By Dan McLaughlin, on December 3rd, 2008
Most of the present day economists are the modern equivalent of the high spirited inventors of prior times, bent on designing a perpetual motion machine. Perpetual motion enthusiasts were convinced they could get around the laws of physics to produce motion without any external source of energy, even though those laws had long been identified and deny any possibility of success. In the same way, most modern economists tinker around with things economic with the belief that he or she knows better and can get around the immutable laws of economics, which have also been established long ago.
They tinker with taxes, government payments, regulations, price controls, market manipulations, etc, even though they fly in the face of the fundamental laws of economics and have been proven wrong in precisely every instance. You cannot artificially set maximum prices below the market price without causing shortages. You cannot artificially set minimum prices above the market without causing surplus. You cannot regulate supply, demand or anything else in the market without paying the price of a grossly distorted market and misery for at least some people, not in even one instance.
In the free market, both parties gain from a transaction. If it was not so, the transaction would not take place.
That is the very nature of a truly free market. Every member is free to enter or not enter into a transaction, whether it is buying a house, a loaf of bread or a tank of gas. The very fact that the transaction is consummated is absolute proof the buyer valued the good or service more than the money and the seller valued the money more than the good or service. The buyer or seller might not be happy that the price was not lower or higher, depending on perspective, but it was obviously the best use of resources, given existing conditions and knowledge.
When government interferes, with taxes, incentives, subsidies, stipends, payments, regulations, services or any other intervention, it picks the winner, the person who will benefit from it’s beneficence. But the only way to pick the winner is by also picking the loser, directly or indirectly. Government is a less than zero sum game, a negative sum game. Something, usually a lot, gets lost in the translation in every government action.
The big difference between the perpetual motion “engineer” of yesteryear and the social “engineer” of today is that the former was playing with toys, things that didn’t have much effect on others. The latter is very dangerous because his or her irresponsible and ill fated experiments affect millions, even billions of people.
The laws of economics are known and are just as immutable as the laws of physics. You can choose to ignore them, or hide them in a mountain of numbers and reports and public relations fluff, but you cannot choose the consequences of ignoring them, any more than you can ignore gravity when you drive off a cliff. History is full of lessons about political leaders who chose to ignore the simple, fundamental laws of economics. The reason that history repeats itself is because people in power, and their economic advisors, like to tinker, even though the punishment is predictable and inevitable. It often becomes obvious that they do know the consequences all too well, but they also know that they will be on the winning side and not be the ones to bear the punishment.
Guess who is always on the losing side.
By Dan McLaughlin, on December 2nd, 2008
I recently heard a very knowledgeable, influential person talking about the future. He had many insights that were helpful and valid. His economic views, however were quite disturbing. He made a comment to the effect that capitalism is immoral. He pointed to the fact that many people have been hurt by capitalism and that it is morally bankrupt. You can’t count on people doing the right thing.
This is an intelligent man, someone who is aware, who’s job it is to look behind the façade to see what is really happening. This is also a man who is a consultant, a businessman, an entrepreneur, a profiteer and , in leftist radical terms, a capitalist pig. It is difficult to imagine that he is unaware of that fact. He is, in essence, an example of what is good and moral and right about capitalism.
He offered his service and he was paid very handsomely. The participants went away with something of value. He has clients all over the world that also pay him a lot of money, and I would expect that he is very busy because he gives something worth paying for. That is the essence of free markets, another name for capitalism, people trading freely with others who are willing to deal with them.
He is a small scale capitalist, but size doesn’t matter. Whether the market is for a gallon of milk or a billion dollar manufacturing plant, as long as the parties to the transaction are free to make their own decisions and use their own resources, economic freedom gives the best result. Consistently good judges of value and of the future are the most profitable and contribute the most to society. The only exceptions are those businesses that use government coercion for their profits, rather than market competition. They are the source of injustice in the markets.
Our consultant friend was committing the error that so many people commit these days. They assume that the markets are actually free because that’s what they have been told. They assume that economic freedom is the source of the problems. The natural inclination with that frame of reference is to look for government to save the day. He refuses to see that there isn’t a single market in this country that is truly free. Further, the markets that are experiencing the most disastrous problems are the ones that are most seriously impaired by government manipulation.
