Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

[jk]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

post contra gross:
a post at bill fleckenstein's web site

Feel free to use me as the case study of why the Fed and the Gov't. should NOT bail out homeowners. As you know, I've been a subscriber since you started this site, and you have patiently read many complaints from me about the price for housing.

I live on Long Island and have two childern - 1 1/2 and 4 years old. I make $100,000 a year and
my wife stays home with the kids. I have been living in a 2 bedroom RENTAL for the last 3 years watching home prices go crazy, and wondering how I would ever be able to afford a $500,000 home with $12,000 in property taxes!!!

But I did not buy into the mania!!! I've been stuck in my small rental because I knew I could not afford these home prices. And now Bill Gross and many other influential people are saying we should bail out the homeowners???!!!! Well, what about me??? What about those of us who rented and didn't buy in??? Hey, can I get a handout also??? While they are giving those homeowners their tax credits, rebates, whatever - how about giving us renters an extra $100,000 so we can buy a home??? It's really unbelievable!

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

gross was not very specific. he just said: don't lower rates to try to help these people. deal with it fiscally, not monetarily. the likelihood is that gambler mae would acquire the defaulted mortgage, i would hope at the loan's true [i.e. heavily discounted] market value. then the holders of the loan take the haircut.

Maybe it was the part about that fiscal solution "scaling Rooseveltian proportions" and the "Write some checks, bail ‘em out" stuff that threw me off ... but to me it sounded like a program to rescue real estate prices in the Hamptons and Cayman Islands. The idea that Bush is somehow gonna take money from the middle class, give some back to the middle class, and have the middle class be one whit better off than it was before ought to make any sane person go "hmm". Not to mention scare the bejeezus out of us all.

But you're right, JK. At some point the lenders have to at least get their fingers burnt. If your "likelihood" is what you would do, then JK's solution sure beats BG's!

[jk]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

For sure, JK. We just need to make sure we wash out that distortion and malinvestment faster than we create new distortion and malinvestment!

That doesn't mean that there's no room to help the innocent that you refer to here. A sizable segment of people saddled with a mortgage they cannot afford probably had little opportunity to learn what they were getting into. Sucked in by aggressive lenders touting teaser rates, many likely didn't even get the opportunity to see the fine print until they were at the closing table. Just based on my own experience, there is a lot of information you don't get until that last minute, when you are under great duress to complete the process. Basic information like "your payment could rise to X in two years and if you can't pay you can lose the home" needs to be revealed before the borrower even completes an application. In such cases, the appropriate remedy would be more like disallowing any foreclosure so long as the borrower can make the payment he was enticed into the deal with in the first place. This way, the loss extends right back up the chain of lenders where it belongs. Under Gross's proposal, taxpayer money merely passes through the borrowers hands and ends up with the lender who victimized him to begin with. Is that really who we ought to be helping?

gross was not very specific. he just said: don't lower rates to try to help these people. deal with it fiscally, not monetarily. the likelihood is that gambler mae would acquire the defaulted mortgage, i would hope at the loan's true [i.e. heavily discounted] market value. then the holders of the loan take the haircut.

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

i'm well aware that the economic system has been distorted and abused. much of the distortion and malinvestment will likely be washed out in the coming few years. subprime borrowers taking a housing lottery ticket, prime borrowers who overreached to buy too much house, and many others will be caught in the flood. i believe that the odds are 100% that there will be government intervention of some kind to try to ameliorate the resultant pain. so one concern is trying to imagine what kind of gov't intervention will do the least harm and/or the most good. there will likely be much suffering, and the innocent [if we can imagine that such exist] will suffer along with the guilty. in the 13th century, during the albigensian crusade, the town of beziers - full of heretics - was sacked. when asked how to decide who the evildoers were, the reply was "kill them all, god will sort them out." i just don't want to forget history's victims here.

For sure, JK. We just need to make sure we wash out that distortion and malinvestment faster than we create new distortion and malinvestment!

That doesn't mean that there's no room to help the innocent that you refer to here. A sizable segment of people saddled with a mortgage they cannot afford probably had little opportunity to learn what they were getting into. Sucked in by aggressive lenders touting teaser rates, many likely didn't even get the opportunity to see the fine print until they were at the closing table. Just based on my own experience, there is a lot of information you don't get until that last minute, when you are under great duress to complete the process. Basic information like "your payment could rise to X in two years and if you can't pay you can lose the home" needs to be revealed before the borrower even completes an application. In such cases, the appropriate remedy would be more like disallowing any foreclosure so long as the borrower can make the payment he was enticed into the deal with in the first place. This way, the loss extends right back up the chain of lenders where it belongs. Under Gross's proposal, taxpayer money merely passes through the borrowers hands and ends up with the lender who victimized him to begin with. Is that really who we ought to be helping?

