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Catering to the bailout nation
Here's where building bubbles on top of bubbles has brought us. Instead of letting the market work and 'creative destruction' run its course, too many people want a handout.
By Bill Fleckenstein
How did we get here? How did the United States get itself into the untenable position where homeowners, Wall Street and most financial institutions need -- and more importantly, expect -- help from one government agency or another?
Another good question might be this: Can those proposing solutions to the current financial crisis answer those questions? If not, how do they know their course of action won't make matters even worse?
What must be understood is that the current economic crisis didn't start with the subprime-mortgage problems of 2007. It has been 20 years in the making (and is the subject of my recent book).
Our present predicament is the culmination of many poor policy decisions. Easy money, lax credit standards and the Federal Reserve's interference with the business cycle -- combined with a lack of supervision on the part of the Securities and Exchange Commission and bank regulators -- created an environment that led to excessive risk taking on the part of individuals and financial entities of all stripes.
Where were the referees?
Wall Street and all the willing partners in the "securitization process" who sliced and diced or bought and sold mortgage-related paper are thought of as the culprits in this financial tragedy. But they were only spokes in this wheel of trouble. Homeowners, who for a number of years were the beneficiaries of the financial daisy chain, must accept some responsibility.
Folks now in trouble with mortgages larger than the value of their homes at some point willingly suspended disbelief in order to convince themselves that home prices could only rise and that this "housing ATM" could be counted on to provide funds in times of financial distress.
Still, the real failure and culpability was on the part of the regulators. No one in a position of authority (the adults, if you will) lifted a finger or sounded a note of caution while the insane housing and credit bubble of 2001-07 was under way.
And it didn't take a genius to see at the time that the problems we now face were a guaranteed outcome of that reckless behavior. Many were worrying about just that for years. Google "housing bubble" and "2004" and you'll find more than a half-million stories. So it was clear to some that there was a problem even then.
Thus the various government entities -- especially the Fed -- that might have been counted on to help prevent the housing bubble deserve some serious blame for the damage inflicted by its bursting.
More debt to solve a debt problem?
Congress and the White House are now attempting to right past wrongs with bailout schemes -- some aimed at lenders and others at borrowers. And of course, the Fed is being called on -- and has willingly obliged -- to provide more easy money in the hope that more of what created the problem can solve it.
The latest example by the Fed: Handing JPMorgan Chase (JPM, news, msgs) a $30 billion credit guarantee to get it to buy Bear Stearns (BSC, news, msgs).
Video: The latest reports on the Bear Stearns meltdown
The insidious and dangerous unspoken corollary to all this: Financial pain is now unacceptable. Those in trouble demand to be rescued, and the government seems to agree that the "creative destruction" component of capitalism must not be allowed to do its work. It's a sad irony that as former communist countries embrace capitalism, we seem to be headed in the other direction.
Walk this way
Actions by "the state" often have unintended consequences. Is it any wonder, with all the talk of bailouts and debt forgiveness, that more Americans than ever have decided to just walk away from their mortgages? (There is even a Web site, You Walk Away, to take folks through the steps.) For many, accepting responsibility seems to have become an antiquated notion. Even the government seems to think that advocating the abrogation of certain real-estate contracts is sound policy.
Where will all this stop? Can those who behaved prudently afford to bail out those who behaved imprudently? Why should they have to? And is that what we really want? After all, this country's median income of roughly $49,000 can hardly be expected to service the debt of the median home price of $234,000, up from approximately $160,000 in 2000.
Let's do a little math. Forty-nine thousand dollars in yearly income leaves approximately $35,000 in after-tax dollars. Call it $3,000 a month. A 30-year, fixed-rate mortgage would cost approximately $1,500 per month. That leaves only $1,500 a month for a family to pay for everything else! (Of course, in many communities the math is even less tenable.) This is the crux of the problem, and the government cannot fix it.
Housing prices, thanks to the bubble and inflation, have risen well past the point where the median (or typical middle-class) family can afford them. Either income must rise -- which seems unlikely on an inflated-adjusted basis -- or home prices must come down.
The housing bubble was the enemy, and we should cheer its bursting. We should not attempt to re-create it. It was the bubble that caused the bust. The bust was not caused by the failure of the government to pull the right levers. That is a fallacy shared by too many.
Let the markets work
A more prudent course of action would be to take the pain and let markets clear, which would set the base for a sound recovery.
When then-Fed Chairman Paul Volcker jacked up interest rates in 1979-82, no one liked it at the time. But it was the right policy to break the back of inflation. Some entities didn't survive that ordeal. However, the pain taken then set the stage for two decades of gains. (Volcker's thoughts on our current problem: "Too many bubbles have been going on far too long.")
The post-Volcker Fed has changed all that. Ever since it bailed out Wall Street during the Long-Term Capital Management crisis in 1998, the financial system has become more leveraged and less transparent. In the ensuing 10 years, not only were interest rates not tightened to prevent a recurrence, the rules were loosened as the Glass-Steagall Act, which had regulated banks since 1935, was repealed.
The Alan Greenspan-led Fed fomented a bubble in stocks, then chose to shortcut the aftermath by creating a housing bubble. That has left us far, far worse off today, and I suspect there are no bubbles left with which to temporarily bail us out.
Why not demand that the regulators do their job and stop reckless behavior before it gets too far out of control? Let's demand that the authorities cure the disease, not just react to the symptoms.
 
At the time of publication, Bill Fleckenstein did not own or control shares of any of the equities mentioned in this column. |
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