When our futurist cited his sources of economic understanding, it became clear as to why he was so far from the economic truth. Economist Joseph Stiglitz was a key reference in the economic analysis. He is one of a breed of influential economists who have been trained in the discipline of central planning. As intellectual superiors, they know how things should work. For this group, the stated aim of economics is to guide government intervention to bring economic nirvana to the people. Lowly peasants don’t know what is good for themselves, so they need the experts to cram it down their throats.
These economists lead intelligent but unwitting people to believe that banking deregulation caused the credit crisis. They say that the boom-bust cycle is an inherent evil of capitalism and that free markets lead to exploitation of the masses. What they don’t say is that the entire banking system is built on a foundation of government manipulation of banks, prices and markets. The Federal Reserve Bank directly and indirectly controls interest rates and monetary policy, the sources of economic instability. Artificially low interest rates initiate and expand credit and asset bubbles. We are living through the latest Fed induced bubble and crash as I write this. The Fed is, at this moment, laying the groundwork for the next big bubble and crash in 5 or 8 or 10 years, which may be worse than what we are experiencing now.
Our world traveling consultant seems to be a brilliant man. He has the answers to many questions and has a good grasp of technological and demographic trends. When it comes to economic understanding, however, it seems that he is missing the obvious. He imputes injustice on capitalism when it is, in fact, the only road to true justice and prosperity. “Capitalist pigs” like him are the reason that all people, rich and poor, are better off in free economies. His comments only empower the enemies of freedom. Moreover, his indictment of capitalism is an indictment of himself. Neither he nor capitalism deserve such treatment.
By G.L.C., on November 14th, 2008
In an attempt to resolve the present credit crisis, the United States government has taken many steps. Since September, it placed Fannie Mae and Freddie Mac, the mortgage giants under conservatorship, taken a majority stake in the American International Group and passed a $700 billion rescue package for the financial sector. The Treasury is injecting $125 billion into the nation’s nine largest banks.
One cannot accuse the government of being a mute spectator. But what everyone wants to know is will these efforts and the rescue plan succeed?
No doubt everyone wants it to succeed. At the heart of the rescue plan is an effort to keep the credit crunch from sending the economy into a tailspin. The economic downturn is going to be much worse if the financial system doesn’t get working again.
Somewhere in all this, one thing seems to be forgotten – the rescue plan and efforts doesn’t directly address the root cause of the crisis: falling home prices. It was the falling home prices that ultimately resulted in the present crisis. According to the National Association of Realtors, home prices are off 12 per cent from their peak and are expected to fall an additional 10 per cent to 15 per cent between now and mid-2009. Much needs to be done to stimulate demand for homes and to reduce mortgage delinquencies and foreclosures.
The steps taken by the government so far does not do anything to stop the spiral in home prices. This is reducing net worth and creating a falloff in consumer spending. To stimulate demand for homes, the federal government could offer low-interest loans to replace 20 per cent of homeowners’ mortgages. It is unlikely that the crisis will be resolved without addressing falling home prices.
Falling home prices leads to an increase in mortgage delinquencies and foreclosure. Many homeowners end up owning more on homes that their current worth. They then default on their mortgage payments causing foreclosures. The rise in foreclosures results in a negative market psychology. It is a vicious cycle.
The supply of homes on the market remains stubbornly high, while demand for those homes remains relatively weak. The $7,500 tax credit passed by Congress in July has failed to jump-start home sales.
Another factor which led to the present crisis is the total breakdown in the integrity of asset valuations. The government efforts do not address this. The government has not yet disclosed the pricing logic on which the US government will purchase bad debt from faltering financial institutions. It now appears that the prices will be determined on a case by case basis.
While some lawmakers want the government to exert influence over private companies in which taxpayer money is invested while some are calling for a ban on lobbying activity, bonuses and perks among the companies that have been bailed out by the government, nobody has suggested taking remedial action to rectify either the impaired status of asset valuation techniques.
Lawmakers are probably aware of the need to revamp asset valuation methodologies but they lack the will and fear the explosive political impact of any efforts that will directly challenge the qualifications of real estate brokers, appraisal specialists, bank managers, certified accountants, project engineers, corporate monitors and financial analysts.
By Bhagwad Jal Park, on November 7th, 2008
Today, we are going to discuss an interesting phenomenon in the world of game theory: namely, adverse selection. Frequently, game theory attempts to isolate and analyze curious phenomena and detect the essential elements that make it work. We can then try and manipulate these element to steer the game in a chosen direction.