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

OK, we agree it's a wash on the balance sheet, excluding commissions & closing costs, but it creates cash flow issues for sellers (who have mortgages). Transactional costs also must come out-of-pocket from ANY seller who purchases an equivalent home.

EJ points to investors' need for cash to pay taxes as a cause of the tech bubble crash. The need for cash to pay for home losses and consumer spending that used to come from home equity loans will bring down this stock market.

Including transactional costs such as commission and closing, by the way, would be throwing in a red herring. For they would be there regardless of whether prices rose or fell. In fact, if they fell, then so too would such costs, so you could even make out a case for a small benefit.

Cash flow also has nothing to do with housing per se. Any time you buy something, it means parting with cash, whether now or later. Unless of course we adopt the view point that one is simply entitled to a home gratis. And that would be a whopper of an extension of the welfare state concept!

Or is that where this is all supposed to be going? If not, then where does this cash flow come from? You are not really suggesting that merely because I have a "need for cash" that my fellow taxpayers are obliged to cough it up for me? If that were all there were to it, then why should anyone work? All we'd need to do is collect checks and buy the stuff we want. Now there might not be much stuff to buy, considering that there would be no doctors, no engineers, no factory workers, no farmers, etceteras, because no one would be working. So we'd all have boatloads of cash, but it would all be worthless and we'd starve.

This little exercise in reducio ad absurdum illustrates the fallacy behind the whole welfare-state-funded-by-inflation concept, and the specific instance of it under consideration here. Money is not wealth. And if we just follow short-sighted impulses like those Gross expresses here, we may make life easier for some people who bought things they couldn't afford, but do so at the risk of destroying the entire country. Not exactly what I'd call compassionate.

Anyone tempted to regard the danger as theoretical only need look at where it's brought us already. Just in the past few years, our dollars have fallen to the extent they will only buy a third of the gasoline they did. A third of the corn, of the wheat, of the copper. Until recently, only about a third of the house! This is great hardship for the low-income people that such impulses purport to help, and it is peeling off the lower layer of the middle class and creating new poor out of them to boot. More of the same is the last thing we need.

[jk]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

i'm well aware that the economic system has been distorted and abused. much of the distortion and malinvestment will likely be washed out in the coming few years. subprime borrowers taking a housing lottery ticket, prime borrowers who overreached to buy too much house, and many others will be caught in the flood. i believe that the odds are 100% that there will be government intervention of some kind to try to ameliorate the resultant pain. so one concern is trying to imagine what kind of gov't intervention will do the least harm and/or the most good. there will likely be much suffering, and the innocent [if we can imagine that such exist] will suffer along with the guilty. in the 13th century, during the albigensian crusade, the town of beziers - full of heretics - was sacked. when asked how to decide who the evildoers were, the reply was "kill them all, god will sort them out." i just don't want to forget history's victims here.

[jimmygu3]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

What you say about my original quote is true, but it's still a complete wash. The additional cash he would need to buy the next home is cash he'd already committed to pay the original mortgage anyway. Double counting, as it were. His decision to sell and buy another home merely alters the timing of cash flow. In order to get a correct picture, one must examine the entire net effect. The exercise of looking at the mortgage and the house separately was to clarify where the apparent loss came from.

OK, we agree it's a wash on the balance sheet, excluding commissions & closing costs, but it creates cash flow issues for sellers (who have mortgages). Transactional costs also must come out-of-pocket from ANY seller who purchases an equivalent home.

EJ points to investors' need for cash to pay taxes as a cause of the tech bubble crash. The need for cash to pay for home losses and consumer spending that used to come from home equity loans will bring down this stock market.

[Rajiv]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Finster,

You are absolutely correct in your analysis. Many people who were home owners through sub primes should never have been buying homes through mortgage finance - they would have been much better off renting and saving some of their income in low volatility liquid assets. It is just that the bubbles ( stock market and real estate) put dollar signs in their eyes



Their best recourse may in fact be to go into foreclosure - and to restart their lives having learned a hard and bitter lesson.

The above only holds if you are in foreclosure because of the interest rate reset - and not because of being jobless. If being jobless is the case then you have more problems than mere foreclosure.

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

If you look at your original quote:

You were not referring to someone who somehow purchases a house for cash. You said that an 80% LTVer would have a "complete wash", which is not true for the reasons I outlined. My point is that even people who were doing it "by the book" are going to need extra cash if they intend to sell and repurchase. Very few people actually have cash anymore- they have mutual funds in retirement accounts. Baby boomers retiring + Housing ATM out of order = widespread selling of stock.

Finster's definition of a mortgage as a short bet against cash is right. And with the policies of this country, it's a pretty safe bet long term. As I have said before, I think we will see nominal housing prices decline no more than 10% nationally, met at the bottom with a wave of inflated dollars pushing nominal prices back up.

