A concise explanation of the credit crunch

David Leonhardt of The NYT has a clear article explaining the credit crunch: Can't Grasp Credit Crisis? Join the Club

It really started in 1998, when large numbers of people decided that real estate, which still hadn't recovered from the early 1990s slump, had become a bargain. At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centered around banks, to a global one, in which investors from almost anywhere could pool money to lend.

The new competition brought down mortgage fees and spurred some useful innovation. Why, after all, should someone who knows that she's going to move after just a few years have no choice but to take out a 30-year fixed-rate mortgage?

As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia's boom or rising oil prices, demanded good returns. Wall Street had an answer: subprime mortgages.

Because these loans go to people stretching to afford a house, they come with higher interest rates - even if they're disguised by low initial rates - and thus higher returns. The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or C.D.O.'s (a term that appeared in this newspaper only three times before 2005, but almost every week since last summer). Once bundled, different types of mortgages could be sold to different groups of investors.

Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody's Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.

All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people - by "people," I'm referring here to Mr. Greenspan, Mr. Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners - decided that the usual rules didn't apply because home prices nationwide had never fallen before.

And that's a faulty premise if there ever was one.

Home prices nationwide collapsed during the Great Depression.

Unfortunately only a few people know that: Some, because they remember their parents and grandparents talking about what happened then, others because they live in areas of the rust belt where housing prices never recovered after the steel industry left town.

When I lived in Convent Station housing prices plummeted when several of the major employers in the area (ATT, Henckles, Exxon, Allied Corporation) had major layoffs. Several homeowners defaulted on their mortagages.

I was working in real estate at the time, and several of my coworkers used to be amazed that I didn't "make" my customers overstretch themselves to the max. A lot of my coworkers' clients had overstretched themselves to the point where, once they closed on the houses they bought, they had zero money left to furnish the place.

Then those homeowners got laid off. Their houses (which had furniture only in the bedrooms, a table and chair in the kitchen, and a sofa and TV in the family room), when shown to prospective sellers, spelled one word in big neon letters:
D-E-S-P-E-R-A-T-I-O-N
They sold at a loss. Some of them defaulted.

But, as the article says, many people live under the illussion that house prices don't come down:

Based on that idea, prices rose ever higher - so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy.

And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it. Last summer, many policy makers were hoping that the crisis wouldn't spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.

Many of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything. That's why a hedge fund associated with the prestigious Carlyle Group collapsed last week.

After seeing what happened in Morris County in the late 1980s, here's what I would advise anyone buying a house:
Don't think of your home as a speculative instrument; instead think of it as a secure roof over your head.

Since it's not a speculative instrument, get a traditional mortgage. If you get a fixed-rate 15 yr mortgage and live in the house for only 5 years because you need to relocate, you have not subjected yourself to mortgage rate fluctuations and you are not dependent on real estate values appreciating in order to recover your investment. If you live 15 years in that house, you own the house free and clear. Real estate values may fluctuate but you won't be losing your house.

The Husband and I have been extremely conservative and have bought the houses we have lived in where the mortgage payments could be met by only one salary - the lesser salary. This is because throughout the course of our carreers we have been laid off and we didn't want to have to worry about "where is the mortgage money" coming from if one employer went bust.

Your job is secure, you say? Then think about the effect the loss of your spouse's income, or a devastating illness (on yourself) would have on your ability to pay those bills.

As to thinking that real estate prices can not come down, or that big profits do not come from big risks, reality's biting now.
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VDH on The Moral Economy

Via Maria, Victor Davis Hanson writes about The Moral Economy (also at Real Clear Politics) :

...despite the politicians' rhetoric, it is not hard to understand why America is in trouble.

First, there has been too much madcap real estate speculation. In recent years, housing prices were driven sky-high on the expectation that almost anyone, often with little security, could profit by borrowing easy money to buy and sell property.

Too many investors lost the old pedestrian notion that the purpose of a house was to be a home in which to live, to raise a family and to take pride in ownership. Its acquisition used to be a multi-year, if not once-in-a-lifetime, investment — not quite comparable to the easy buying or selling of volatile paper stocks and bonds. Others did not have the means to afford the type of home they purchased, once risky variable interest rates climbed.

Back when I lived in Convent Station, Morris County, NJ, I used to sell houses.

