The Fed’s Role in the Housing Crash of ‘07
“This is the biggest housing slump in the last 4 or 5 decades: every housing indicator is in free fall, including now housing prices.”
-- Economist Roubini Nouriel, Dow Jones, August 23, 2006
“The Fed, in effect, has become a serial bubble blower.”
-- Stephen Roach, chief economist, Morgan Stanley
The American people appear to be oblivious to the economic hurricane that is expected to touchdown in late 2007. That’s when $1 trillion in ARMs (Adjustable Rate Mortgages) will “reset” triggering a massive increase in foreclosures and plunging the country into a deep recession. If energy costs continue to rise at the same time or if the dollar loses more ground, we may be rooting around in the backyard garden plot looking for passed-over spuds and radishes.
The crisis is entirely the work of former Fed Chairman Alan Greenspan, whose “cheap money” policy caused a speculative frenzy in the real estate market that sent home prices through the stratosphere. In fact, the bubble originated in 2001 when Greenspan lowered interest rates to a meager 1% and ignited a refinancing boom as well as a sudden up-tick in home sales. Now, after 17 straight interest rate increases, the bubble is quickly losing steam and the effects are being felt from sea to shining sea. Rest assured, the sudden downturn in the housing market is just the first gust from an impending tornado. By the end of 2007, America’s matchstick economy will look like the rubble strewn landscape of New Orleans 9th Ward.
Greenspan has been the biggest player in this pre-Depression operetta. He kept the printing presses whirring along at full-tilt while the banks and mortgage lenders devised every scam imaginable to put greenbacks into the hands of unqualified borrowers. ARMs, “interest-only” or “no down payment” loans etc. were all part of the creative financing boondoggle which the kept the economy sputtering along after the “dot.com” crackup in 2000.
It worked like a charm too. Aided by the Fed’s cheap money policy, the housing market sizzled. In just six years the total value of real estate jumped from $11 trillion to $21 trillion! (“From 2001 through 2005, outstanding mortgage debt rose 68% from $5293 billion to $8888 billion”) It’s the biggest expansion of debt in history and it was all engineered by seductively low interest rates.
Greenspan executed the swindle with the adroitness of a carnival huckster, luring millions of buyers to the real estate gold rush. Now, many of those same buyers are stuck with enormous loans that are about to reset at drastically higher rates while their homes have already depreciated 10% to 20% in value. This phenomenon of being shackled to a “negative equity mortgage” is what economist Michael Hudson calls the “New Road to Serfdom”: paying off a mortgage that is significantly larger than the current value of the house. The sheer magnitude of the problem is staggering.
For example, an article in the New York Times last week noted that, “1 in 5 sub-prime loans will end in foreclosure. . . . About 2.2 million borrowers who took out sub-prime loans from 1998 to 2006 are likely to lose their homes.” In real terms, that translates into roughly 10 million people!
Greenspan, of course, nodded approvingly while the new regime of shaky lending practices was being put into place. What really mattered to the Fed chief was making sure the economy could be kept on life support while the massive “unfunded” tax cuts were provided for his well-healed buddies in corporate America and while the country charged off to war in Iraq.
Greenspan knew that his “low interest rate bonanza” was driving the wooden stake into America’s heart. In fact, every banker understands the effects of interest rates; it’s fundamental to their trade. Lower the interest rates and the people will swarm to the banks like piranhas to a hambone. It never fails.
The housing bubble has nothing to do with “market forces” or (Gawd help us) supply-and-demand. That’s all gibberish. Low interest rates provide a channel for pumping cheap money into the economy, which inevitably creates equity bubbles. When Greenspan lowered rates to 1%, he knew that he was simply trading a technology bubble for a real estate bubble. Now, of course, he has retired before the wheels fall off the cart so he can avoid being blamed for the coming catastrophe.
The fallout from the housing explosion will be much more destructive than what most people imagine. In fact, Peter Schiff, president of Euro Pacific Capital Inc., believes that the NY Times’ estimates are too optimistic. Schiff anticipates that failures in the sub-prime loan market will put greater downward pressure on housing by increasing inventory and lowering prices.
“The secondary effects of the “1 out of 5” sub-prime default rate will be a chain reaction of rising interest rates and falling home prices engendering still more defaults, with the added foreclosures causing the cycle to repeat. In my opinion, when the cycle is fully played out we are more likely to see an 80% default rate rather than 20%.”
40 million Americans headed towards foreclosure? Better pick out a comfy spot in the local park to set up the lean-to.
Schiff’s calculations may be overly pessimistic, but his reasoning is sound. Once mortgage holders realize that their homes are worth tens of thousands less than the amount of their loan they are likely to “mail in their house keys rather than make the additional mortgage payments.”
