Which building will be our Bastille?

The mass of men lead lives of quiet desperation.

Henry David Thoreau (1817 - 1862), "Walden", 1854

My dad used to say this all the time.

I've been resisting the urge to run around in the street, flapping my arms and yelling "The SKY IS FALLING." Well, only since yesterday.

The Federal Reserve is BUYING mortgage backed securities. Uh .. is this akin to bailing the Titanic with a tin can? I don't know.

I've been sharing this ongoing bit of drama with a few friends, and they (being smart and thoroughly read) people are still having trouble understanding it.

So, here's my down and dirty description of what's happening - I apologize for any misstatements of "economic theory" or mis-attributions. But, basically, this is what's happening:

15:10] Brian : OK, remember, economics are not my forte.
[15:10] DrDivo1: okay
[15:12] Brian : So describe it in terms I can understand
[15:14] DrDivo1: http://www.bloomberg.com/apps/news?pid=20601087&sid=aZ.cxsJa71xg&refer=home
[15:14] DrDivo1: Okay, in terms that anyone should be able to relate to
[15:15] DrDivo1: six years ago, the economy was headed for a serious recession. Bush "won" the election campaigning that it would do so.
[15:15] DrDivo1: He came into office, and seven months later, we had 9/11 and a HUGE pulldown in economic activity.
[15:15] Brian : And GM got it back on track, so to speak, right?
[15:16] DrDivo1: to "prime" our nation's economy, which is 65% consumer spending, the government, through the banking regulators and the Federal Reserve relaxed lending requirements on home equity and home buying.
[15:16] DrDivo1: and they pushed interest rates down from the 6.5% range where they had been to the 5.00% range.
[15:16] DrDivo1: they held those interest rates down there for almost four years
[15:17] Brian : OK
[15:18] DrDivo1: These low interest rates, combined with relaxed credit regulations created a whole range of mortgage loan products that were unprecedented in their liberality and accessability
[15:18] Brian : Such as the interest-only mortgage?
[15:18] DrDivo1: hundreds of thousands of people bought "up" or bought homes that previously would have only been renters
[15:18] DrDivo1: and the low start mortgage payment
[15:18] DrDivo1: 100% financing
[15:18] DrDivo1: etc.
[15:18] Brian : Which aren't necessarily bad, per se.
[15:19] DrDivo1: the broad access to cheap credit also had people buying "investment" property with nothing down
[15:19] Brian : 100% financing is fine...if the person buying has decent credit and isn't buying to the max of what they're able to pay, right?
[15:19] DrDivo1: correct
[15:19] Brian : But people were buying homes beyond what they reasonably could afford.
[15:19] DrDivo1: but, these loans allowed people to borrow up to 55% of their monthly income in payment.
[15:20] Brian : And paying nothing towards the principal on the house, so they were building no equity
[15:20] DrDivo1: since the payments were kept articifically low by low "introductory" rates on adjustable rate mortgages or interest only mortgages ..
[15:20] Brian : On the assumption that the housing prices would go up and up and up and up and up. Right?
[15:20] DrDivo1: everyone was counting on the price appreciation which was based on the reduced cost and easier access to credit
[15:20] DrDivo1: yes
[15:20] Brian : And then people were compounding their debt by borrowing off the increased value of their homes, no?
[15:21] DrDivo1: yes
[15:21] DrDivo1: with which they bought swimming pools, cars, vacations, stocks ..
[15:21] Brian : Even though they had no equity in where they lived, and probably were upside down from the moment they took the keys.
[15:21] DrDivo1: our nation was living on home equity lending and new home sales for the last five years
[15:21] DrDivo1: People could live on what they could borrow on their increased equity in some states/markets
[15:22] Brian : Because houses were undervalued until about five, six years ago
[15:22] DrDivo1: no, house were valued at what they traded for.
[15:22] DrDivo1: Which was based on supply and demand
[15:22] DrDivo1: demand was artificially incented five ish years ago by the wide availability of very cheap credit
[15:22] Brian : But, I mean, some of this growth was fueled by people returning to downtown areas that were abandoned in the 60s
[15:23] DrDivo1: to respond to that increased demand, the home builders created huge tracts of new homes
[15:23] Brian : I remember back in the mid-90s, you could still buy property in DC for five figures, which was too low.
[15:23] DrDivo1: I'd say that so little of that growth was based on regentrification that it was insignificant
[15:23] Brian : And that was what kicked off the housing boom that spread to the suburbs
[15:23] Brian : I'd only say it was significant because it's what kicked off everything else.
[15:24] Brian : Though now, prices within regentrified areas are as out of whack as everywhere else.
[15:24] DrDivo1: the gentrification was based on low property values in those inner city areas, which is natural demand
[15:24] DrDivo1: if not more so
[15:24] DrDivo1: and in those inner city re-developed areas, the price falls are harder
[15:24] Brian : Then the suburbs? Really? Because that would seem to sheild cities like Atlanta and Houston more.
[15:25] Brian : But Atlanta has a repo rate twice the national average
[15:25] DrDivo1: all of the grown in Houston has been in the suburbs
[15:25] Brian : Same in Atlanta
[15:25] Brian : OK, so what happens then?
[15:26] DrDivo1: foreclosed homes start to overtake the natural supply - inventories of unsold homes increases beyond demand (especially now that interest rates have rebounded to near 7%) and prices start to fall
[15:26] DrDivo1: this creates more foreclosures, as people who can't sell or refinance are pressured to let their properties go
[15:27] Brian : OK
[15:28] DrDivo1: until the prices of the real estate fall to a point that those who can buy (usually as investment properties) start to buy, even with 10% or more down payment and interest rates around 8% - when it all balances back out.
[15:28] DrDivo1: Then, people who used to be homeowners and are now foreclosed out become renters again.
[15:28] Brian : OK
[15:29] Brian : And that's, what, 14 million homes right?
[15:29] DrDivo1: the tax base for local governments falls dramatically, as the falling real estate values begins to take down commercial values about 18 - 24 months later.
[15:30] DrDivo1: since raw residential land falls to near zero value, that falls into the commercial side sooner or later, as no land is worth what it was
[15:30] Brian : OK
[15:31] Brian : And then?
[15:32] DrDivo1: and then everything's down lower than it was before. And, for those who have money, a huge buying opportunity is created.
[15:32] DrDivo1: massive wealth transfer is accomplished.
[15:32] Brian : So, rich get richer?
[15:32] DrDivo1: very much so
[15:33] Brian : Since there's no proper taxation to rebalance income?
[15:33] DrDivo1: they got hugely richer by investing in these CBOs and then dumping them when they started to falter months ago
[15:33] DrDivo1: and now, they'll be able to buy up the properties with the money that they made off of developing them in the first place
[15:34] Brian : I see
[15:36] Brian : So, how is this stopped?
[15:36] DrDivo1: I don't know