I advised every single one of my two-salaried customers to buy the house they could afford with only one salary.

I always had the customer speak to a mortage rep and discuss not only the no-documentation, low-downpayment adjustable rate mortagages but also the fifteen-year 25% down mortages. Once the customers could make the numbers and see the difference, a surprising number opted for the 15-yr mortagage.

Each one of those customers is free of mortgage debt right now.

A lot of real estate agents (who rely on a commission to make a living, and the commission is paid by the seller most of the time) would insist that their buyers overstretch with the wildest possible financing. Obviously I have a different mindset from theirs.

The reason was simple: I started a carreer in real estate when my husband got laid off from his job at Allied Corporation, and I knew there were more layoffs coming. He was not in a unique situation: within two years, the major employers in the Morris County area, Allied, AT&T, Henkel and Exxon had major layoffs. I mean ALL of these employers, at the same time. I wasn't psychic, I just had enough contacts that worked in managerial/supervisory jobs in those companies to know there was reason to be cautious.

People who had purchased the most expensive house they could - most frequently having only enough money left to buy a kitchen table and chairs, furnish the bedroom(s) they slept in, and purchasing a sofa and a TV for the family room - were left in desperate straits when one of the salaries disappeared.

There was a glut of ten-room houses on the market. Imagine hundreds of ten room houses with most of their rooms empty signalling to the buyers that the owners are hurting and have to sell. The ones that overstretched ended up owing money to the bank when the houses finally sold at a much lower price than they bought them.

Economies are cyclical. As a homeowner, it is your personal responsibility to you and your family to not gamble on your family's basic need for shelter.

In the larger issue of the economy, VDH continues,

First, at this late date, Republicans shouldn't vote for any candidate who promises another tax cut without first offering a matching slash in expenditures. And Democrats should reject any candidate who promises another multi-billion dollar entitlement without detailing how the additional revenue is to be raised.

Second, instead of demanding new billion-dollar programs for health care and education, we should take more responsibility for our own welfare.

Americans need to readjust their budget priorities. One might be able to believe that a $200 dollar a month private catastrophic health plan is out of the reach of most Americans — if we were also to hear that sales of video games, cell phones and plasma televisions have crashed.

Third, we need to ignore the alarmist hysteria, calm down and appreciate that life is better than at any time in the last 5,000 years of civilization. People are living longer; we're healthier; and millions of Americans have the opportunities to travel, communicate and avoid physical drudgery that were once reserved only for a tiny aristocracy. There is plenty of excess in modern American life that can be shed without real hardship.

Finally, we must view our present economic challenges in a larger philosophical and ethical framework — and redefine success as being able to pay off what we owe, and spend only what we earn.

Amen to that!


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These new podcasts, and this old New Jersey House

Two dear friends, Siggy and Dr Sanity, are now podcasting.

Yesterday I was Siggy's first guest and Dr. Sanity joined in. I had a wonderful time talking to both of them, and am sure you're going to enjoy listening.

Today Siggy and Pat conversed about defense mechanisms in the new The Sanity Squad podcast.

While you listen, read my latest article at the Star Ledger, This Old New Jersey House.
Update: Those Were The Days, My Friend...


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Bamboozled with Global Warming piety

Via Francisco, "We Have to Take Away People's Fear of Climate Change"

Hans von Storch is one of Germany's leading researchers on climate change. DER SPIEGEL spoke with him about why fears of global warming are exaggerated and the doom-mongering tendencies of German scientists.
...
SPIEGEL: Are there only negative consequences when the temperature increases by two or three degrees on the planet?

Storch: Detailed forecasts are not possible, because we don't know how emissions will in fact develop. We climate researchers can only offer possible scenarios. In other words, things could end up being completely different. But there are undoubtedly parts of the world that will benefit on balance from climate change. Those areas tend to be in the north, where it has been cold and uncomfortable in the past. But it's considered practically heretical to even raise such issues.

Finally, a believer in global warming who's not globalarmist. He's a heretic.

Meanwhile Jeff Goldstein posts on Secular Piety and the New Age Orthodoxy (h/t Larwyn), since Time Magazine has come up with 51 things to make us globally pure. Among the 51 things Time Mag recommends for saving the Earth/your soul/whatever is

Plant a bamboo fence
Bamboo makes a beautiful fence, and because it grows so quickly (as much as 1 ft. a day or more, depending on the species), it absorbs more CO2 than, say, a rosebush. Most homeowners have to restrict its growth, lest it get out of control. Do this, however, and you reduce bamboo's capacity as a carbon sink. Only large-scale plantings, which absorb CO2 faster than they release it, can favorably tip the scales. How big is your yard?