Jimmy

What you say about my original quote is true, but it's still a complete wash. The additional cash he would need to buy the next home is cash he'd already committed to pay the original mortgage anyway. Double counting, as it were. His decision to sell and buy another home merely alters the timing of cash flow. In order to get a correct picture, one must examine the entire net effect. The exercise of looking at the mortgage and the house separately was to clarify where the apparent loss came from.

[jimmygu3]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Think about this carefully, Jimmy. What you characterize as a loss on the home isn't that at all. The homeowner who buys a house for its value to him as a home has the same shelter and amenities after the price decline as before. The only way you can arrive at a conclusion of loss is by assuming the existence of and considering a mortgage. Try omitting that from your calculus and you just can't extract the same conclusion. Consider the home and the mortgage separately, and it becomes clear that the loss came not from the home, but from the mortgage.

If you look at your original quote:

Home prices would have to decline by more than 20% to underwater even the maximum traditional 80% LTVer. Otherwise, he doesn't care what home prices do unless he was speculating that he'd profit by selling the home and using the money for something else. This is because even if he sells the house for less than what he paid for, so long as he buys another home with the proceeds he's paying proportionately less so that it's a complete wash.

You were not referring to someone who somehow purchases a house for cash. You said that an 80% LTVer would have a "complete wash", which is not true for the reasons I outlined. My point is that even people who were doing it "by the book" are going to need extra cash if they intend to sell and repurchase. Very few people actually have cash anymore- they have mutual funds in retirement accounts. Baby boomers retiring + Housing ATM out of order = widespread selling of stock.

Finster's definition of a mortgage as a short bet against cash is right. And with the policies of this country, it's a pretty safe bet long term. As I have said before, I think we will see nominal housing prices decline no more than 10% nationally, met at the bottom with a wave of inflated dollars pushing nominal prices back up.

Jimmy

[Finster]

Tim Wood Weighs In

Tim Wood gives an excellent perspective, weighing in with a market technician's view. He recognizes that the problem we face now is the direct result of the last bailout attempt.

The battle between the natural forces of the market and the desire to prevent these natural forces from occurring has now moved to a new level. Up until recently, these efforts were more subtle and more traditional. We are now seeing an outright campaign to keep the market afloat. As I see it, these efforts do not instill confidence, but rather go to show just how desperate the situation with the market truly is...

...By the time the stock market hit bottom in 2002 and began moving up in 2003, the long-term cyclical advance in commodities was well underway. As the stock market continued to advance we continued to see more and more interest rate cuts and massive increases in the money supply, which of course were all efforts to hold the market up and to kill the deflationary threat...

Another by-product of this massive re-inflation effort was the housing bubble, which at the time I specifically remember that no one wanted to admit existed, much less that there was a problem...

So at this point, as I see it, we now have an even worse problem than we did back in 2001 and 2002...

http://www.financialsense.com/Market/wrapup.htm

[GRG55]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

That the issue is far from merely ideological is painfully obvious to anyone undergoing foreclosure. There are real consequences to trying to build an economy on a paper pyramid...

No, it is not I that am living in a fantasy world. The economy has been limping along on a fantasy and is now getting a taste of reality. Here in the US, we have been consuming more than we produce. Either production must take a great leap forward or consumption must decline. There is no mere accounting artifice that is going to relieve us of that reality. To the contrary, the main reason our production has been falling short of our consumption is repeated efforts to deny it and to perpetuate the fantasy.

The housing bubble itself - and its inevitable collapse - is a prime example. Americans were led to substitute paper financial machinations for productive effort to sustain their consumption habits. Cash-out refis led to the illusion that asset price appreciation (aka inflation) was a viable substitute for production as a means to enable consumption. The natural result is ... guess what? ... the gap between our production and consumption widened!

Now that we have a veritable force of nature trying to restore that balance, short-sighted voices come out of the woodwork arguing that it must be fought. The US consumer might actually have to consume less! Or ... perish the thought ... produce something of value to exchange to those who are producing what we consume. It is no fantasy to understand that the inevitable rebalancing will happen. And it involves a true appreciation of reality to understand that yet further official efforts to sustain the imbalance can only dig the US deeper in the hole and make it all the harder to get back out.

I agree with the foundation of Finster's argument. In an open trading economy, housing would appear to be a fundamentally unproductive activity, as comparative advantage in tradeable good(s) is what creates wealth for society. As in any liquidity boom there is mis-allocation of some of the capital and in this instance too much went into real estate. This isn't the first real estate bubble, but this is probably the first time it's happened on this scale in the US and globally. The same thing has happened in many other locations including Spain, Ireland, London, Sydney and Dubai - and the cracks are showing there also. The US isn't the only place where the authorities will be struggling with the political fallout of a popped real estate bubble.