The phenomenon of adverse selection occurs when several people are trying to obtain a particular goal, and the criteria which make the person either suitable or unsuitable to obtain that goal from the point of view of the entity and from the person trying to obtain it are diametrically opposite.
Let us take the example of a company who is trying to project to the world that only the most stylish and fashionable people wear their watches. To accomplish this, it decides to selectively sell their watches only to the most fashionable people in the world. From the point of view of the watch company, the people who must wear it must be really stylish and fashionable. However, the people who will most want to wear the watch will be wannabes. The wannabes will benefit most from the watch since, if they have the watch, they will be projected as stylish and fashionable. Hence, the watch company must be very suspicious of anyone who desperately wants to wear the watch.
Those who are really stylish and fashionable will not want to wear the watch so badly since their reputation is already made and they gain little from wearing it.
Adverse selection is characterized by the fact that people who most want to obtain something are typically the least worthy to have it.
Image Credit: stark23x
This manifests itself beautifully in the case of insurance companies. Regardless of what anyone says, insurance is essentially gambling. Insurance students will cut my throat out for saying this, but when all the smoke clears, it’s pretty obvious that when you take out an insurance, you’re hedging your bets.
Since insurance companies want to maximize their profits, they will want to have the odds stacked on their side. This means that they will want to give insurance to people who are least likely to demand a payout from them. On the other hand, those who most badly want insurance will be the people who are most likely to demand a payout.
A person who is old and has several ailments would love to have cheap insurance, whereas a young man in perfect health will have less to gain. However, insurance companies want the young man to sign up for insurance and not the old person. This is adverse selection in its most characteristic form.
It’s actually somewhat tragic. Giving insurance only to those who don’t want it completely defeats the purpose of insurance from the customer’s point of view. What’s the big idea of refusing insurance to those who need it most? That’s like selling pizza to a person who isn’t hungry! However, adverse selection doesn’t apply in the case of pizza.
Since insurance companies don’t play fair by testing people and even excluding some people from insurance based on their riskiness, the people who want insurance are perfectly justified in trying to fool the insurance companies by hiding their ailments. It’s a dance, and the outcome all depends on whether the insurance company can discover the hidden ailments of the person or not.
There is no stable solution to this. In other words, no Nash equilibrium exists. One of the parties will always wish that they had – or didn’t have – insurance, or the insurance company will always wish that they had – or didn’t have – a certain person’s business. A zero sum game. In the end, both parties can be happy only if they assess the situation differently. That is, each thinks that they have outwitted the other.
By J.D. Seagraves, on October 29th, 2008
Last week, I looked at the first five planks of Karl Marx’s Communist Manifesto and the extent to which they have been integrated into the U.S. government. This week, I’ll examine planks 6-10.
6. Centralization of the means of communication and transport in the hands of the State.
Check. We have the Federal Aviation Administration (FAA), the Interstate Commerce Commission (ICC) and government ownership of Amtrak, the U.S. Interstate Highway System and its centralized funding, and the Federal Communications Commission (FCC) to regulate everything from radio and TV to telephones. Even satellite radio is regulated by the state, limiting the band to just two stations (Sirius and XM) who then had to ask the government’s permission to merge.
7. Extension of factories and instruments of production owned by the State; the bringing into cultivation of waste-lands; and the improvement of the soil generally in accordance with a common plan.
President Truman socialized the steel industry in 1952, reasoning that steel was vital to America’s defensive interests. With a military-industrial complex so vast, what isn’t “vital” these days? Regardless, the Supreme Court rejected this Marx-like expropriation after the fact. Would today’s SCOTUS remain as true to the Constitution? The EPA and various environmental regulations do much of what’s included in the second half of the plank above. Overall, we’re not quite there on #7 — a half-hearted cheer (perhaps more of a whimper) for capitalism.
8. Equal liability of all to labour. Establishment of industrial armies, especially for agriculture.
Both John McCain and Barack Obama favor some type of mandatory “national service.” The Army Corps of Engineers is a psuedo-industrial army. FDR’s WPA projects would certainly fit the bill, and as the current recession turns into a depression, don’t be surprised to see the next president reinstitute public works projects.