Aside the fact that Time's also saying to "ditch the mansion" (are you listening, Al?), and "move to a high-rise", which would not permit you to plant bamboo, let me tell you the first thing you need to know about bamboo: You can not just plant a bamboo fence
Down the street where I live there's a modest house on a corner where the original owners planted bamboo, thinking it'd make a nice hedge. That was in the 1950s.

This is what the yard looks like this morning:

This bamboo website says,

On the other hand, bamboo is the fastest growing plant on Earth. Some species have actually been measured to grow over 4 feet in 24 hours. A pole of bamboo can regenerate to its full mass in just six months! Bamboo can be continuously re-harvested every 3 years, without causing damage to the plant system and surrounding environment. During the time it takes to regenerate, the bamboo plant's root system stays intact so erosion is prevented. Continuous harvesting of this woody grass every 3-7 years, actually improves the overall health of the plant.

They are not kidding.

Bamboo is extremely invasive in this part of the country. By extremely invasive I mean that it not only takes over the entire land mass you allocate to it and the neighbors' yards, it breaks through concrete sidewalks and curbs.

If you try to fool yourself into believing the bamboo will be a carbon sink, I guarantee you that you'll produce more than enough carbon trying to contain the bamboo. Like the song says,

I'm tellin you
When you're blue
Why there's a lot to do
In the house of bamboo

Why there's a lot to do, because you'll be trying to contain the bamboo.

When you cut the bamboo down to the roots and dig all the stumps and roots out of the ground, it comes back. No matter how cold the winter, how flooded the spring and fall, how hot and dry the summer, bamboo will be there for you forever.

Bamboo is the kudzu of the North East.

The people who own that house have had not only to constantly cut back the bamboo because it obstructs the view of the intersection, they've had to repair the public sidewalk at their expense, and once had to redo the foundation of the house because of root damage.

Take my advice and DO NOT PLANT BAMBOO.

And while you're at it, forget about mint, too.

If you still want bamboo, buy one of these and keep it indoors:

Update: for the love of everything holy do not plant a bamboo fence. You will end up wanting to invent time travel solely so you could go back to your previous self and beat yourself with a bamboo club.

Technorati tags Global Warming, Time Magazine

Edwards: premature, but building big

Via Betsy, Edwards: 2004 run perhaps premature, and superficial, too

"When I ran in 2004, I spent most of my time thinking about being a good candidate,"

And his hair:

but he still has plans,

Edwards told a packed crowd spilling out of the 2,300-seat Wait Chapel. "These days I think about what I want to do as president of the United States."

He claims that

"Jurors are like any other human beings -- they're like voters," Edwards said. "They're always looking for someone to trust. They want to find comfort with someone who's being straight with them."

Like that time he sent someone to buy him a PS3 at Wal-Mart, after beating on Wal-Mart for years. Who knows, maybe Edwards's assistant bought the 10-year-old little girl a coat and a sandwich while he/she was at Wal-Mart.

"The Two Americas" guy must be trying to outdo Wal-Mart now that he's built himself a 28,200 sq ft home, bigger than our local Wal-Mart.

Or maybe he's planning on having the Two Americas over for a party: Dean Barnett says the manse has

an indoor recreation building that contains a basketball court, a squash court, two stages, a bedroom, kitchen, bathrooms, swimming pool, a four-story tower, and a room designated "John's Lounge."

Two stages: the better for practicing those campaign speeches? Who'll be at the other stage?

Hmm.

Casa de Fausta has one shed that houses the lawnmower and the sports and camping gear. And my "main house" has three johns, but no "John's Lounge". On the other hand, The Husband pays more attention to me than what he does his hair, a preferrable situation for all involved.

If Edwards expects people "to find comfort with someone who's being straight with them" - meaning himself - he must really believe that Everyone loves a good hypocrite.

Special thanks to the friend that sent the photo

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Note I seem to be having the same email problem I had a few days ago where I send one email and the recipient gets multiple copies. My apologies for the inconvenience.