AskDong

Yesterday, I wrote about the financial bailout of the banks.  Today I write about the help the government will potentially offer to individual homeowners.   Obama has proposed a plan to help at risk homeowner help in modifying or refinancing mortgages. This is intended to stem the surge of foreclosures, and help keep people in their homes.   Is it fair that those who may have purchased more home than they could afford are getting help while frugal folk like me getting by with only bathroom get nothing?

Mortgage Modification Assistance (Bailout)

President Obama a few days ago unveiled a plan to assist potentially troubled mortgage holders.  The basics of the plan is to facilitate loan modifications and refinancing for borrowers who are in danger of defaulting.   The mechanisms include cash incentives to banks to encourage them to modify loans, and subsidies that will make up the difference between new lower payments and previously higher payments.

People are angry.  People who’ve borrowed less than they could have, and have lived modestly are not getting any help.   Those who took on more risk than they should have, spending yesterday instead saving for today, are getting a lifeline from the Government?   Why do they deserve any charity?

I believe that the Government should help those who qualify and need the assistance.  It is not only good for the person being helped but for the entire economy.   Just as bailing out the banks prevents a collapse of the banking sector, providing assistance to troubled mortgage holders has the potential to prop up the housing sector.  Why should the housing sector be propped up at all?   Don’t housing prices need to return to levels that are more commensurate with wage levels? Yes, but how quickly this happens makes a world of difference.

Just as a bubble can take on a life of it’s own, a collapse can as well.  I know there are those who blame the bubble on Government intervention via Fannie and Freddie Mac and the mandate that home ownership should be extended to more families.  The Government is not blameless with regards to many of the housing related policies.   The mandate to encourage mortgage lending to subprime looks foolish in hindsight.   However, if there’s any policy that’s more distortionary, it’s not the provisions that encouraged the subprime mortgages, but the mortgage interest deduction that is universally popular.  If there’s any policy that encourages people to borrow more than they should, it is that.  However, few pundits seem to be complaining about that.  Bubbles do not need the Government to get started.  Banks and home buyers were all too willing to put fuel to the fire.   Nobody forced Citibank or Countrywide to make risky loans that were later packaged into mortgage back securities.  Most of the securities that are at the heart of financial collapse have nothing to do with Freddie or Fannie.  Greed alone is enough, just as it was enough during the tech boom of the early 2000s.

Just as greed is enough on the way up, fear is powerful enough to spur economic Armageddon.  I don’t fear lower housing prices.  I actually welcome lower housing prices.  I welcome foreclosures.    I welcome the correct prices.  Housing prices need to come down.  Foreclosures are part of the solution.   When a house gets foreclosed because the borrower owes more money than the house is worth, the person who benefits most is the borrower.  They can walk away from a 300k mortgage, but only a 250k house.   The only hit they take is on their credit scores.  The bank doesn’t benefit.  Other taxpayers don’t benefit.

The purpose of helping those in danger of losing their homes is to soften the pace of falling home prices.   It’s much better to have housing prices fall 30% over the course of 10 years than it is have it fall in one fell swoop over 6 months or a year.   In a panic situation, there’s a greater chance that housing prices will fall too much.  Why is this?   As greed is the fuel that feeds the bubble, fear stokes the flames of collapse.  Without even considering the emotional aspects that come with panic selling, we can still  understand basic rational premises why quickly falling home prices lead to further lower prices.  Most homeowners are mortgage holders who only have a small equity stake in their homes.  A sudden drop in prices fuels fear.  Drastic market shifts are also more disruptive to the economy in their own right as people and industries are less prepared for immediate change.

