Tuesday, September 30, 2008
Everyone pays taxes and everyone is the taxpayer. When a blowup happens, it's the taxpayer who will pay. When there is economic destruction, the taxpayer pays. (And, conversely, when we pay taxes there is economic destruction… generally.)
Now that we've dealt that, who should they pay?
Should they pay borrowers, who didn't realize that living expenses might go up but their wages wouldn't, so they might want to default?
Or lenders who didn't expect the borrowers’ wages to stay low and prices to go up, leaving them less to make payments with?
Should we pay the flipper, who bought houses, hopefully with the intention of improving them and quickly selling? He didn’t know costs would go up and home values would go down, decreasing the return on his now costly improvements.
Or should we pay the lenders, who loaned to flippers at low rates, but put a ballooning interest rate on the loan so that the flipper would sell to someone else if he didn’t improve the property fast enough? He didn’t know that improvement costs would go up and tightening budgets would cause home prices to go down.
Or should we pay the banks, who bet that they would not see default risk go up, bet that they would receive sub-prime principal in lump sums, bet that they would not see sub-prime principal payments in installments after 2 years, bet that they would not see interest payments at ballooned rates, then borrowed on those bets and bet bigger?
Best and Worst Case Scenarios
Nothing is done. Banks, afraid to lend to eachother and faced with watching their assets depreciate, loan to good borrowers with higher down payments or collateral and lower interest rates. Portions of loans with 6% or higher interest rates are refinanced at a lower rate, probably around 4%, on the existing value of the house or other collateral, the owner must pay the portion of the principal not covered by the current value of the house at existing terms, but the current rate is locked in. Owners deemed too risky at the new low rates default. Some banks holding mortgage backed securities that are dependant on the cash flows on the portion of the loan refinanced and on defaulted loans go bust. The assets of failed banks are sold off and the debts are nationalized. Inflation is kept in check, so costs of living do not increase relative to income, so default risk goes down. Commodity production increases to take advantage of recent rises in prices, continuously rolled over long positions on commodities are seen as untenable long term investments. Money is moved away from commodities, and prices of consumables fall. Default risk further decreases and some risky assets become valuable again.
And now the Worst Case:
Bailout happens. Inflation increases, but home values continue to decline and wages remain flat. Home owners, with budgets already crunched beyond expectations, are burdened with even higher costs of living and default risk increases greatly. Defaults increase and home prices fall more. The bailout causes the interest rate the government borrows at to go up, moving money away from businesses and causes banks to expect higher interest rates from home buyers, putting further downward pressure on home prices. Scared money also goes from home and business loan to continuously rolled over long positions on commodities, which people expect production not to increase for but demand to remain. Prices go up relative to income, and default risk goes up....Credit markets freeze up within the next week and many businesses cannot meet their payrolls. Margin calls cannot be met and the NYSE shuts down for a week. Hardly anyone can get a mortgage so most home prices end up undefined rather than low. There is an emergency de facto nationalization of banks to keep the payments system moving... There is no one to buy up the busted hedge funds, so government and the taxpayer end up holding the bag. The quasi-nationalized banks are asked to serve political ends and it proves hard to recapitalize them in private hands. In the very worst case scenario, the Chinese bubble bursts too.
Here are Tyler Cowen's
And Commentary at Megan McArdle's
Update: via commenter Nelson at Megan's Industrial Companies Can Thank Banks for Lower Rates.
Money-market funds that gorged on the debt of financial companies are now pouring cash into Treasury bills and corporations which avoided the troubled mortgage bonds that contributed to the failures of New York-based Lehman Brothers Holdings Inc. and Washington Mutual Inc. of Seattle. Yields on 30-day non-financial commercial paper dropped to 1.86 percent on Sept. 24, the lowest since November 2004.
Lower short-term rates are proving irresistible to companies that haven't relied on borrowing, or leverage, to pump up profits.
General Electric Co., the world's biggest provider of aircraft leasing, jet engines, power-plant turbines, medical imaging machines and locomotives, is having no problems accessing the short-term debt market even though about half of its business comes from lending, Chief Financial Officer Keith Sherin said on a conference call with investors Sept. 25.But, then there's also this (via Instapundit):
Places off limits areas within fifty miles of the coast line, where 80 percent of the oil and gas deposits are. This bill, if it becomes law, will place these energy rich areas off limits permanently.
* Places off limits such energy rich areas as the Destin Dome off Florida and the super-rich areas off the coast of California on a permanent basis.
* In a gesture of what she probably thought was courage, Speaker Pelosi allows drilling on seven percent of the acreage offshore in the most difficult, deep water areas, one hundred or more miles offshore.
* If state legislatures sign on, drilling would be allowed in a further 12 percent of the untapped areas between 50 and 100 miles offshore -- again, difficult areas to explore and difficult areas in which to drill.