By Evelyn Black, on October 8th, 2008
The U.S. stock market has been nothing if not volatile this year, especially over the course of the past few weeks. As the current credit crisis tightened and the world watched in horror, what most people saw was the stock market spiking and plummeting, often on mere rumor and speculation, and sometimes on the strength of what seemed like nothing at all. We’ve gotten used to this show, and for many people, it has become a source of rage and disgust.
The 777 point plunge in the Dow Jones Industrial Average after the defeat of the House $700 billion rescue package was dramatic and scary. By most accounts, about $1 trillion was lost in a single afternoon. I personally lost a quarter of my 401(k). The very next day, however, more than half of that loss was recouped on the mere hope that some kind of bill would in fact pass by the end of the week, even though it was impossible to know what kind of bill that might be.
Meanwhile, radio talk shows were busy interviewing everyone who had ever held any kind of opinion about anything related to finance, and some of it was not just misleading, it was nuts.
For instance, at one point I heard the crisis described as something that would “…make it harder for people to get car loans and would also cause small businesses to have to use their credit cards instead of lines of credit with their banks.” At the other end of the spectrum was a semi-hysterical comment by a cable news pundit who said, “People want to know if they will be able to use their ATMs by the end of the week!”
Both of these remarks are misleading.
First of all, the ATM issue is not an issue. Sometimes ATMs don’t work even when there isn’t a credit crisis. The things actually run out of money sometimes, often on Sundays, and on top of that they are subject to computer software glitches, mechanical breakdowns, and all sorts of other gremlins that are just part of life. Stuff happens with ATMs, and the credit crisis is not the kind of “stuff” that happens to them. It’s not related at all. You have no more reason to worry about your favorite ATM now, this week, than you ever have.
So calm down.
The other remark is just as misleading though. If auto loans are harder to get and business trips are put off, that’s bad for the economy, certainly. But explaining the credit crunch this way gives the impression that it is something that will just make people tighten their belts a bit, and tightening our belts is something that the overwhelming majority of us feel is long overdue and probably a good thing. I have noticed a real effort on the part of the media not to scare people. Fine. But let’s be honest at least.
The real scare with a credit crunch has nothing to do with your purchasing habits and everything to do with the fact that so many businesses, including big banks, run on short term credit. By short term I mean a day, a week, sometimes a month. A business needs this credit to even out cash flow so it can function properly. So, for instance, the garden center where you work as a clerk probably makes about 80% of its money in May and June. The rest of the year, your paycheck is likely written on a line of credit from the bank. This is true of many businesses, especially retail and construction. Profit is not spread evenly over twelve months.
Free flowing credit is good for business because, over the course of a year, if a business still makes lots of money during that May and June flower frenzy, they will turn a profit and stay current on their short term lines. The bank stays happy, the business stays happy, and you stay employed and get paid in checks that don’t bounce. You take those good checks to your bank and spend the money on stuff, and the world goes round and round like it should.
When credit gets too tight, it’s like throwing a wrench into the gears of that whole system, and commerce grinds to a halt. When commerce grinds to a halt we get a recession, or worse.
That is the fear that is behind the current attempt to “rescue” the U.S. financial system fast, but it is just abstract enough to be a non-issue for the average person. We all see that DJIA looping up and down like an out-of-control hang glider, and we think, that’s nuts. Those guys deserve to fail.
What is harder to understand is that, if those guys fail, they will retire to their homes in Martha’s Vineyard and Connecticut and Vale, and we will lose our jobs and wait in line to buy milk because, if you don’t buy it on the day it comes in, you don’t get any.
I believe that the truth is that that might happen anyway, no matter what Congress does or doesn’t do. But I also think part of the problem right now is the complexity of the situation and opaque nature of the mess our economy is currently in. The stock market is only the thermometer, and it seems to be a broken thermometer at that: One that works sometimes and other times seems completely, psychotically detached from any day-to-day reality.
The excesses of the financial world and the real estate bubble have left us with a loss of trust in our leaders and our business, and they in turn have all lost trust in each other. Nothing good happens financially in an environment in which there is no trust, and once lost, trust is a very hard commodity to lay one’s hands on.
So it’s no wonder that the American people are overwhelmingly against any government intervention in this historic economic mess. What is frightening is that by the time people do realize that this mess is going to hit them personally, and hit them hard, it may well be too late.