9. Combination of agriculture with manufacturing industries; gradual abolition of the distinction between town and country, by a more equable distribution of the population over the country.
Various zoning, anti-”sprawl,” and “smart growth” policies fit the bill here.
10. Free education for all children in public schools. Abolition of children’s factory labour in its present form. Combination of education with industrial production.
Just as with plank #5 (”Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly”), the U.S. passes this test with flying colors. Not only is education in America “free and cumpulsory,” it is also federally controlled, now more than ever thanks to the disastrous No Child Left Behind. Anti-child workplace discrimination was codified by various “progressive” reforms in the early 20th century — long after most child labor had stopped, voluntarily, as living standards rose thanks to the free market — and today’s schools meet an updated version of combining education with “industrial production” in that they’re designed primarily to train children to be “good” employees.
In Conclusion
Karl Marx was a brilliant man who properly diagnosed the ills of what he called “capitalism” — a system in which the rich and propertied classes were given legal sanction to plunder the poor and working classes. Marx believed that all nations with “capitalism” (as he defined it) would eventually disintegrate into socialism and then the true worker’s paradise of Communism. The five tenets above, along with the previous five, were the preconditions that Marx thought needed to be met before a “capitalist” nation could become socialist (and then Communist). We’re almost there.
But as brilliant as Marx’s analysis of “capitalism” was, his solution — Communism — was utterly off the mark.
What we need in America is true capitalism: a system of peaceful and voluntary exchange, wherein capital is employed in the best interests of its private owners and without government interference. To the extent that capitalism and its Invisible Hand are allowed to operate, living standards of all from the poorest to the richest are improved. To the extent that the government intervenes, we become more like Marx’s version of “capitalism” and take another step on the road to his nightmarish vision of the total state.
By Lee Jamieson, on October 23rd, 2008
When compared to more traditional investment options, the contemporary art market is highly inefficient – but this hasn’t dampened the enthusiasm of buyers and investors.
The contemporary art market has left its critics standing. Many presumed that it would be one of the crisis’ first victims as collectors tightened their purse strings and investors redirected their funds to safer areas. Yet somehow, the art market has boomed beyond expectation.
It is ironic that, in this period of economic turbulence, this inefficient little market has become more stable than the giant financial institutions. On the same day that Lehman Brothers filed for bankruptcy, Sotheby’s auction house raised nearly $100 million for the work of British artist Damien Hirst.
Many in the media have viewed the art market’s boom with suspicion since the start of the crisis, and they have been keen to pounce every time a market correction occurs – corrections are to be expected from any fast-growing market. They have presented the market’s success as a mystery and suggested that the market has somehow become disconnected from the underlying economy.
But the art market is not disconnected – it cannot be. Rather, it is a perfect reflection of the current state of the global economy.
New Art Investors
A new breed of collector is stalking the auction house: many corporate investors have increased their exposure to fine art in an attempt to diversify away from the financial markets. You would be forgiven for presuming that art is a high risk investment considering the subjective nature of art appreciation, yet corporate investors have brought with them more reliable valuation methods to an industry reliant on historical post-auction data.
A whole industry has sprung up around the needs of these corporate investors: there are now a number of fine art funds that trade artwork as you would any other commodity and indexes with which to more accurately anticipate future trends. Earlier this year, intelligence provider Artprice.com launched its Art Market Confidence Index, aimed at providing serious investors with more reliable metrics for the art market.
Many buyers are using art purely as a tool for financial gain which, in turn, has pushed up the price of the market. It is sad that the growth of the market has made it difficult for legitimate museums and public galleries to purchase new stock; a larger proportion of our international art heritage is finding its way into private collections. Of course, private collections are nothing new, but is the financial motivation behind the purchase (and therefore the price) changing the way we look at art? Should we be worried when art becomes nothing more than a commodity?
New Art Collectors
Salvation comes from an unlikely source. The image of the elitist western collector is slowly being eclipsed by the cash-rich Russian oligarch – reportedly, a third of the buyers at the Damien Hirst auction mentioned above were from the ex-Soviet Union.
These new Russian buyers have injected the art market with liquidity. Although the investment potential of art may influence their purchases, their primary interest is aesthetic – they are in search of unique and sophisticated items to complement their luxurious lifestyles and new-found wealth.