As Schiff says, “Why would anyone stretch to spend 40% of his monthly income to service a $700,000 mortgage on a condo valued at $500,000, especially when there are plenty of comparable rentals that are far more affordable?”
Why indeed? There’s simply no incentive to hang on to a home or condo that’s losing value every day.
Economist Nigel Maund describes what over-leveraged homeowners can expect as real estate values continue to plummet:
“For the majority of homeowners, they are now ‘lobster potted’ for the rest of their lives in the 21st Century’s version of the Victorian treadmill. Welcome to modern debt-controlled serfdom, where if you lose your job, either through retrenchment or illness, you lose your home. It has become a veritable Sword of Damocles, or a stick with which to beat recalcitrant labor into a bloody pulp, should they ever prove restless or disobedient. The ruthless and faceless plutocrats who benefit vastly from this dreadful scheme must be laughing on their return to a status of demagogic power which is the modern equivalent of Roman or Medieval Aristocracy at its exploitative worst. . . . The mortgage weapon forms an integral part of the armory of the so-called New World Order (NWO) as it seeks to accumulate wealth and power to control people by stealth.”
Maund nails it. The “mortgage weapon” has been used effectively to thrust millions into debt servitude and shift the nations’ wealth to the upper 1%. Meanwhile the Decider-in-Chief has been busy rewriting the nation’s laws so they meet the requirements of an economically polarized society. (The erosion of civil liberties is the unavoidable consequence of the greater divisions in wealth)
The first wave in the tsunami is timed to hit in late 2007 when $1 trillion in ARMs reset, wreaking havoc across the country. That means that millions of borrowers will see dramatic increases in loans on homes that are of steadily diminishing value. (Many monthly payments will nearly double!) The number of foreclosures will skyrocket, unemployment will soar, and America ’s consumer economy will swoon.
How bad will it be?
According to statistical analyst, Jim Willie, “One third of job creation has come from the housing industry in the last 5 years.”
How will we make up those losses in employment?
Equally worrisome, is the amount of money that will stop flowing into the economy because of the declining home values. In 2005, Americans pulled $732 billion out of their home equity to spend on consumer items. By the 2nd quarter of 2006 that number was down to $327 (annualized) a loss of more than half. In an economy where 90% of growth has depended on the housing boom, these are ominous signs of impending disaster. (Current Fed Chairman Ben Bernanke said that the slowdown in housing has been a “major drag” on the economy, which has already caused a 1% decrease in GDP in 2006. What effects will it have in 2007 when the real storm hits?!)
If homeowners can’t tap into their equity to augment their stagnant wages, GDP will shrink and investment will flee to foreign markets. That’s when we’re likely to see the lines at the neighborhood shelter winding around the block and whole families camping out in the backs of their Suburbans.
The Sub-prime “Time Bomb”
It looks like the meltdown in sub-prime loan business will trigger a steady downturn in the entire housing industry. The Center for Responsible Lending (CRL) issued a report which says that they anticipate a “humanitarian disaster worse than Katrina.” The report states:
“The sub-prime market was designed with a built-in time bomb. In testimony to the Senate Banking Committee in September, Michael Calhoun, the President of the CRL, showed an example of the most typical sub-prime loan, known as a 2/28, with an ‘exploding ARM’ (adjustable rate mortgage). Buyers can qualify for this type of loan if the original (‘teaser’) monthly payment is not higher than 61% of their after-tax income. At the end of two years, even without a rise in interest rates, the payment will typically rise to 96% of the purchaser’s monthly income. No wonder then, that the study conservatively forecasts that one-third of families who received a sub-prime loan in 2005 and 2006 will ultimately lose their homes!”
“96% of the purchaser’s monthly income”?!! That leaves a measly 4% of one’s earnings to pay for clothes, food and other essentials!
The disaster in sub-prime loans is leading the housing market into a waterfall type decline. It’s the first indication that a real catastrophe is just around the corner. The inability of over-leveraged borrowers (many with a poor credit history) to meet their obligations is spreading to other areas of the market. This is called “contagion”. The defaults are symptomatic of a larger problem that could quickly affect the entire system.
Realtor Don Stacey describes the phenomenon this way:
“The fact of the matter is that sub-prime lenders are closing shop and dropping like flies . . . What does this signal? To me it suggests that the sub-prime lending cycle is history . And, if it is history, then a very large chunk of the nonconforming borrowing seen in 2004, 2005 and most of 2006, will not be repeated in 2007.”
Why should this matter to the average homeowner?
Because in 2003, 35% of all mortgages were “nonconforming” loans. In 2004, it went up to 59%. And in 2005, nonconforming loans were a mammoth 65% of all mortgages! As the lenders return to more conventional practices the pool of potential customers will dry up accordingly and housing prizes will fall precipitously.