By Evelyn Black, on September 11th, 2008
After posting a 24.5% decline in August sales, GM announced on September 3 that it was encouraged by falling gas prices and signs that the market might finally be bottoming out. It takes a whale of a positive attitude to see a bright spot in a sales report like that, especially when the drop occurred during a much-hyped “Employee Discount Sales Event” designed to rid GM lots of a backlog of large to mid-sized trucks and SUVs. Ford reported a 26% drop in August sales, Chrysler a 35% drop.
Sales at Honda and Toyota also dropped but less than 10%, while Nissan actually saw a 15% increase in sales.
Gasoline prices have fallen 11% since mid-July when they hit their peak price ever, but customers remain skittish and for good reason. With three new Atlantic hurricanes currently stacked up like airplanes waiting for a runway and a near-miss from Gustav on gulf oil refineries, there is little cause for celebration. One major disaster could send oil skyrocketing all over again, and that’s not counting geopolitical problems, just hurricane risk.
GM, Ford, and Chrysler are all looking forward to 2010 when they plan to put all kinds of brand new fuel-efficient and alternatively fueled small cars on the U.S. market. Until then, the “bottoming out” of the U.S. auto market is likely to be a long bumpy bottom, made worse by tightening credit conditions and the  possibility of a new waive of unsecured credit and auto loan defaults. In other words, it’s going to be a long year before the U.S. auto industry can expect to see much relief, and what the country will look like at that point is almost anybody’s guess.
Both major presidential candidates are championing $25 billion in low-cost loans to help the U.S. auto industry build the fuel-efficient cars it needs to sell right here in the U.S. Recently, the auto industry requested another $25 billion in government loans to retool their assembly plants. It’s been almost 30 years since the U.S. bailed out Chrysler to give them a leg up against the Japanese, and now here come all three of the Big Three again, hats in hand, asking for rescue so they can “keep jobs in America.”
I confess, I have a chip on my shoulder when it comes the the Big Three. Why is it that lately, after hearing for 25 years about how free markets always regulate themselves when allowed to do so, the U.S. government is suddenly expected to bail out some of the largest corporations on earth? The airlines, the Big Three automakers, Bear Stearns, Faddie Mae and Freddie Mac, and what next?
GM built a successful and wildly popular electric car in 1996 – 12 years ago – to show the state of California that it couldn’t be done, and that people would hate it and refuse to buy it. They wanted to show that new fuel emissions standards enacted by the state would cripple the auto industry.
What happened?
People in California loved the GM electric car, which was dubbed the “EV1.” They loved the EV1 so much that nearly every single person who agreed to the trial lease of the vehicle (it was not for sale but only leased to select customers as a test) wanted to purchase and keep it. GM reacted in 2003 by recalling and destroying every single EV1 in the state. An excellent documentary on this bit of recent history can be purchased or rented almost anywhere; it’s called Who Killed the Electric Car?
It’s a little known fact that the very first car ever built was an electric car. William Morrison built the first model in 1890. It ran for 13 hours at a stretch and achieved an average speed of 14 mph. In 1900 Camille Jenatzy built an electric car that reached a maximum speed of 66 mph. In 1903 the first electric/gas hybrid car was manufactured by Krieger. Then, in 1930, with the invention of the internal combustion engine and the release of Ford’s famous Model-T, production of electric cars came to an abrupt halt until once again, in 1996, GM released one to prove a point and ended up making itself look ridiculous and corrupt.
Here’s a thought: maybe the Big Three are ridiculous and corrupt. They knew in 1996 that 1) they could build an efficient electric care at a reasonable price and 2) there was a market for this car. Why didn’t they keep building it? The documentary has some things to say about that, but I submit that one less conspiratorial reason is that they have rarely been much for innovation, preferring to stick to what (they think) works and ignore what is actually happening in the wider world. And electric cars aren’t even all that innovative: they’ve been around for 118 years!
Businesses that conduct themselves so pigheadedly often fail.
I want to see automobiles made in the U.S. as much as the next guy. More, actually. (I live in Michigan.) But why give $50 billion the U.S. doesn’t have to robber barons who squandered their inheritance by thinking short term, playing it safe, and shipping their factories overseas? Why not give someone else a chance? Why not subsidize start-ups with great automobile ideas in the area of alternative energy and fuel efficiency instead? Hand it off to the little guy, see if he can score a touchdown, because these three sure can’t.
It’s going to be a long, slow 2009 any way you cut it.
Am I worried about how the Fords are doing this winter?