The art market has boomed because it has attracted these new breeds of investor and buyer. In this respect, the art market has not disconnected itself from the realities of the global economy – rather, it reflects the global shift in economic power: western capital is moving away from financial institutions into other areas, oil and gas-rich BRIC countries have a major economic advantage and investments from cash-rich countries are cushioning the downturn in certain sectors.
Perhaps the ultimate lesson to be learned about our economic system is that, given time, all bubbles burst. Time will tell.
By J.D. Seagraves, on October 22nd, 2008
All nation-states reside somewhere on the continuum between laissez-faire and total-state central planning. No country is completely capitalist and no country (with the possible exception of North Korea) is entirely socialist. So how are we to define roughly “capitalist” and “socialist” countries? Where is the dividing line? How do we know if we are still a capitalist country?
Ludwig von Mises said the difference between a roughly capitalist country and roughly socialist one was a functioning stock market. In a socialist country, Mises said a market simply could not function. With the recent unprecedented interventions into the economy, the stock market isn’t functioning. Is this a temporary setback or have we passed a crucial threshold into socialism?
In this first of a two-part blog series, I will examine how the American system compares to the 10 planks of Karl Marx’s Communist Manifesto . According to Marx, these were the ten preconditions a country needed to meet before transitioning from capitalism to socialism.
1. Abolition of property in land and application of all rents of land to public purposes.
We still use the term “real estate,” which is derived from the historic “royal estate,” meaning that royalty (the government) was the true owner of all lands. Although the U.S. has a noble history of homesteading and laissez-faire, we now impose property taxes on the supposedly private property of individuals and evict them if they don’t pay. That sounds an awful lot like the rent system of feudalism and Marx’s manifesto.
Eminent domain further calls into question whether people really own their land. The Constitution, itself a step away from the comparative laissez-faire of the Articles of Confederation, gave the federal government the authority to seize private property for public purposes. Now, thanks to the Supreme Court’s Kelo Decision, government at all levels can take “your” land and give it to Wal-Mart for the “public purpose” of “economic development.”
2. A heavy progressive or graduated income tax.
Although the top marginal tax rates have dropped considerably from the peaks above 90%, the graduated income tax is a staple of the U.S. economic order. Barack Obama would raise taxes on the wealthiest, making the tax code more “progressive,” but John McCain wouldn’t undo the progressivism of the code: it’s here to stay.
3. Abolition of all right of inheritance.
We still have the right to transfer property upon our deaths, but that right is subject to taxation. Still, not “all rights” of inheritance have been abolished, so I guess we fail to meet Marx’s third condition.
4. Confiscation of the property of all emigrants and rebels.
We don’t quite meet the grade here, either. No one dare act in open rebellion to the all-powerful federal government — we haven’t had any “rebels” since the War Between the States, in which the North followed Marx’s prescription and confiscated the property of rebels. Marx, it is said, was an admirer of Lincoln.
5. Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.
There’s no ambiguity whatsoever here: we have exactly the system Marx envisioned in the Communist Manifesto. And what’s more, there’s literally no disagreement on the matter between the nation’s dominant political parties.
Credit is centralized in the hands of the Federal Reserve, the country’s national bank. The Federal Reserve System acts as a cartel with an exclusive monopoly on credit and money creation. Thus, the government can easily fund pseudo-Marxist schemes via its printing presses — which has allowed it to cut back on Marx’s heavy progressive tax code. Even Marx could not have imagined the willingness with which people all over the world trade real goods and services for essentially worthless paper notes. In this area, we’ve out-Marxed Marx!
Next time, I’ll look at the remaining five planks:
- Centralization of the means of communication and transport in the hands of the State.
- Extension of factories and instruments of production owned by the State; the bringing into cultivation of waste-lands; and the improvement of the soil generally in accordance with a common plan.
- Equal liability of all to labour. Establishment of industrial armies, especially for agriculture.
- Combination of agriculture with manufacturing industries; gradual abolition of the distinction between town and country, by a more equable distribution of the population over the country.
- Free education for all children in public schools. Abolition of children’s factory labour in its present form. Combination of education with industrial production.
By G.L.C., on October 22nd, 2008
An auction rate security generally refers to a debt instrument with a long-term nominal maturity for which the interest rate is regularly reset through periodic auctions. It allows issuers to borrow for the long-term but at lower, short-term interest rates.