That was what came before, but it makes more sense to discuss it after:

[14:45] DrDivo1: If I said something about the amount of money the central banks have been pumping into the economy, would it mean anything to you?
[14:46] Brian : Possibly.
[14:46] Brian : I do, you know, read and jonxt.
[14:46] DrDivo1: most people I know do, but this is beyond most of them.
[14:46] DrDivo1: Today, the Fed has put over $38B into the economy; more than $15B of that buy BUYING mortgage backed securities that aren't FNMA grade
[14:47] DrDivo1: Japan put in 9.5B today
[14:47] DrDivo1: dollars
[14:48] Brian : OK...explain
[14:49] DrDivo1: everyone who's invested into CBOs (non Fannie Mae mortgage backed securities) has been slammed - cash calls, increased pricing on their debt, stock declines in the 20 to 70% range.
[14:49] Brian : CBO = ?
[14:49] DrDivo1: all of the banks who have exposure to CBOs
[14:49] DrDivo1: collateralized bond obligation
[14:49] Brian : OK
[14:49] Brian : Go on
[14:49] DrDivo1: all of those banks have pulled ALL the way back on lending to mitigate their potential risk
[14:50] DrDivo1: some bakns are cutting off access to funds for some of their clients who have substnatial positions in CBOs
[14:50] Brian : OK
[14:50] DrDivo1: in Europe, Korean, Canada and here
[14:50] Brian : OK
[14:51] DrDivo1: so, the central banks are throwing money in - which they do by dropping interest rates on loaned liquidity to next to nothing
[14:51] DrDivo1: today, the NY Fed dropped its basic rate.
[14:51] DrDivo1: however, the Fed Funds are trading at a premium to the quoted rate - meaning (as I understand it) that the money is being soaked up faster than it's being released
[14:52] Brian : So...it's like a drought of money needed to keep the mortgage brokers liquid due to all the bad loans they made defaulting?
[14:52] DrDivo1: no
[14:52] Brian : Oh.
[14:52] DrDivo1: much much much higher up the food chain
[14:53] DrDivo1: keeping UBS Paine Webber liquid.
[14:53] DrDivo1: pension funds.
[14:53] DrDivo1: hedge funds.
[14:53] DrDivo1: Bank of America.
[14:53] Brian : Funds and banks that invested in the mortgage companies?
[14:53] DrDivo1: invested in the mortgages. Not the mortgage companies.
[14:53] Brian : How does a hedge fund invest in an individual mortgage?
[14:55] DrDivo1: the mortgages are "bundled" together into a CBO - then, the CBO (with the mortgages as security/collateral) are sold on the stock market
[14:56] Brian : I see
[14:58] Brian : So...these organizations that invested in these CBOs...what's happening to them?
[15:08] DrDivo1: their stock price has been slammed
[15:09] DrDivo1: the organizations that existed primarily to fund/sell these CBOs are basically without value
[15:09] Brian : I see.

So, what's looking more and more probable is that not only will our economy hit the wall, but our currency will devalue significantly. The housing market is SCREWED for two decades or more in the absence of a huge productivity boom (which I think is quite possible.)

I will admit that I, like my father, am so progressive that I'm a near Socialist. I believe that the Bushies put this together to a degree. Well, a BIG degree. After all, Bob Perry (one of the nation's largest home builders) was Bush's original "Pioneer."

But, this loosening of bank regulations put in place during the great depression has been coming on for years - and Bill Clinton was up to his nipples in working with the Gingrich Congress to make it happen. I also admit that I nearly always attribute any tendency of those who have to accumulate more to be at cause.

So, take it for what it's worth, filter out the dogma but this is basically what's going on. Absent our foreign debt, the oil markets, climate change, globalization and so on.