Not on your life.
By Evelyn Black, on August 29th, 2008
On August 26, the Federal Deposit Insurance Corporation increased the number of banks it considers in danger of failure from 90 to 117 and responded indirectly to concerns about its ability to insure money on deposit at retail banking institutions. The FDIC is considering increasing the fee it charges retail banks to insure their deposits to 14 cents for every 100 dollars of insured deposit money this October. A serious fight from the banking industry is expected since banks are already struggling to survive. The fee increase could not come at a worse time for them, and yet without functional FDIC deposit insurance, bank runs become all too likely all over again.
In the immediate aftermath of the recent failure of IndyMac Bank in California, FDIC officials were all over the media assuring a skittish public that the situation was well in hand and that the number of banks on the troubled list is actually lower than it was in the 1990s. What was not said, possibly because it defeated the whole point of going on TV to reassure the public, was that the size and scope of the banks currently facing failure is far beyond anything the FDIC has had to face since the Depression.
IndyMac was the third largest bank failure in history, and it is but one of a large number of major regional banks that are currently struggling to stay above water. Earnings at banks and thrifts declined a whopping 86% from April to June and are currently down to $4.96 billion from $36.8 billion only a year earlier. At the same time, the credit crisis appears to be spreading to lending products that were not really of concern only six months to a year ago. Credit cards, auto loans, and other types of retail consumer debt are beginning to go into default a higher and higher rates, and already institutions are experiencing a rapid increase in late payments.
Small business credit lines, which insure the smooth operation of daily life in many cities, are already getting much tighter as underwriting departments react to a steady drop in the value of business capital due to the housing crisis. While it is true that more homes sold this July than expected, the drop in housing values for June was the largest on record. Many of those sales were “short sales” on foreclosures.
As home prices continue to plummet, both personal and small business customers have fewer and fewer options for securing needed credit. Already many homeowners are “upside down” on their mortgages; that is, they own more on their homes than their homes are currently worth. When this happens to customers who have home equity lines at retail banks, the lines are frozen and credit is no longer available.
Sadly, many customers are tapping their unsecured credit cards to fill the gap and are consequently having a harder and harder time managing those payments now too. The high cost of gasoline and the rise in foreclosures has also resulted in an increase in voluntary defaults on auto loans. Banks don’t really want or need a wave of people calling in to “give back” their SUVs right now since, with gasoline still closer to $4 a gallon than $3, those vehicles are incredibly hard to sell at any price.
Many analysts fear a second huge waive of defaults on credit cards, HELOCs, and auto loans that will hit banks harder than they can stand to be hit right now. The FDIC currently provides up to $100,000 per customer in insurance for checking and savings accounts and up to $200,000 for married couples, per financial institution. However, much of that promise depends on the FDIC never having to actually deliver on that promise in a truly huge way.
Even in the wake of the single IndyMac failure, some multinational banks were refusing to cash checks issued by the FDIC on IndyMac acccounts, putting extensive holds on the deposited items or refusing them altogether, hoping to shuffle these customers off to another bank before anything went to court. It’s hard to imagine the chaos that might be caused by multiple simultaneous bank failures, so we don’t see a lot of open discussion about that possibility.
That lack of discussion doesn’t mean the possibility isn’t out there, it just means the topic of simultaneous multiple bank failures has become “the elephant in the living room.” Banks, federal regulators, and some customers see the danger quite clearly, but no one knows quite what to do about it. Add to that the concern about not causing panic and you have a truly uncomfortable situation for all concerned.
The financial crisis that has gripped the U.S. since last November as the subprime loan mess began to hit full force has been like that all along: a series of choices between difficult options both of which might have major negative consequences. For example, when the Fed cut the interest rate for the funds banks lend each other daily from from 5.25% to 2% over the course of less than a year, it probably saved credit markets from freezing up completely. On the other hand, it almost certainly fueled inflation, which is now at record levels.
If the FDIC draws undue attention to itself by increasing the fee it charges retail banks to insure their customers’ deposits, it will almost surely provoke the very reaction it wants to avoid: runs on the most troubled banks. If the FDIC does not increase this fee, it risks having inadequate resources to actually provide the money for the insured deposits should more banks fail. That’s a devil versus the deep blue sea sort of decision, and right now, there’s really no avoiding it.
