Saturday, August 18, 2007

Credit Markets

I'm way over my head in the current credit turmoil that seems to be roiling the markets, and I certainly sympathize with Friedrich von Blowhard's concern that "the Fed seems to be working its limited rhetorical tropes pretty hard to avoid the suspicion that they're acting to bail out people in the financial service industry who have made pots of money making, securitizing and investing in ridiculously lax loans to questionable borrowers".

Cure, in the comments section, has a good response where essentially he says that the Fed's interventions are similar to the government stepping in to prevent a bank run. True crises of liquidity, where the underlying assets are sound, are different from crises of insolvency, where the underlying assets are not sound. In the former case, it makes sense to offer short term loans to smooth over the bank run, in the latter case, it makes sense to liquidate the assets so they can be put productive use somewhere else.

I don't know how to judge Cure's comments, they seem quite reasonable, and I also very much liked liked Tanta's post on Calculated Risk. In particular, she makes it very clear that the underlying asset here is a mortgage, and those rooting for a "let the defaults default" approach are grabbing the wrong end of the political stick.
Do you really want to live in a world in which mortgage servicers--I'm talking mortgages, kids, the loan for the roof over the family's heads here, not your basic yacht financing--work on the "collect payments or foreclose, no judgement exercised" basis? You like doing business with outfits like that? You happy calling up the customer service line and getting some untrained bored squirrel on the other side who tells you nothing can be done if you're not late, but that nothing can be done if you are late? You like paying .25-.50 extra in interest every month so that your mortgage servicer can act like Major Major? You think it's not bad enough that we made 100% loans to people, giving them little incentive to repay the debt, we should make it worse by giving them no hope if they try to pay it? You think people who are asking for forbearance should be told just to walk away?
Great point.

It's clear from a public opinion perspective who the winners and losers should be. Everyone feels sorry for the low income borrower who bet on their house price rising, and is now stuck with a monthly mortgage they cannot repay. No one feels sorry for rich financiers who get paid big buck$ just for showing up. I have no idea how you help group A without bailing out group B.

I would also add that the above analysis leaves out the lowly renter. Homeowners make up about 70% of the US population, leaving a reasonable chunk of people who rent. I've argued earlier that renters are essentially short housing, and they've done very badly in the great housing run-up of 2001-2006. If house prices do not return to their historic levels, these folks will bear a permanent loss.

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