Chains of Fiscal Discipline
As a general rule, the most successful man in life is the man who has the best information
Alan Greenspan was chairman of the Federal Reserve from 1987 to early 2006. Greenspan used monetary policy to ignite one of the longest economic booms in history. Of course booms can soon turn to bust and nowhere was the boom more evident than in the housing industry - the sub-prime crisis collapsed the housing boom just after Greenspan left the Fed.
"The banking problems of the '80s and '90s came primarily, but not exclusively, from unsound real estate lending." L. William Seidman, former chairman of both the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation
Between 1997 and 2005 mortgage fraud increased by 1,411 percent. In 2001 the US Federal Reserve lowered the Federal funds rate eleven times, from 6.5 percent to 1.75 percent. Mortgage denial rates were 28 percent in 1997, in 2002 - 2003 they were 14 percent for conventional home purchase loans. "Fog the mirror loans" were common, if you breathed you got a loan.
In June 2002 President George W. Bush set out to increase minority home ownership by 5.5 million. Bush's lofty goals would be accomplished by tax credits, subsidies and Fannie Mae committing $440 billion to establish Neighbor Works America.
In June 2003 Federal Reserve Chair Alan Greenspan lowered the federal reserve's key interest rate to one percent - the lowest rate in 45 years.
Throughout 2003 Fannie Mae and Freddie Mac bought $81 billion in subprime securities. President Bush signed the American Dream Down payment Act - the Act provided a maximum down payment assistance grant of either $10,000 or six percent of the purchase price of the home, whichever was greater.
U.S. homeownership rate peaked to an all time high of 69.2 percent in 2004.
From 2004 to 2006 Fannie Mae and Freddie Mac purchased $434 billion in securities backed by subprime loans.
In late 2004 the Securities Exchange Commission (SEC) suspended net capital rule for five firms - Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley. Free from government imposed limits on the amount of debt they could assume, they all levered up, as much as 40 to 1.
The United States housing market bubble burst in the fall of 2005. By year-end a total of 846,982 properties were in some stage of foreclosure. From the fourth quarter of 2005 to the first quarter of 2006, median prices nationwide dropped off 3.3 percent.
The U.S. Home Construction Index was down over 40 percent as of August 2006. A total of 1,259,118 foreclosures were filed in 2006, up 42 percent from 2005. Homeowners were going underwater (they owed more than the house was worth) and many had had questionable credit to start with.
In 2007, lenders started foreclosure proceedings on nearly 1.3 million properties, a 79 percent increase over 2006.
Foreclosure proceedings increased to 2.3 million in 2008, an 81 percent increase over 2007 and increased by another half million in 2009 to 2.8 million. By January 2008, the mortgage delinquency rate had risen to 21 percent and by May 2008 it was 25 percent.
By August 2008, 9.2 percent of all U.S. mortgages outstanding were either delinquent or in foreclosure. By September 2009, this had risen to 14.4 percent.
From September 2008 to September 2012, there were approximately 3.9 million completed foreclosures in the U.S. As of September 2012, approximately 1.4 million homes, or 3.3 Percent of all homes with a mortgage were in some stage of foreclosure compared to 1.5 million, or 3.5 percent, in September 2011.
The Great Recession started in December of 2007 and took a sharp downward turn in September 2008. It was started by the U.S. sub-prime crisis which burst the housing bubble. Businesses failed, consumers lost wealth estimated in the trillions of dollars and economic activity and international trade slowed.
So what caused the real estate crisis? Three things stand out:
Irrational exuberance - irrational exuberance was caused by a deliberate easy credit fueled boom.
"Most economists now believe that low, stable, and--most important--predictable inflation is good for an economy. If inflation is low and predictable, it is easier to capture it in price-adjustment contracts and interest rates, reducing its distortionary impact. Moreover, knowing that prices will be slightly higher in the future gives consumers an incentive to make purchases sooner, which boosts economic activity." Ceyda Oner,Inflation: Prices on the Rise
In other words, economic growth - prosperity at the national level - can be driven by consumption. Saving is bad because money sitting in bank accounts will not stimulate the economy. The world's central bankers believe inflation is necessary because it discourages the hoarding of money and encourages consumers to consume.