The year 2009 promises to be as difficult, if not more difficult, for retail banks and the Federal Reserve as the year 2008 was. At the bottom of the whole mess is a lot of American consumer debt, a huge tremendous amount of debt, much of it probably bad debt, that no one is quite sure how to manage. The economy can’t recover without spending, people can’t spend without credit, and banks really can’t afford to extend any more credit given the current economic conditions.
That’s a recipe for disaster (for the banks at least), but in the long run, if it provokes a broader discussion of debt and the American consumer lifestyle, it might not be such a bad thing. This mess didn’t create itself: a lot of bad decisions at the level of individual people and banks themselves got us into this. I don’t think we can really get out of it without a long, hard discussion of those bad decisions and how to avoid them in the American’s economic future.
In the meantime, if you still have unsecured credit available to you, you may want to pay it down or off as soon as possible. Already major banks are slashing credit limits even on good customers in anticipation of further problems. If you have $5000 charged on a card with a $10,000 limit and your limit is reduced suddenly to $5100, your credit score instantly plummets, making it harder for you to get a mortgage or conventional secured loan.
All of which puts the banks into one of those lose/lose situations too: reduce unsecured lending and banks reduce credit card losses but also credit card profits, right at a time when profit is dropping like an SUV off a Minneapolis bridge.
One last thought: if you’re losing your house, now might not be the best time to sleep under a bridge either.
By Evelyn Black, on August 25th, 2008
My last post here at Amateur Economists was all about the crazy run-around I experienced trying to get heating oil delivered to our house this summer for the coming winter. We ordered the tank filled in early June; but it was just last week that I finally got a heating oil company to fill our tank. CBS News also ran a special report last week about how the credit crunch in the financial markets is making it difficult for small East Coast oil companies to purchase heating oil for delivery. Subsequently a number of such companies in New England have already gone belly up.
While everyone I called here in Michigan staunchly denied that Mid-west supply problems or credit issues were crimping the availability of heating oil, the fact remains that, for the first time, it took a summer of arguing with various heating oil distributors to get one to finally deliver some to us, even though we were prepared to pay for it in full (and did). This is very unusual, since in the past these companies have always been anxious to deliver oil out of season, and even offer a discount for ordering it early.
Those days appear to be past.
Last winter it cost us about $2300 to heat a 1000 square foot, well insulated home with our oil burning furnace, and the cost per gallon is higher this year, even now. So we decided to research alternative ways of heating our home without committing to any one particular plan. After getting prices and reading up on all sorts of heating methods, we decided to buy a wood pellet stove.
Wood pellet stoves burn much cleaner than wood stoves. They make so little ash that they can be vented directly outside via a three inch pipe, much like a clothes dryer. They do not require a chimney and they do not build up dangerous creosote. The wood pellets are relatively cheap (currently about $350 for a pallet of bags that will keep a home this size heated all winter), and save the homeowner from constant scrounging for wood and the labor involved in splitting and storing wood.
Best of all, wood pellets are made from waste wood and sawdust that is compressed to remove all the moisture, so no trees are destroyed solely for the purpose of fueling pellet stoves. This is wood and wood products that would be thrown away anyway, and the burn is so clean it produces very little smoke. Some pellet stoves will also burn dried corn. Others will burn switchgrass pellets. So basically, the energy source is almost completely renewable.
One drawback: Because the pellets are fed into the burner from a hopper electronically, a small amount of electricity is needed to run the stove. This means that if you plan to rely heavily on a pellet stove, you want to make sure you have a back-up generator or another source of heat, just in case the electricity goes out.
We found a pellet stove for $1100. The installation will run about $400, and the pellets for the winter between $350 and $500. This means we will completely recoup our investment our very first winter, and we do have a full tank of oil and a working oil furnace that we can use for back up if necessary. Speaking with friends who actually live in larger homes and have used pellet stoves for several years, we discovered they rarely needed to use their original source of heat (the furnace). The pellet stove was sufficient.
So far, so good. But consider this: Almost every place we went to look at these stoves had a story to tell. The first store manager told us that last year he sold two pellet stoves in July. This July he sold 46. The next two places we visited have been unable to obtain the stoves for months and have tons on backorder. Three stores told us the stoves are no longer available from East Coast distributors, but some Mid-west distributors still have them in stock. We felt lucky to find a company that did have some still available for delivery. Ours should be here in about five days.
An article in the New York Times explains that even though oil companies made record profits this year, all of them are having supply problems due to geopolitical issues. U.S. oil supplies have been dropping for five consecutive quarters now, with the most recent quarterly drop being the steepest of all.