The auction-rate securities market involved investors buying and selling instruments that resembled corporate debt whose interest rates were reset at regular auctions, some as frequently as once a week. They were sold as being safe as cash.
Over the years, auction-rate securities became popular among investors looking for cash-like options with slightly higher yields than money-market funds and certificates of deposit. The investments—in reality, long-term bonds—were considered more like short-term debt because they could usually be sold at weekly or monthly auctions.
In August 2007, investors began pulling out of the auction-rate-securities market. It seized up earlier this year when Wall Street firms who kept auctions from failing by stepping in to buy any unpurchased securities stopped supporting the market en masse, leaving millions of investors without access to investments they believed were nearly as liquid as cash. Tens of thousands of investors nationwide — including institutional and individual investors, cities and towns, charities and small businesses — were left holding damaged, illiquid securities when the market collapsed.
The U.S. Justice Department is now ramping up criminal investigations into the collapse of the auction rate securities market. Federal prosecutors in Brooklyn,New York , are looking at whether Lehman Brothers Holdings Inc. defrauded its clients by dumping auction-rate securities into their accounts before the market broke down despite knowing the market could collapse. The prosecutors are probing Lehman’s handling of investments for two brothers, Brian Maher and Basil Maher. The brothers sold their family’s billion-dollar shipping business and invested some of the proceeds with Lehman. They lost access to $286 million that was tied up in the securities when the auction-rate market collapsed. Another issue being probed is whether the firm used clients’ money to purchase the securities to prop up auctions that might otherwise fail.
Federal Prosecutors are also probing the role of UBS employee David Shulman to decide whether to charge him with insider trading for selling his own holdings of auction-rate securities ahead of that market’s collapse. Shulman ran the auction rate securities business for UBS. As the credit crisis began to scare away buyers for many types of securities, UBS began to buy up the securities so that the auctions, which the firm ran, wouldn’t fail. Shulman was under pressure from UBS executives to reduce the firm’s holdings of the product, and he allegedly helped mobilize UBS brokers to sell more of the securities to customers as safe cash alternatives, despite his knowledge that the market may not hold up. Around the same time, Shulman sold more than $6 million of his own inventory of auction rate securities.
So far, most investigations have been about the role played by institutions and banks. These investigations are among the first to look at whether individuals committed crimes as the market collapsed in the credit crisis – a step in the right direction.
By Evelyn Black, on October 20th, 2008
A recent article splashed across the front page of the mid-size mid-western city where I live tells a surprisingly unfamiliar story about how ordinary people have pocketed hundreds of thousands of dollars by investing in subprime real estate. Though the current financial crisis has brought about intense discussion about the moral hazard of borrowing beyond one’s means, as well as the irresponsible underwriting that went hand in hand with the subprime borrowing fever, much less attention has been paid to the phenomenon of mortgage fraud.
We know mortgage fraud mushroomed during the boom times of subprime loans. Yet it continues to hover just off the main radar screen, remaining conveniently just outside of public awareness. What exactly is mortgage fraud anyway?
In the case recounted in my local paper, two men–let’s call them Mr. Smith and Mr. Jones–decided to go into the real estate development business by buying up properties in depressed neighborhoods, ‘flipping’ (that is, renovating) the houses they bought, and then selling the houses or renting them out and thereby making a profit on their investment.
So far, that doesn’t seem like a bad idea, especially when credit is readily available and the houses in question are close to a university or a major manufacturing center, or are part of a boom market like some areas in Florida or California. We’ve all watched TV shows on the Learning Channel and on the Discovery Network that chronicle the adventures and misadventures of these flipping entrepreneurs, and many of us have vicariously enjoyed their journeys while eating Cheetos and keeping our own hands soft and clean.
What we don’t see, however, are the house flippers who never flip, never sell, and then default on the loans.
Here’s how it works:
Mr. Smith buys a home in a slum neighborhood for $20,000. He hires an appraiser to value the home at $80,000. The appraiser is committing a crime at this point–the house is not worth $80,000 in anyone’s imagination–but the appraiser and Mr. Smith know each other and are working together to defraud the mortgage industry. Mr. Jones comes along and offers to buy the house (which is actually worth $20,000 or slightly less but is now appraised at $80,000) for $100,000. Mr. Jones is a ’straw buyer’. He doesn’t really want to own the house; he is working with Mr. Smith and the fraudulent appraiser.
