No Silver Lining

A perverse meme is circulating in the news media and blogosphere that some good can come out of house price declines, mortgage defaults, and mortgage restructurings.

Charles Hugh Smith discusses Why a 35% Decline in Housing Values Would Be Good for the Nation. Smith, an otherwise competent commentator, does state the obvious: people have been spending too much on housing and to spend less on that will help households and consequently, the economy in other areas. However he neglects to mention the enormous economic catastrophe that will result from having a huge part of the US National balance sheet permanently wiped out. The US financial sector, as healthy economic agents, cannot survive the permanent impairment of mortgage assets that would result. Bank equity - which forms the basis of banks ability to lend, and even just hold deposits, would be wiped out.

As a matter of fact, it is already wiped out de facto - the FDIC and other regulators just keep banks going in the hopes that a recovery in housing prices will make most of the mortgages legitimate investments again. A further decline to lasting low prices will make that charade simply the legitimisation of a zombie banking system a la Japan.

In a Wall Street Journal editorial on 'walking away' masquerading as an article, the author states:

People's increasing willingness to abandon their own piece of America illustrates a paradoxical change wrought by the housing bust: Even as it tarnishes the near-sacred image of home ownership, it might be clearing the way for an economic recovery.

and:

For the 4.8 million U.S. households that data provider LPS Applied Analytics estimates haven't paid their mortgages in at least three months, the added cash flow could amount to about $5 billion a month -- an injection that in the long term could be worth more than the tax breaks in the Obama administration's economic-stimulus package.

"It's a stealth stimulus," says Christopher Thornberg of Beacon Economics, a consulting firm specializing in real estate and the California economy. "The quicker these people shed their debts, the faster the economy is going to heal and move forward again."

Unfortunately, less money flowing out of the pockets of consumers as debtors means less money flowing into the pockets of citizens as creditors (e.g. the proverbial little old ladies who rely on savings income). It is a bogus calculus which could in any way construe the process as 'healing'.

If "shedding debts" means defaulting (as the article seems to imply), then citizens as taxpayers will feel the suck of money coming out of their wallets as Uncle Sam through the FDIC has to make depositors whole. And, as mentioned above, having a walking-dead banking system is not going to help recovery.

On the whole, the intellectual basis of the perspective of this 'article' is entirely flawed. We suspect it is simply another in a long series of efforts by the Ministry of Truth to put a positive spin on the ongoing havoc caused by the Depression.

Not that this flawed intellectual notion doesn't get the support of some heavy guns. Nobel-prize winning Joseph Stiglitz is quoted in Bloomberg as saying a new kind of bankruptcy needs to be created to let mortgage holders write down their mortgage to a market level and keep it! Either Mr. Stiglitz knows better and is dissembling, or he is the one suffering from bankruptcy - intellectual bankruptcy.

There is a serious moral hazard issue here. Dysfunctional economic units must be allowed to suffer the consequences of poor decisions. Stiglitz's proposal is yet another bailout - this time a bailout for credulous, housing-bubble participants on the borrowing side.

We do not approve of bailouts for housing-bubble participants on the lending side, either. But two wrongs do not make a right. The more poor decision-makers are coddled through bailouts, the more society at large is harmed by resources being diverted to the thieving, hapless and stupid; and the less resources are available to be used by the Intelligent who were wise enough not to get involved in the housing bubble, and who are truly the World's only hope of economic progress.

Bank Losses Growing

This weekend the FDIC took three more U.S. Banks into receivership. The losses absorbed by the FDIC were rather striking. Out of total assets of the three banks of $4,444,500,000 there was a total $1,437,500,000 in expected cost to the FDIC. Added to the FDIC losses are the losses born by stockholders and uninsured creditors of the banks. The total losses are thus well over 1/3 of the value of the assets.

The loss level of FDIC losses to total assets from all 57 U.S. bank failures since the Depression started stands at 5.16%, up from 4.84% last week. Excluding the costless WaMu operation, the level stands at 23.56%, up from 23.08%.

It is impossible to know how much worse the failed banks and not-yet-failed banks are than the survivors. Or indeed, what percent of banks will fail. Nevertheless, we will make a few 'back of the envelope' calculations.

Suppose 10% of the banking industry is slated for liquidation. This would constitute about one and a half trillion dollars of assets. If the FDIC can contain losses to the 5% level that would be 75 billion dollars - a lot of money, but manageable given its substantial credit lines from the U.S. Treasury. If losses are closer to the 25% level, that would be 375 billion, or a good chunk of those credit lines. Substantially more than 25% losses, or more than 10% of the industry doomed means the FDIC will need larger credit lines.

The subject of FDIC credit lines raises an interesting question. How is that money to be paid back? Formally, that means raising the (already high) premiums the FDIC charges banks for deposit insurance. The consequences will include lower savings rates, more bank fees (ouch!), and higher interest costs for borrowing. These effects will aggravate the Depression due to less income from savings, and from the greater disincentive to borrow.

As the Depression grinds on, we will continue reporting the FDIC loss statistics and their possible significance.

Income Replacement

Because the 2007 Depression will entail income loss for just about everyone, we would like to discuss some ways of replacing your lost income.

Passive Investors are currently faced with income losses from (among other things): lower interest rates; cut dividends; and loss of capital. The solution to this lies in either taking greater risks, or rebuilding capital by reinvesting more income.

Self-Employed Persons are seeing business drying up right and left. The solution here, as ever, is to dynamically be on the look-out for income opportunities. At present, opportunities are fewer than before, but they are still there.

Many Employees are presently experiencing cuts in pay and hours, as well as the ever increasing layoffs. We believe that many, if not most, of the currently employed will become formerly employed. The approach of collecting unemployment until the economic situation improves may not work out as it has in the past. Furthermore, reemployment will likely come at vastly lower wages. One solution here will be to become entrepreneurial, which only promises hard work and uncertain income.

The Industrial system has historically been neo-feudal: in exchange for 'knowing one's place', employees would be both offered the security of steady income and relief from the burden of figuring out where the business was coming from. As globalism progresses, workers in OECD nations will find increasing downward pressure on their remuneration. We suspect that most workers will opt for the security of the paycheque, even at lower wages.

The relentless downward pressure on wages and its effects on the economy as living standards decline have been recently discussed elsewhere in Worse than the Great Depression. It is not a happy prognosis for the world's top quintile of income receivers. For most, income will decline and not be replaced.

You, Reader, can make an exception of this for yourself through creativity and Peasant Virtues.
Good luck!