers paying for their mistakes, taxpayers become creditors. There are ways to create incentives for people to pay back these funds. Just have to make it painful enough for them do it. And if they don’t, they pay in the end.

  8. Not-so-angry home owner

    February 17, 2009 @ 7:57 pm

    8

    Rich:

    You make some interesting points, but there is no way in hell I’d take you up on your proposal (for details of my predicament, see above). Depending on the circumstances of a borrower, the only skin they have in an underwater mortgage is their good(?) credit score. I will not sacrifice a cent of retirement savings, or risk indentured servitude to preserve my credit score.

    PS, since my post above, I have consulted a CPA (in addition to RE attorney). I have zero tax liability if I walk away, and zero liability on the debt. I do wish to exit the situation gracefully, somehow, and thus I continue to pay my mortgage on time every month (I can afford it, but made the mistake of taking a time-bomb — I mean ARM) note.

  9. AZREBEAR

    February 28, 2009 @ 11:14 pm

    9

    RE: Angry Homeowner’s post February 12.

    >I used equity to buy a new home and now that equity is gone, and I am >upside down because of greedy unregulated, unrestricted asshats you call >investors. You still got your money, I deserve my home. So you damn well bet > I want relief. And I don’t give two shits if you ever invest another dime or >make another dollar.

    I have only one question for Angry Homeowner and thousands of others in the same self – induced – as far as I know nobody put a gun to these Homeowner’s heads at the close of escrow – negative equity situation. WHEN YOUR HOUSE APPRECIATED IN VALUE AS YOU SURELY MUST HAVE EXPECTED, HOW MUCH WERE YOU GOING TO GIVE BACK TO THE GOVERNMENT AS A DONATION? That’s what I thought, big fat zero. And with our ^&(*(ed up capital-gains taxes on homeownership, there would not have been any forced donation either as long as you stayed in your house long enough.

    Grow a set and quit trying to blame others. YOU MADE A CHOICE. I choose to live my life as a chooser, not a victim. Quit playing the victim.

  10. dave

    August 20, 2010 @ 10:52 pm

    10

    The banking system would not fail…just some banks within the system. America has about $6 Trillion more in “overleverage” that needs to be purged/cleansed from the system.
    Do not doubt for one second that you are in a depression. Your lying politicians begging for your vote tell you otherwise but I hope you are smarter than that.

  11. kurt

    September 24, 2010 @ 9:32 am

    11

    I agree with what you say and I am sure you arent making up the conversation with you money management friends. The problem is we live in a democracy.

    ‘Much of the justification for government intervention comes from the assertion that markets have failed. One money manager scoffed at this idea. “The markets are working fine, but they’re giving people answers that they don’t like, so people cry market failure.” ‘

    I totally agree with this. The thing is, if our government didnt try to intervene, first under a conservative Republican and now a moderate(but more liberal) Democrat, the “public” would be even more outraged. Welcome to mob rule.

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