Mr. Jones approaches an out-of-state mortgage broker who, not knowing or caring too much about the value of local real estate, is only too happy to make Jones a loan of $80,000 or even $100,000. When Mr. Jones explains he will be improving and then reselling this hot property, the broker envisions repeat business and repeat commissions when Jones buys and flips his other houses.
Mr. Jones then repeats this same process with a dozen or more other properties, all in league with Mr. Smith and his fake appraiser. They pocket the profit on the homes ($60,000 or $80,000 on just the first one alone) and then Mr. Jones proceeds to default on every single mortgage, sticking the out-of-state company who wrote the first mortgage with a $100,000 debt on a nearly worthless house.
 Although FBI tables show that mortgage fraud has increased dramatically in recent years, the cases that are actually investigated are really just the tip of a very large iceberg. The FBI doesn’t have anything close to the staff it needs to launch a thorough and comprehensive investigation into this kind of scam because of the sheer volume of cases since 2006 alone.
In my own town, with our own local Mr. Smith and Mr. Jones, neither man has ever been formally charged with anything and neither have paid anything to the mortgage companies that made them the loans. The FBI will neither confirm nor deny whether the two of them are under investigation for fraud. These two men, under their own initiative, have purchased, sold, and defaulted on over 60 homes in the worst neighborhood in this city over the past two years for a net profit of over $1.5 million for Mr. Smith and over $750,000 for Mr. Jones. Their defaults account for more foreclosures in that specific neighborhood than all the other individual foreclosure cases combined.
Both Mr. Smith and Mr. Jones now claim to be disabled and speak to the press only through their spouses, who both insist no wrongdoing has occurred. None of the homes were ever rented or improved. All of them are currently vacant and in a state of serious disrepair. Mr. Jones never took out a single building permit. He claims that he planned to do the work himself but health issues intervened.
Is it possible that these two men are just a couple of enterprising fellows who fell down a flight of stairs at the same rather convenient time? I guess so. Is it likely?
What do you think?
A new and particularly nasty wrinkle on this scheme is called foreclosure fraud. While many different scenarios can be set up, by far the most common involves a ‘foreclosure rescue’ agency that approaches (or is approached by) a longtime homeowner behind on his or her house payments. You’ve probably seen signs posted around your town that say, “We Buy Houses!” Many of these agencies are set up to defraud people in danger of foreclosure. If you try to track them down or investigate them, all you will find is a list of post office boxes and vague nonspecific names attached to no specific person.
Here’s how it works: The foreclosure rescue agency offers to buy the house from the mortgage company about to foreclose on the property and then rent it to the homeowner for a set period of time, during which the homeowner hopes to improve his or her financial situation. At the end of that mutually agreed-upon period (typically two or three years), the foreclosure rescue agency promises to then resell the property to the homeowner on terms they can actually afford. The rescue agency claims to make their money on fees and appreciation, the people get to stay in their house, and everybody is happy.
Except, what really happens is that the minute the homeowners sign the house over to the ‘foreclosure rescue’ folks, the rescue agency runs right out to the easiest lender on the farthest block, cashes out the equity in the home, then disappears off the face of the earth, leaving the homeowner still about to foreclose and owing more in some cases than the house is even worth.
 Foreclosure fraud is off the charts in recent years and is growing so fast no one is quite sure how many people have been hit. If you are in danger of foreclosure, read up on some of the most common schemes before you agree to talk about your situation with anyone except your original lender.
As we listen to the most recent attempts to bail out and/or stabilize the U.S. economy, we have also been hammered by lots of campaign rhetoric meant to push our emotional hot buttons by assigning blame for the current mess to individuals we might already mistrust or dislike: certain ethnic groups, minorities, members of certain financial occupations, Wall Street bankers, mortgage brokers, Democrats or Republicans, and so forth. What we are witnessing is a veritable frenzy of blaming, and it gets to be contagious. For some reason, it feels reassuring in times of crisis to find a scapegoat, to blame somebody, anybody, for what is happening. Blame, when properly or improperly placed, always creates the illusion of control. We think that if we find the right person or persons to blame, we can then proceed to hold them accountable and then fix the problem at hand.