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

the reality is that the u.s. housing market is built on the institution of mortgages, and that mortgages were embedded in the system by the tax deductibility of the interest. had there never been mortgages, house prices would never have risen the way have even prior to the housing bubble. if people had to save the total price of house before being able to purchase one, we would have much less private housing. one could easily argue that this would have been preferable economically - the u.s. has overinvested in housing, a consumer durable, which has reduced productive investment.

nonetheless, this is the world we live in, not some ideologically pure fantasy. the argument you make, finster, applies to the fantasy world and also to people who in this world have the choice of buying a house for cash or of borrowing. very few people have that particular choice available to them.

That the issue is far from merely ideological is painfully obvious to anyone undergoing foreclosure. There are real consequences to trying to build an economy on a paper pyramid. Okay, so mortgages were "embedded in the system" via an artifical tax subsidy. Further subsidized by artifically low interest rates and decades of inflation. Now we are supposed to compound the error by using yet more tax subsidy to prop up the resulting mess?

No, it is not I that am living in a fantasy world. The economy has been limping along on a fantasy and is now getting a taste of reality. Here in the US, we have been consuming more than we produce. Either production must take a great leap forward or consumption must decline. There is no mere accounting artifice that is going to relieve us of that reality. To the contrary, the main reason our production has been falling short of our consumption is repeated efforts to deny it and to perpetuate the fantasy.

The housing bubble itself - and its inevitable collapse - is a prime example. Americans were led to substitute paper financial machinations for productive effort to sustain their consumption habits. Cash-out refis led to the illusion that asset price appreciation (aka inflation) was a viable substitute for production as a means to enable consumption. The natural result is ... guess what? ... the gap between our production and consumption widened!

Now that we have a veritable force of nature trying to restore that balance, short-sighted voices come out of the woodwork arguing that it must be fought. The US consumer might actually have to consume less! Or ... perish the thought ... produce something of value to exchange to those who are producing what we consume. It is no fantasy to understand that the inevitable rebalancing will happen. And it involves a true appreciation of reality to understand that yet further official efforts to sustain the imbalance can only dig the US deeper in the hole and make it all the harder to get back out.

[jk]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

The loss incurred is a result of a bad short bet on the currency. The mortgaged homeowner went long a house and short money. His wager was that the value of cash would fall faster against his home than the rate of interest he pays. It's not entirely irrational, given that he's been conditioned by decades of inflation to expect his currency to fall in relation to real assets, but nevertheless that was his bet.

the reality is that the u.s. housing market is built on the institution of mortgages, and that mortgages were embedded in the system by the tax deductibility of the interest. had there never been mortgages, house prices would never have risen the way have even prior to the housing bubble. if people had to save the total price of house before being able to purchase one, we would have much less private housing, but the private housing available would also be cheaper by virtue of the smaller demand. one could easily argue that this would have been preferable economically - the u.s. has overinvested in housing, a consumer durable, which has reduced productive investment.

nonetheless, this is the world we live in, not some ideologically pure fantasy. the argument you make, finster, applies to the fantasy world and also to people who in this world have the choice of buying a house for cash or of borrowing. very few people have that particular choice available to them.

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Actually, even excluding transaction costs, any price decline puts a seller/repurchaser in a negative position. If you purchase a $250k house (U.S. median) with $50k down and prices decline 10%, the house sells for $225k with $25k paid to seller at closing. He goes out to buy an equivalent house for $225k and needs a $45k down payment, so he must pay an additional $20k of cash. Of course, most sellers end up paying a 6% commission, leaving our responsible 20% LTVer $33,500 out of pocket just to move to an equivalent home and be back to 20% equity.

It's even worse for a 5% LTVer, requiring $12,500 paid by seller at closing, $11,250 for the new down payment, the same commission as above, for a total of $37,250 cash out of pocket.

Where does a median-income person find that kind of money? That's right! Cash out the retirement account. Welcome to the stock market crash.

Jimmy

Think about this carefully, Jimmy. What you characterize as a loss on the home isn't that at all. The homeowner who buys a house for its value to him as a home has the same shelter and amenities after the price decline as before. The only way you can arrive at a conclusion of loss is by assuming the existence of and considering a mortgage. Try omitting that from your calculus and you just can't extract the same conclusion. Consider the home and the mortgage separately, and it becomes clear that the loss came not from the home, but from the mortgage.

So if there is no loss on the home, how did we get one when we introduced a mortgage? Simple, if not obvious. The loss incurred is a result of a bad short bet on the currency. The mortgaged homeowner went long a house and short money. His wager was that the value of cash would fall faster against his home than the rate of interest he pays. It's not entirely irrational, given that he's been conditioned by decades of inflation to expect his currency to fall in relation to real assets, but nevertheless that was his bet.