Western oil corporations deny vehemently that the scary “peak oil” scenario is responsible for this decline. Instead, they refer to “geopolitical peak oil”; which means that countries like Venezuela, Russia, and Iraq want to keep their oil profits in their own nations, even if it means having to develop the oil fields themselves and shut out multinational oil corporations.
It is completely understandable why developing nations would want to nationalize their oil profits. What is somewhat harder (for me) to understand is why our own government isn’t addressing what could turn out to be a real crisis here in the U.S. should we get hit with a very cold or severe winter.
Last winter, in the Michigan city in which I live, an elderly woman froze to death in her own home because the only disconnect notice legally required of the utility company was a warning flier tucked in her front door. It was still tucked in her front door when relatives found her body. She had been dead of exposure for several days. Family members said she was probably embarrassed to ask for help.
By Evelyn Black, on August 14th, 2008
In early June, worried about the rapid increase in the cost of oil, I called my home heating oil provider here in Michigan and ordered a delivery to fill our tank, which is currently almost on empty. The price to fill the tank at that date was just shy of $1100, and last winter we needed to fill it four times. The house we live in is about 1000 square feet and well-insulated, and we’ve added extra insulation and stopped using hot water. Last winter cost us about $2300 to get through: This winter will easily be double that, if not worse, barring a miracle.
We don’t have a gas line to our house, and even if we could afford to install one this year, we would also have to replace the furnace, so my thought was, better to start out with a full tank of heating oil at the outrageous June price than an empty tank in November when the temperature starts to plummet and prices might be anything at all.
Three weeks later, no oil delivery. I called our company and was asked if I needed the oil to heat water. I said, “What does that have to do with it?” The woman on the other end of the line said they rarely deliver oil in the summer unless it’s truly needed, which I know is untrue: Usually oil companies like it if you order in  summer because it’s one less winter delivery they need to make when everyone and their brother is calling after the first snowfall. Often you even get a discount for summer delivery.
I said, please, deliver it. We’re nervous. Fill our tank. We have payment in full.
Another month went by, no oil. I called again. They said no trucks had been out our way. (We live in a city of under 100,000 people.) I said, well, when might trucks be out this way? She didn’t know. A couple weeks maybe?
Now it’s three weeks later and still no oil, and tonight on CBS news I learned that because of the credit crunch, many small home fuel oil delivery companies are unable to obtain credit to buy the oil their customers need. Some customers on the east coast have paid as much as $5000 in advance for winter heating oil, only to find out the company has gone belly up, their money is gone, and they still don’t have oil. Basically, they will have to pay for it twice because you can’t get through winter in New England without some way to heat your home, but can you imagine, in this economy, having to come up with 10K on the spur of the moment just to make sure your pipes don’t freeze this winter?
So now, I have to start calling oil companies in our locale and find one that actually has oil that they will actually deliver to our home. It’s sailing into mid-August now, and in another six weeks it will no longer be a topic for an economics blog; it will be time to get out mittens, long underwear, and start burning furniture in a hot-wired wood burner.
Over the not-very-long run, we will have to find a different way to heat our house. Sooner would be better than later. But for the short term, we need oil, and at least one of us is getting scared. I’m not writing this to cause a panic. Panic never solves anything. I just thought some of our readers might like a heads up. I know I certainly would have liked one in June, as in the truth straight out, instead of waiting to see it on the Nightly News from Katie Couric, who is not exactly my best friend.
I’m a Brian Williams kind of girl myself.
To read the complete article at the CBS New website about the coming home heating oil crisis, you can go to Home Heating Oil Hell at the CBS website.
Then, without making to much of a fuss or freaking out overly, you might want to get on the phone and keep calling oil companies until you find one who will deliver some heating oil to your home, now. Today.
That’s what I’m going to do. I’ll let you know how it turns out in a future post, along with our best and worst ideas for what to do to change this next year.
By Evelyn Black, on August 11th, 2008
According to a New York Times business editorial published on August 5th, when the Federal Reserve recently asked for comments on its proposed rules on abusive credit card practices, it received over 56,000 responses. Most of the responses were from credit card customers who were enraged over practices such as arbitrary interest rate hikes based on factors other than the customer’s payment history, moving up due dates and shortening payment periods, and all manner of exorbitant fees.