While the need to assign blame is completely understandable, especially in an election year, it unfortunately obscures the sheer volume of criminal activity that took place at every level of commerce during the height of the housing bubble. Even at the most basic level–the level of buying a single house–an underpaid local reporter was able to uncover millions of dollars of what was, for all intents and practical purposes, most likely out and out fraud. And that’s just in one small mid-western city. All the poor people on that entire side of town didn’t cause as much damage as those two guys and their fast thinking. And that’s at the very lowest, most transparent level of the whole mess. Now multiply that scenario by every city in the U.S., and square with every level of finance and speculation, and you’ve got the mother of all criminal messes.
So far, few people are going to jail for any of this. But maybe at some point a few should.
At the very least, it’s food for thought.
By Cheryl Grey, on October 17th, 2008
Traditional global credit markets have frozen, and they’re proving difficult to unstick. Under-capitalized banks are not keen to lend out what’s left on their balance sheets—not even and sometimes especially not to each other—and the value of the U.S. currency has risen steeply relative to those of other nations as banks around the world hoard greenbacks to shore up their reserves.
Few consumers are yet being hit hard enough to hurt except those who let the euphoria of easy credit tempt them too far. But the largest danger for the national economy lies in the companies large and small that provide employment, many of which depend upon short-term credit to fund their day-to-day operations.
Corporations that would normally issue commercial paper to finance their capital needs have been disappointed lately, as the market for such short-term debt fell by 11% over the past four weeks, according to the Federal Reserve. Granted this is a volatile data series; however, a fall of U.S. $22 billion in one month is still painful. Research conducted by Greenwich Associates reports that 45% of large corporations and 67% of medium-sized ones have located fewer buyers for their CP, while companies which have been able to sell their debt report that the cost of doing so has risen, in some instances significantly, to further increase the already steepening cost of doing business. Whether the Fed’s plan to bulwark the CP market will bear success remains to be seen.
The Fed’s most recent survey of senior lending officers reported that 65% of domestic banks have raised their lending standards for business loans in all categories, while a recent survey by the National Small Business Association claims that 67% of U.S. small businesses have been affected by the credit crunch, up from 55% in April.
So if the banks aren’t lending, what’s an established small business with the opportunity and desire to expand supposed to do? For that matter, what about the entrepreneur with a great idea? That other “business loan” traditionally employed, the owner’s credit cards, is looking increasingly problematical even if the owner can convince the loan officer to raise the credit limit.
Enter Alternative Financing
Americans are amazingly adept at finding new ways of financing their businesses. Two of the newer methods available are business cash advances and peer-to-peer lending via the Internet.
Unsecured business cash advances drawn on future credit card sales are becoming increasingly popular among small businesses. The funds are generally available within days rather than the weeks required for banks to sort through their paperwork, and because the funds are based on “plastic” sales to be made in the future, not on credit utilized in the past, no credit check is required. Think of them as payday loans for businesses.
Peer-to-peer lending can include loans from friends and relatives but it’s growing fast on the Internet. Of course, angels and venture capitalists have been around for a long time, but for much of that time they’ve limited the amount of exposure they’ve offered to the general business-owning public for fear of an avalanche of funding requests. However, the advent of the Internet has created social networking for entrepreneurs and investors, in the form of bulletin-board websites where those seeking capital can post their business plans and qualifications, and those with capital can locate ideas and teams that interest them.
With the credit crunch freezing traditional funding avenues, one such bulletin board, RaiseCapital.com, reported a “dramatic increase over the last few months” in the number of users on their site. “Both the registered users looking for capital and investors looking for opportunities have increased,” wrote Alyssa Miller, vice president of 5W Public Relations, in an email exchange discussing RaiseCapital.com.
Another online lending service, Angelsoft.com, displayed live statistics indicating 24,478 requests for funding currently submitted, up from 16,030 through the second quarter of 2008, a surge of 52.7%. However, the number of investors only rose from 9,416 to 12,336 in the same time period, a growth rate of 31%.
RaiseCapital.com is a free service, while Angelsoft.com charges a fee to both investors and entrepreneurs to weed out tire-kickers. Even with such entry hurdles to overcome, only 1.32% of all ideas submitted to Angelsoft.com receive funding, but whether that’s an indication of tightness in the market or lack of preparation among the entrepreneurs was not immediately obvious.
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