Once again, we need to remind ourselves that the housing boom was not created by market forces, “real demand” or increases in wages. It is entirely the outcome of Greenspan’s “cheap money” policy (low interest rates) as well as the widespread shabby lending practices. (“Creative financing”, ARMs etc.) These factors have caused the largest expansion of personal debt in history and are creating a real risk of a complete financial collapse.
So, why would the banks commit to such a risky scam when the standard criterion for loaning money has been understood for hundreds of years?
For the banks to ignore the rules for prudent lending (20% down payment, fixed interest rate, sufficient collateral and income) is like a scientist saying that the rules of gravity no longer apply or that the chemical composition of water has changed.
It simply makes no sense, does it?
It’s different for the Federal Reserve. The Fed knows that the US consumer is already overextended and mired in debt. They’ve decided to increase our (collective) obligations while their corporate colleagues load the boats for more promising markets in Asia and Europe. They cling to the notion that they can preserve the greenback as the “reserve currency” even after it has been deflated to the value of the Peso. (The actual face value of the dollar makes no difference to the Fed as long as they continue to produce the “international currency.” That preserves their power base and control of the global system.)
“Cheapening” the dollar by doubling the money supply paves the way for hyperinflation and (the Fed believes) a more competitive American workforce going nose-to-nose with competitors in China and India. It’s a plan that globalization’s foremost champion, Tom Friedman, would probably greatly admire.
By pulverizing the dollar, the Fed can crush the middle class and lay the foundation for a “class-based,” police state -- Bush’s nascent Valhalla.
The first step to “reordering” society is destroying the currency.
Famed economist John Maynard Keynes showed a keen grasp of this when he said:
“Lenin was right. There’s no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
This suggests that the greatest threat to “democratic institutions” is not repressive legislation (as most believe) but monetary policy. The manipulation of currency can precipitate economic divisions in society that make democracy impossible. That’s why Thomas Jefferson said:
“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of our currency, first by inflation, then by deflation, the banks and the corporations that will grow up around (the banks) will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”
Jefferson understood that monetary policy is central to the maintenance of personal freedom and should not be ceded to a few “unelected” and unaccountable men whose interests diverge from the public good. The Fed’s ability to “inflate and deflate” the currency allows privately-owned banks to decide the country’s future and remake society according to their own inclinations.
America’s political transformation is being engineered by the Federal Reserve.
But what about the banks?
What would compel the banks to break with traditional lending practices and put themselves at risk of millions of foreclosures?
The banks eke out their survival in an extremely competitive environment where short-term profit determines their behavior. Not only have they loaned out zillions of dollars to people with poor credit, they’ve also played a major role in repackaging substandard loans and selling them off to Wall Street as “mortgage backed securities” (MBS) These MBS are high-yield debt instruments that evolved through “deregulation”. They’re sold to hedge funds as securities and are rarely (if ever) checked for the reliability of the borrower. This has created a great opportunity for the banks to loan as much money as possible using funky ARMs and nontraditional loans knowing that they’ll be rubber-stamped on their way to Wall Street. (The practice of shipping B-grade loans to fund managers is like gift wrapping dog poop and selling it as Belgium chocolates. Nevertheless, it has fattened the bottom line for nearly all the major lending institutions)
Unfortunately, the terms of the MBS allow non-performing loans to be sold back to the lender that originated the loan. Now that the number of “non-performing” loans is on the rise, (through defaults) the banks are scrambling to avoid liability. (In fact, according to National Mortgage News, Fifth Third Bank is “selling $11.4 billion in securities (almost all MBS) before year-end 2006 and is taking a loss of approximately $500 million.) This reflects the new mood in steering away from shaky loans.
As the great housing Hindenburg continues its downward trajectory, the banks will undoubtedly do their best to prevent the deluge of foreclosures (and failing MBSs) from dragging them under. Perhaps, they will offer more flexible terms to over-leveraged homeowners as a way of recouping their losses; it’s impossible to know. It’s also hard to gage how many struggling homeowners will be able to hang on even with a more flexible payment schedule. Unfortunately, the present trend lines offer little reason to be hopeful.
These are grim times for the mortgage industry and we shouldn’t be too surprised if one or two major banks hobble into receivership before the storm is over.
Housing Hullabaloo: “The worst is yet to come”
Reports in the mainstream media tend to obscure the severity of the housing bubble. Typically, the articles are full of “Sunny Jim” claptrap about a “rebounding market” that is suddenly “correcting” after an explosive decade of growth. For example, over 250 articles appeared in US newspapers this week celebrating; “New Home Sales Rise in November.” Readers should not be taken in by this type of hype. A careful reading of the facts indicates that, “rather than foreshadowing a quick rebound, the news highlighted how fragile the residential construction remained and suggested that the downturn rattling the housing market has not run its course.” (NY Times)
Translation: The worst is yet to come.