The NYT editorial urged the passage of a consumer’s rights bill sponsored by House Financial Services Committee Representative Carol Mahoney, a Democrat from New York. Her bill would prevent credit card companies from arbitrarily raising interest rates on a balance incurred under an old rate and would stop the practice of “universal default,” now common in the business, which allows credit card companies to hike rates on a card if that customer pays a completely unrelated bill to another company late.
The bill is a good start, but of course banks are fighting it ferociously, despite its fairly modest restraints. This resistance by the industry to any oversight or regulation raises the question of whether practices which used to be considered usurious or unethical have become “normal.” Has the financial services industry mainstreamed abusive lending to the point that banking has completely lost whatever moral compass it might once have possessed?
I think the answer is clearly yes. Of course it has. But there are always reasons, and some of them require systemic changes that will not be accomplished without bloodshed.
At the top of the list of factors that motivate abusive lending (besides greed, which you can really only say so much about before you’re out of things to say about it) is the trend towards larger and larger corporations and the selling of debt. In the not-so-olden days, if you wanted a credit card, you went down to your local bank or credit union, where they actually knew you, and you applied. If you had a good history with the bank and a steady job, they would issue you a card with a low limit and a decent interest rate. They’d handle the underwriting and the billing themselves. If you screwed up, you could go down there and talk to a person.
Today, Bank of America, Citigroup, and Chase issue most of the credit cards in the U.S., and they are huge. The banks that they have not yet swallowed up are not small either. Huge financial institutions can take huge credit risks and absorb the damage in the form of fees, increased interest, and the sale of bad debts. Because of this, underwriting standards have become much more lax and usurious fees and rates have developed to offset the risk.
Another factor influencing abusive lending is the outrageous salaries now payed to CEOs and the unrealistic expectations of stockholders who pay them. A CEO should answer to stockholders and customers, not just stockholders. People who buy stock have come to expect ridiculous returns on their investments, and the CEOs they employ are judged and paid according to whether or not they deliver those ridiculous returns. So long as this corporate culture prevails in the financial industry, regulations will be skirted and customers will be fleeced. The money has to come from somewhere, and it’s been trickling upward for some time now.
A third factor influencing abusive lending practices has been the government practice of encouraging spending in the absence of money. I know that sounds stupid. It is stupid. But we hear it all the time. We’re bombarded with, “Are consumers consuming? How much are consumers consuming? What if consumers stop consuming? This is a consumer economy! Consume! Buy stuff! Buy more stuff!”
Most Americans got tax rebate incentives this year in an effort to get them to buy stuff. Many people saved the money, put it in their gas tanks, or fueled up for winter heat in the dead of July, foiling the hopes of economic stimulus through conspicuous consumption.
Last but not least, lower incomes and rising costs encourage abusive lending practices. When people don’t make enough money to meet their basic needs, they will accept terrible lending terms to get by, especially if these terms are easy to get. In effect, Americans have been doing just that with credit cards for the past year, especially since the subprime mortgage crisis hit and many home equity lines dried up as a source of ready cash.
Our healthcare system has become so completely unattached to any kind of sane fee structure that people  who spend a day or two in the hospital and who have health insurance can suddenly be deluged with bills from all over, leaving them thousands of dollars in debt before the problem is even successfully treated. All of these bills come with the words “Due in full on receipt.” Put them on a credit card and suddenly you can add as much as 30% interest to that debt. It doesn’t take very many emergencies to sink an ordinary family.
So credit card reform is overdue, yes it certainly is. But the larger issue is, why aren’t we focusing on the underlying problems that lead people to lean so hard on abusive unsecured lending?
If we are to have a consumer economy, it strikes me that what we need first and foremost is a pool of people who make enough money to cover their basic needs with a bit of surplus left over to spend on consumer goods. That means good jobs, a healthcare system that works for everyone with a sane billing system and fees ordinary people can afford, and lenders who take their fiduciary responsibility seriously and don’t promise outrageous returns to stockholders or run up billions with risky schemes while chasing an impossible profit expectation.
Regulation and reform can solve part of this. But without jobs, healthcare, affordable housing and food, and a market that works for everyone, not just the rich, we will just get more of the same old wolves in fluffly new clothing.
By Evelyn Black, on July 7th, 2008
 Most people living in the US are fully aware that we are currently in the middle of a crisis. What kind of crisis is a more slippery sort of topic, but even the most optimistic (read: delusional) pundits tend to agree this crisis has something to do with money, and that it started a couple of years ago when US financial institutions put sanity and common sense aside to write mortgage loans on properties with badly inflated appraised values, for people who couldn’t afford them.