Currently, the depressed housing market is primarily affecting people who’ve purchased at the height of the bubble and/or put only the smallest of down payments (less than 5%).   Without the hope for housing appreciation, these individuals aren’t able to refinance to attractive payment levels.   Banks that foolishly lent to bad credit risks, today are unwilling to engage even some of the better credit risks.  For many, the rational choice is abandonment.   For most people the choice of abandoning a home is one of the last resort.   As more houses foreclose or become abandoned this is likely to further erode the housing market.  Neighborhoods in which fewer homes are owner occupied or at worse abandonment lead to lower housing values.  Lower housing values in turn lead to more people becoming underwater.   Let’s say for example I paid 20% down for a $300k house in 2004, two years from the height of the bubble at which time my home would’ve been valued at $320k.   If housing prices were to fall 30%, I would now be underwater on my mortgage.   I would owe nearly 230k for a 224k house.   Let’s say I’m able to make my payments, but I’m suffering economic distress that would lead me to consider abandoning my house.   The more underwater I am on my mortgage, the more likely I would choose to abandon my house.  Why would someone choose to make such a morally reprehensible choice?  Job loss and escalating medical bills are some of the possible reasons.

If we can slow the pace of falling prices, the blow is less.   Over the course of a few years, inflation will mask the real fall in prices making the falls psychologically easier to bear.  More importantly, by extending the fall of prices over the course of years, homeowners will have a chance to build equity slowly. Increased equity not only makes homeowners more personally invested in their property, but continued mortgage payments shore up the underpinnings of the mortgage backed securities that are at the center of parallel financial crisis.

The other point that needs to be made about many of the people who need assistance is that they are not in the position they are in because they are stupid, or more spendthrift than their neighbors.  Some are, but most are just unfortunate enough to have purchased at the height of the market.  Why did they purchase at the height of the market.  Maybe because they just got married, or had children.  Maybe because they just found a job in a new city? Could some of these individuals have been more careful?  Without a doubt, but most are no different than other mortgage holders who will be receiving no assistance.  The difference is of circumstance and timing.

I want to end to say that we should criticize and question the bailout(s).  We should question if they are effective.  We should criticize excess spending.  We should wonder if there are better free market solutions.   However, we should not worry about being “fair” in spite of what might be the right thing to do.  Let us not cut off our noses to spite our face.

I’m a rare bird, or so it would seem from my reading on the web.   I support the bailouts, all of them.  I support bailing out the banks.  I support bailing out homeowners.   Most people, if they are to be believed, are as angry as rabid raccoons.   Maybe it’s because I’m just not that angry a person, or maybe it’s because despite my 33 years, I still believe in a greater good.

I want to tackle quickly the two bailouts, why they’re okay with me, and why I think the notion of “fairness” has been overextended.  An eye for an eye is fair.   Personally, I like to think we’re all a little better than that.   This is not to say we should not try to be fair, but sometimes an eye for an eye isn’t such a good idea.  Let’s say my neighbor and I are on a race up a mountain for a cash prize.   As we race up the mountain, he pushes past me and pokes my  eyes out.  He then falls off the side of the cliff to a narrow outcropping.  However, I’m holding a rope that can help him. The “fair” thing for me to do would be to poke out his eyes, right?  But we’re lost.  We both still need his vision to get back down and he needs my help to climb up.  But fair is fair, right?

The Bank Bailout

I think people have taken too much to anthropomorphizing the banks.    They have also taken to confusing the banks with their executives.   Banks are not people.  Banks are institutions and not just extensions of their executives or employees (which has been part of the problem of excess risk taking).  Yes, the government has bailed out the banks.  Should we be mad that big bonuses have been paid out by banks who’ve taken the government’s money?  Somewhat.  Any given bank is not just one person or even one group of people.  Within a bank that’s losing billions of dollars, there are still groups and people making billions.   The banks that are receiving the bulk of the TARP money are so large that they are a mini empire  unto themselves.  Citibank employs over 200k people    Many of these people did not reap the rewards when subprime bankers were raking in the money.  Should they now be punished?  Is it fair their bonuses be cut because their coworker in a building down the street screwed up?

Cutting the salaries of bank employees is only one facet of the anger and one that I can agree with.  I can get on board with the idea that current employees who are making money should defer their bonuses to a later date when the banks are in better financial shape.  Make the bonus promises rather than cash payments.  That’s an idea I can get on board with.   I also believe that bankers are in general often overcompensated for what they do.  For whatever reason, we live in a society that overcompensates people who work directly with money.   While I’m currently okay with the idea of the Government taking a direct hand to dictating compensation policy at Banks that have taken large TARP infusions, I’m not okay with the idea of the Government generally dictating wages.   Shareholders must start behaving like owners, and not allow boards to rubber stamp compensation packages.