"In January of 1959, the personal savings rate in the United States was 8.3 percent - this means that, on average, Americans were able to save 8.3 percent of their disposable incomes. In the early 70s, the average savings rate started to spike, hitting a peak of 14.6% in May of 1975. The spike in personal savings rates from 1973 to 1975 coincided with the deep recession that was ravaging the country over the same period of time...The recession of the early '80s was a particularly nasty mix of high inflation and weak economic activity, otherwise known as "stagflation". The average savings rate spiked to 12.2% in November of 1981, which was right when the national unemployment rate in the country really started to trend higher.
The average savings rate pulled back when the economy started to recover, spiked over 10% once again in 1984, and then really started to noticeably pull back in the mid '80s. Consumer confidence was rapidly improving in the country, Ronald Reagan swept to victory on the back of a strengthening economy, and people were starting to spend their money once again. It was "morning in America". There was another recession in the early '90s, but no noticeable increase in the average savings rate. As a matter of fact, the savings rate of the average American held steady during the recession of the early '90s, and then proceeded to fall like a stone throughout the rest of the decade.
By January 2000, the average savings rate was 3.5% - it would end up falling below 1.0% multiple times between 2000 and 2010.
Why the dramatic drop in the average rate of savings between 1990 and 2008?
The mindset of the average US consumer changed. There was greater access to credit and increasingly sophisticated marketing campaigns that had people cracking open their wallets or purses in droves.
Due to the surge of available credit, many people actually maintained negative savings rates. I'm sure that we all have known somebody who has spent more than what they made - this was all made possible through the explosion of available credit.
This access to credit made people want to spend, and marketers exploited this to the nth degree. People were flush with cash (and credit) in the post 9-11 economy. Interest rates were low, the real estate market was strong and many people were in a mood to spend. And spend they did." Savings Rates In The United States Have Collapsed Since Mid '80s, Manuel.com
The personal saving rate for Americans was a record low at the height of the housing bubble.
Moral hazard - in economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. In other words, it is a tendency to be more willing to take a risk, knowing that the potential costs or burdens of taking such risk will be borne, in whole or in part, by others - Wikipedia.
Almost 100 international banking crises have occurred during the last 20 years, according to the World Bank all were resolved by bailouts at taxpayer expense.
"The risks inherent in mortgage lending became so widely dispersed that no one was forced to worry about the quality of any single loan. As shaky mortgages were combined, diluting any problems into a larger pool, the incentive for responsibility was undermined." Mark Zandi, Moody's Analytics
Forbearance - banks, mortgage underwriters and other lenders abandoned any pretense of having loan standards and having applicants meet any normal level of criteria such as:
- Employment history
- Down payment
- Credit rating
Q: Who cared or asked about property loan-to-value ratio and debt-servicing abilities?
A: No one.
"Where the Fed really failed was as a regulator. It could have gone after the predatory lending in the subprime world, if it had wanted to. At least one Fed governor suggested doing so. Greenspan rebuffed him. Counter-factuals are always tricky, but if the Fed had clamped down on the endemic fraud in the mortgage market, it's not difficult to imagine the run-up in housing prices being much more muted. After all, if the problem had been low interest rates, prices should have skyrocketed across the board. That prices only skyrocketed for housing tells us that something peculiar was going on there, namely an abdication of any regulatory oversight." Matthew O'Brian, Happy Birthday, Alan Greenspan, the Atlantic.com
This was an overall decline in regulatory oversight known as forbearance.
"During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions." Declaration of the Summit on Financial Markets and the World Economy. dated 15 November 2008
The U.S. Financial Crisis Inquiry Commission, in January 2011, concluded "the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserve's failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels."
The sub-prime mortgage crisis and collapsing housing industry threatened the U.S. economy, as the crisis started to spiral out of control and go global, the Fed had to act, and it did.
Economic Stimulus Goes Steroidal
After Fed chairman Greenspan left office, the Federal Reserve, under the stewardship of new chairman Ben Bernanke, started easing monetary policy aggressively. By December of 2008, the federal funds rate was between 0 and 1/4 percent. The Fed had used up its traditional stimulus, all the 'Creature from Jekyll Island' had left was the ability to print money so they started throwing cash at everything.