Then, just to make things interesting, all these bad loans were chopped up and repackaged into investment vehicles and sci-fi securities that were traded with such abandon that at some point it became impossible to even figure out who owned the bad debt and who owned the good debt.
Fast forward to July 7, 2008 and what we have now are the two biggest government-backed mortgage lenders, Fannie Mae and Freddie Mac, unable to back up the loans they’ve made with adequate cash. As a result, stocks for each of these major lenders (at this moment) have plunged 18% in a single day.
This free-fall was kicked off when Lehman Brothers announced that a pending accounting change would require both lenders to raise an additional $17 billion. In May, Freddie Mac promised to raise an additional $5.5 billion but has not done so yet. As its stock plummeted today, a Freddie Mac spokesperson declined to comment on its ability to raise funds until second the quarter earnings for the mortgage giant are announced. It’s not likely that the second quarter earnings announcement will be a happy one.
What does all that mean?
It means the economy is in a really, really bad mess and no one knows how to fix it.
Basically, that’s it in a nutshell.
Currently, the US Congress has been locked in a battle to pass some kind of too-little-too-late help for homes in foreclosure, a measure that would almost certainly involve refinancing through Fannie Mae and Freddie Mac for homeowners who qualify for whatever program Congress might eventually pass, once they all quite fighting about it, which will happen, well, who knows when it will happen?
The point is, by the time Congress agrees on a package, it seems clear that neither of these lenders will be in any position to help anyone in any way, least of all themselves. Instantly, the too-little-too-late Congressional measures will become worthless measures, that is, no measures at all. It is what we have come to expect from this Congress (their approval rating is hovering around 17% right now, even lower than the President’s), but it isn’t nearly good enough.
We need bold action on this, and we needed it months ago.
It strikes me that the financial crisis that started with the sub-prime lending mess has gotten rapidly worse for one major reason, and it’s always the same reason, over and over again: Denial. Every month, for months now, we’ve been hearing that the housing mess is finally bottoming out, and then the next thing you know, it’s worse. And not just a little worse either; a lot worse.
When the Federal Reserve took the extraordinary step of brokering a deal so that Chase could buy out Bear Stearns at a fire sale price, the Fed was acknowledging in a backhanded way that this particular US financial crisis is an extraordinary crisis, not just an economic lull. The Fed correctly recognized that the Bear Stearns failure had the potential to freeze up credit markets completely, and that a string of domino-effect bank failures could happen very quickly without the dramatic intervention it made.
And yet, it didn’t take long for Wall Street to lull itself back to sleep and start looking for signs that the worst was already over.
It’s not even close to over. Ordinary people have known this for over a year now, but Washington does not seem to know this. The Fed is out of ammunition and will likely have to start raising interest rates very soon. Not only that, the money it has been loaning financial institutions to get them through this rough patch can’t keep flowing at the rate it is currently flowing, and the Fed knows this. At some point, the Federal Reserve will have to allow some banks to fail: At last count, the FDIC was looking at about 70 of them, mostly large regional commercial banks.
The next big wave of defaults will be on home equity lines of credit and unsecured credit like credit cards; in fact, it’s already starting, with many banks freezing both kinds of lines and cutting way back on availability. Some people who had home equity lines maxed out at 100K or 200K are now being sent letters that their new appraisal gives them a credit line of 30K or 40K, the line is frozen, and by the way, the line is past due too. These aren’t necessarily customers with bad credit, but they are customers who are now facing mounds of debt and no way to get any other loans. So the crisis continues to spread and infect other areas of commercial and personal finance that no one thought about when it all started to go sour.
It seems incredible that with these extraordinary negative developments happening on a daily basis, pundits can still be kicking around the precise meaning of ‘recession’ and ‘Bear market’. It’s as if a hemorrhaging patient arrived in an emergency room, and instead of taking emergency measures to save the patient, the doctors started to debate the exact moment and which the bleeding moved from ordinary heavy bleeding to hemorrhaging, and why. And while the doctors debate this, the patient bleeds out and dies.
I don’t envy Benjamin Bernanke. I don’t want his job. But it would be refreshing to hear at least one know-it-all admit that, well, we’re screwed. I mean, it comes down to that, doesn’t it? The truth is always a good place to start, I think.
If we’d have started with the truth two years ago, we wouldn’t be here.
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