However, what I cannot get on board with is the idea that we should withhold assistance completely from the banking sector.  Questions on how to best do this are valid.  Should we nationalize?  Maybe.  Let them fail?  I hope not.  Letting these large banks fail outright, while it may seem fair, is probably not wise.  When a bank fails, shareholders are wiped out.  But more critically, bondholders and anyone else to whom the bank owes money is put into limbo.  Most are unlikely to get the money which they are owed.  Who are these creditors?  Companies that you or your family members may work for.   It’s best not to start this domino effect in motion.  Bankruptcy serves the bankrupt, not the company and the people to whom the bankrupt owe money to.  While it may seem like just dessert for banks to go bankrupt, it’s most likely not the best thing for the nation.   Yes, we’ve become over leveraged as a nation, but banking is critical not only to the recovery but at the core of a vibrant economy.   The process of de-leveraging will be painful, and bankruptcy would make it even more painful as that process would be abrupt and uncontrollable.   The role of the government right now is to make that transition bearable.   It’s better to slide down a hill than jump off a cliff even though one ends up in the same place.

I don’t say any of this to imply that the banks should not be held accountable.  They should be.   We should critically think about the regulations in place that have allowed the largest banks to effectively hold the rest of the nation economically hostage.   Have banks been allowed to become too big? I also think that we should have more thoughtful debate about the compensation structure in place going forward.  Bankers should not be able to make and keep bonuses based on what turns out to be illusory profits.   I even think that efforts should be made to “clawback” bonuses that have been paid out to individuals for profits that have turned out to be nothing more than smoke and mirrors.  What I don’t believe is that we should whipping Paul for the crimes of Peter.

Tomorrow, I will extend my defense to the home mortgage bailout program.

It’s hard to believe that the stock market is about as low as it was when I first graduated college, over 11 years ago.  Taking inflation into account, it’s even lower than that.  I’m not sure it can go much lower, but in truth it can go all the way to zero.  While I’m certainly poorer for it, I’m young and have a lifetime of earnings ahead of me.

In the end however, I hope for the nation that this collapse is not a momentary dip before the next meteoric rise.    Like the last turn of a century, this recent speculative bubble across all asset classes has been fed by unrealistic greed.    As a nation we’ve forgotten that real wealth comes from real work.    Some believe that real work only produces real tangible things, i.e. manufacturing.   I don’t subscribe to this limited view.  Music and film have little worth if measured solely in physical terms, but have enormous value in real terms.   Making scientific discoveries even if they have no practical value increases our understanding of the universe.   I don’t believe knowledge is worthless.

What true wealth is not - is the act of buying something for $10, and turning around and selling it in month $20 more.   This is not to say there isn’t room for wheelers and dealers, speculators and their ilk (I could be counted amongst these people).    There is real value when someone recognizes what is truly undervalued, and is able to buy at a discount.   Such individuals facilitate the process of price discovery which benefits everyone involved.  Sellers get a fairer market price, and buyers learn of something that they might want.  There is also value creation when financiers allocate capital between different business opportunities.  I do not discount the value that financiers, and financial institutions provide the economy.  A solid banking system is critical to well functioning economy.

What I do discount is rampant unabashed speculation of the last quarter century.   We’ve become a nation of get rich schemers at every level.  From the house flipper in Florida, to the hedge fund mogul in Connecticut.   As a nation we’ve decided the way to riches is to sell higher rather than to add value.   The greater financial mess in some ways mirrors the truly egregious financial scams that have already to come to light.   The wealth of nation when built on rampant speculation is not much different from Madoff’s Ponzi scheme.

It’s my hope that we as individuals and as nation learn some valuable lessons in these difficult economic times.   Get rich quick schemes are built on castles made of sand, sustained wealth only comes from true work and real sacrifice.  Is it any surprise that the “Greatest Generation” rose from the ashes of the Great Depression?  That was generation that learned the value of saving over transient paper profits.  I hope my generation can be such a generation.

