The Market Ticker

There have been many treatises written on the Credit Bubble, its causes and who's responsible.

There are lots of arrows to cast at both Republicans and Democrats.  You can trivially find things like the CRA, or what look suspiciously like bribes on mortgage rates (sub-market rates given to "Friends of Angelo" from Countrywide, etc) handed out to Congresspeople, and other abuses.

You can find hundreds of thousands of dollars given in campaign contributions.

All of these factors contributed to the bubble.

But if you want to know why it happened - why the market did not step in and stop it, which everyone involved wrings their hands and laments - you need to look to only two decisions, and both of those decisions were made not by Congress but by executive fiat in the Bush Administration.

These were:

1. The decision to file suit to overturn state regulation of mortgage issuers, specifically targeting New York among other states, where state regulations required that "ability to pay" (and other anti-abusive lending provisions) be part of the underwriting decision.  These suits barred states from clamping down on lenders who made loans to people who could not pay.
2. The decision by the SEC to lift broker/dealer leverage limits in 2004.

#2 is particularly outrageous because in 2000 Henry Paulson, then the head of Goldman Sachs, asked the SEC to lift those limits and was told "no" - The SEC at the time said that it believed that removing those limits was unsafe.

In 2004 Henry Paulson (two years before he came to Treasury) came back with the request a second time, and the request was granted in what was the culmination of a furious lobbying crusade by Wall Street firms.

Now look at this chart:

(Black line home prices, orange consumer confidence)

Note very carefully when the home price index went over 150.

Late 2003/2004.

Why is this important?

Because 150 is the maximum level that the home price index had obtained during all of the previous "housing booms" since WWII.

Here is the simple, raw, unadulterated and ugly fact:

It is not possible to pump home prices beyond about the 150 level on that index without intentionally increasing leverage and reducing supervision of lending beyond safe levels.

The actions of every one of the government participants since the housing bubble popped have been focused in one and only one place - obfuscating this simple fact and trying desperately to avoid being held responsible for both their actions and the outcome on the American economy.

Isn't the reason for this "need" obvious?

To admit the truth would mean that Henry Paulson would have to immediately resign in disgrace, and George W. Bush would have had to apologize to the American Public.  In addition, it would only be reasonable for Henry Paulson to disgorge his $500 million in personal wealth gained from the bubble, since it was, effectively, "ill-gotten gains."

Both are simply not going to happen.

Not now, not ever.

All of the other issues (the CRA, bribery of Congress, etc) are important - but none of them were the cause of the bubble, and none of them could have led to the bubble, for one simple reason:

You cannot have the price of a capital good expand beyond the earnings capacity of the underlying owner of that good without creating an environment where lending takes place without limits or standards.

That is, so long as sane leverage limits and a requirement that borrowers be reasonably able to pay exist, a bubble of this magnitude cannot occur.

This is math, not politics.

Tonight Cramer was talking about either letting unlimited immigration take place (to buy up all the homes) or literally bulldozing them (aka what FDR did during The Depression to pigs, cows and fields!), and he's threatening to send that to Obama as "his plan."  Back in the 1930s when this was done it cost thousands of farmers literally everything; their crops were destroyed and livestock shot, and they lost their homesteads as their income was cut off.

That idiocy, should it be attempted with houses, will guarantee that all middle class and lower Americans will go bankrupt, because your cost of living will double, home prices will remain unaffordable, and your wages will not increase by a nickel.

Think about that folks - take your "mandatory bills" and double them, then tell me what the odds are that you escape bankruptcy.

Leave it to a Wall Street thief to come up with something that would grossly increase the amount of damage that America's middle class sustains - never mind CNBC employing someone promoting a policy that would bankrupt half its viewers.

Cramer needs to be put in the stocks - alongside Paulson Bernanke and Bush.

I want to throw rotten tomatoes.

But back to the underlying theme of this entry.....

The mathematical reality of how we got here places in stark relief what must be done to get out of this mess:

1. Leverage limits of 12:1 must be placed on all financial institutions.  No exceptions and no games.  If we cap leverage we cap systemically-important bubbles and prevent them from forming.
2. Ability to pay at the fully indexed rate, inclusive of any potential penalty must be "the essence" of any loan agreement for both consumer and business loans.  This includes credit card "penalty" rates, mortgages and all other forms of debt.  Evidence of this computation being done and within safe and sound limits must be prepared and maintained with all loans.
3. It is already illegal to lie on a loan application.  Falsification of loan applications must be aggressively prosecuted.

Do these three things, prices immediately contract to affordable levels on all things bought with credit, leverage is reduced to affordable levels and debt taken on can be repaid.

This will not prevent the pain that is currently in our economy from being manifest, nor will it "magically fix things." 

But it will contract house prices to where you can afford to actually own your home, it will force credit card issuers to reign in either limits or penalty rates (and perhaps both) and it will arrest future bubbles of systemic significance before they can do critical damage to the financial system.

My recommendation: Repeal the "Bankruptcy Reform Act."

Senator Obama voted "Nay".

Send up a bill to repeal that act.  I bet Congress would pass it and both Nancy Pelosi and Harry Reid would be for it, as it goes directly to "helping the little guy."  Sign it.

This instantaneously shoves all the bad debt written by the imprudent bankers back where it belongs, while at the same time not letting imprudent borrowers off the hook (going bankrupt isn't painless by any means!)

Market discipline is a wonderful thing, and this would go a long way toward restoring it.

I strongly recommend that President Obama do so 20 minutes after being sworn in as President, and tell the American People right here that he will do so as part of his "First 100 Days" initiatives.

What 'ya say Mr. President?