The number of homes sold in November was the LOWEST IN ALMOST 4 YEARS causing inventories to swell to a “7.7 month supply, the highest since December 1995.”
These are very bad numbers.
So, why is the media cheering?
The news reports draw attention to a slight 3.4% increase in sales in November from a thoroughly dreadful October! If, however, we compare the figures from November 2005 to November 2006, we find that housing sales are actually down 12.4% from a year earlier. (And this, of course, is how one normally evaluates a downturn in the market)
The media is no more dependable in their coverage of the housing bubble than they are about Iraq. The reader must do his own research and draw his own conclusions. But one thing is certain, house prices are way beyond any historical relationship to rents or salaries. They are bound to come down . . . and fast.
We can also assume that the number of foreclosures will skyrocket in 2007 from defaults on sub-prime loans and the “resetting” of Adjustable Rate Mortgages. (The monthly payments on these loans will go up significantly whether the Fed raises interest rates or not)
Business Week summarized our current predicament saying:
“Today’s housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low rates of a weak economy. Either the economy’s long-term prospects will get worse or rates will rise. In either scenario, housing will weaken.”
The real estate slump will seriously dampen consumer spending and further shrink the already miniscule US GDP (1.9%) This will undoubtedly have the added effect of curtailing foreign investment, putting more downward pressure on the floundering dollar and triggering a round of hyperinflation. Ultimately, the Fed will be forced to make one of two choices: either lower interest rates and forgo foreign investment ($2.5 billion a day) or keep interest rates where they are and accelerate the collapse of the housing market. There is no “third” option.
Most analysts and traders believe that Fed Chief Bernanke will follow the well-worn path of Dr. Weimar and begin “hurling bundles of greenbacks from helicopters” rather than allow the economy to grind to a halt. Hence, we are likely to see the further “debauching of the currency” sometime in the very near future. As Stephen Jen, the chief currency economist at Morgan Stanley, said recently in an article in the New York Times, “All the policy makers still believe in the possibility of a dollar crash. It’s still lingering out there.”
No doubt, Fed-master Bernanke will work towards that goal by keeping the printing presses humming along while praying for the elusive “soft landing.”
The Fed’s Plan to Reshape American Democracy: "One bubble after another"
As a privately owned organization the Federal Reserve cannot be expected to operate in the public interest. The Fed’s views on policy are primarily shaped by elite opinion, which favors a small group of powerbrokers at the top of the economic food-chain. The Fed’s power to manipulate interest rates and increase the money supply, allows it to engage in “social engineering” which merely reinforces its own class interests. This, in fact, is what Jefferson intimated when he warned that if “private banks” were allowed to control the issuance of currency, than they would inevitably “deprive the people of all property until their children wake up homeless on the continent their fathers conquered.”
That shift in wealth is underway even as we speak.
These massive equities bubbles (stock market and housing), which have had such a devastating effect on working class people, are the predictable result of a class-based orthodoxy. They inevitably widen the chasm between rich and poor and strengthen the power of the ruling elite. It is crazy to think that they are merely “accidental”.
The upcoming recession is the direct result of policies which originated at the Federal Reserve and which were intended to create a crisis. It is a clear attempt to change American society on a structural level by exacerbating the divisions in wealth. The expansion of debt invariably strengthens private ownership and enhances corporate profits. It also weakens democratic institutions and national sovereignty.
Democracy cannot long endure when the money supply and interest rates are controlled by privately owned banks. Their behavior is guided by self-interest and profit and is hostile to liberty and the equitable distribution of wealth. The policies of the Federal Reserve are transforming the country in a way that will eventually make democracy in America unworkable. We are becoming a de facto aristocracy and will continue along that path until the “issuing power of currency is taken from the banks and restored to the people, to whom it properly belongs.”
The Federal Reserve System was established by President Woodrow Wilson in 1913. Wilson bitterly regretted his foolishness from the very onset and said in his book, The New Freedom:
“I am a most unhappy man. I have unwittingly ruined my country. A great industrial country is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all of our activities are in the hands of a few men. We have come to be the worst ruled, one of the most completely controlled and dominated governments in the civilized world. No longer a government of free opinion, no longer a government of conviction and the vote of the majority, but a government by the opinion and the duress of a small group of dominant men.”
As millions of people lose their homes and life savings from the crashing of Greenspan’s Housing Bubble, we should reconsider Wilson’s words and make a concerted effort to dump the Federal Reserve.
Mike Whitney lives in Washington state, and can be reached at: firstname.lastname@example.org.
Other Recent Articles by Mike Whitney
Game in Turkmenistan