I don’t say any of this imply that there isn’t a place for investing.  There is, but people should neither expect or desire to quickly double their money.   Investors in companies that add real value to society will continue to be rewarded.  The illusory profits tha puffed up the “earnings” of many of the financial istutions have been revealed to be what they always were - smoke and mirrors.   Banks should have spent more time worrying about who they lent money to instead of selling the next mortgage backed security.

I made few comments to Dave Henderson’s post on the Econlog on the tax credit phaseout of Obama’s $400 tax credit. Dave asserted that the tax credit effectively raised the marginal tax rate for those who do not qualify for the tax credit.   At first, I protested as I incorrectly interpreted his use of marginal.  When I see marginal and taxes together in any sentence, I immediately think of the top tax bracket.   Oops.   You can read my comments there, but let me expound here a little on what Dave’s talking about. I will only consider a single filer, and not worry about the complexities that come with deductions.

What Dave Henderson’s speaks to is that odd kink in the effective marginal tax rate caused by Obama’s $400 tax credit.  In the phaseout range, a tax filer’s marginal tax rate is actually higher than the base marginal tax rate.

At the start of the phaseout range, $75,000 the base marginal tax rate is 25%.   So for the 1st dollar earned after that I get taxed at 25% as I would normally be, but it addition I would also have to give up an additional .02 cents of the earned tax credit given the phaseout.   Effectively I would be paying 27 cents in total taxes for that dollar over 75,000,  making my effective marginal tax rate 27% instead of 25%.    Once you’re in the next tax bracket that begins at 82,250, you would be paying effectively 30% instead of 28%.

This tax credit introduces an odd kink in the effective marginal tax rates that means middle income earners in the $75,000 - $95,000 will be paying more a on a marginal basis than higher income earners who are completely phased out of the tax credit.

However, one thing that should be kept in mind despte the marginal tax rate increase in the phaseout band, nobody is actually paying more in taxes.  Those in the phaseout band are benefitting from the lower effective tax rate at the lower bands of their income.

I’ll save my feeling on how I feel about progressive taxation and the impact of small marginal tax increases for another day.   In truth, I think I’ve already talked about that previously.  I generally favor a progressive tax system, and believe that small increases in the marginal tax rate at the high end is unlikely to curtail productivity.   Of course my actual opinion is far more complicated than that.

My perspective is different than Dave Henderson’s, but I do believe that introducing a kink in what I consider a middle income range of salary is less than ideal.   That’s income range in which workers are likely to have more control on how much they earn either by working overtime, or expaning their business if self-employed.   I would’ve preferred a slight reduction in the lower tax brackets with a slight increase in the top bracket.   I don’t believe people at the top top bracket would curtail their work for a .1% increase in their marginal tax combined with a reduction of the 15% bracket down to 14.5%.    However, it’s much easier to implement a tax credit than to make broader changes to the tax code.

If you haven’t heard, we’re in a recession, and from the looks of it a pretty bad one.   Fortunately, I’m still employed and so are most of my friends.  However, almost everyone I know knows at least a couple people who have been layed off in the last few months.   This time around my company has yet to make any “force moves.”  I have however in the past experienced the carnage of sudden layoffs.   It’s never pretty.

I suffered from survivor guilt in the past.  I have a chance of not suffering that in two ways; get laid off myself or not to have any layoffs in my company.  On the bright side if you are one the survivors, economic turbulence often offers great opportunity for career advancement.

Assuming that one keeps his or her job, because of the vacancies and restructuring that often accompanies layoffs career opportunities reveal themselves.   For many of the survivors, there is often greater job security than otherwise.   In tough economic times, many companies cut the number of employees in excess of what they actually “need” to.   Often there becomes too much work for too few employees.  For these remaining workers, job security actually increases.  They become indispensable to the company.

The real boon for those who are career minded is not just keeping a job, but advancing a career.   If the ranks above are thinned out, upper mobility is eased.   The real chance is not however just advancing through attrition but recognition of opportunity.  In Chinese at least according to Chinese man who was quoted on NPR, the word for crisis is combination of the word for danger and opportunity, but according to Wikipedia this actually fanciful mythmaking.   However, I like Lisa Simpson, the Iconoclast,I believe that the power of myth can sometimes be more powerful than truth.   Crisis is opportunity.  In what other environment can someone truly show their worth?