Additional stimulus was injected into the economy by:
The System Open Market Account (SOMA) purchased mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae (agency MBS).
The Term Auction Facility was $40 billion in loans to rescue the banks. It wasn't near enough, the Treasury department got authorization to spend $150 billion more to subsidize and eventually take over Fannie Mae and Freddie Mac, they also bailed out AIG.
Dollar Swap Lines exchanged dollars with foreign central banks for foreign currency to help address disruptions in dollar funding markets abroad.
The Term Securities Lending Facility auctioned loans of U.S. Treasury securities to primary dealers against eligible collateral.
The Primary Dealer Credit Facility provided overnight cash loans to primary dealers against eligible collateral.
The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility provided loans to depository institutions and their affiliates to finance purchases of eligible asset-backed commercial paper from money market mutual funds.
The Commercial Paper Funding Facility provided loans to a special purpose vehicle to finance purchases of new issues of asset-backed commercial paper and unsecured commercial paper from eligible issuers.
The Term Asset-Backed Securities Loan Facility supported the issuance of asset-backed securities (ABS) collateralized by loans related to autos, credit cards, education, and small businesses. In March 2009, the Fed announced that it was expanding the scope of the TALF program to allow loans against additional types of collateral.
The Troubled Asset Recovery Program was proposed and $350 billion was approved by Congress - the money was used to buy bank and automotive stocks.
Late in 2008 there was a run on ultra safe money market accounts - according to AMG Data Services a record $140 billion was pulled out in one day.
In response to the continuing crisis and a stalling economy the US Federal Reserve initiated Quantitative Easing and Operation Twist.
In September of 2008 the $1.7 trillion QE1 was started. The Fed purchased mostly mortgage backed securities and established a commercial paper lending facility.
In October of 2010 QE2 started. At $600 billion, QE2 was much smaller then QE1 and its buying was mostly confined to purchasing long term government bonds.
QE1 & QE2 failed to restart the economy and housing market.
Operation Twist is the Fed's initiative of buying longer-term Treasuries while simultaneously selling shorter-dated issues in order to bring down long-term interest rates.
By purchasing longer-term bonds, the Fed drives up prices which forces yields down - price and yield move in opposite directions. Selling shorter-term bonds causes their yields to go up because their prices fall. These two actions "twist" the shape of the yield curve, hence the name Operation Twist.
Quantitative Easing Three, QE3
On September 13, 2012, the Fed announced that it would buy $40 billion a month of mortgage-backed securities until the unemployment rate fell below 6.5 percent, or the expected inflation rate rose above 2.5 percent. In December the Fed added buying $45 billion/month of longer-term Treasury securities per month - QE3 is more than one trillion dollars a year.
In 1Q2013, which comprised the first three months of QE3, the Fed increased the size of its balance sheet by $285 billion, or 9.8 percent.
During the first 3 months of QE3, the Fed increased the monetary base by 10.83 percent.
U.S. labor force participation is now down to where it was in 1979 - 63.3 percent. The unprecedented 2.5 percentage point decline in labor force participation under President Obama amounts to 6.2 million Americans being pushed out of the job market - 6,200,000 have stopped looking for work, these people have been forced to give up.
If labor force participation had remained at the 65.8 percent level it was at when Obama took over from Bush the unemployment rate for March would have been reported at 11.1 percent - that equates to a 3.1 percentage point rise during Obama's presidency.
In the final quarter of 2012, the US economy expanded at an annual rate of 0.4 percent. The 0.4 percent growth rate for the gross domestic product (GDP) was the weakest quarterly performance in almost two years.
For all of 2012, the economy grew 2.2 percent, that's after a 1.8 percent increase in 2011 and a 2.4 percent advance in 2010. Since the recession ended in the summer of 2009 the economy has been expanding at sub-par rates.
The Congressional Budget Office (CBO) has estimated that the combination of tax increases and spending cuts (the much talked about fiscal cliff) could trim economic growth this year by 1.5 percentage points leaving just 1.4 percentage points for growth in 2013. If the CBO's estimates of just 1.4 percent real GDP growth this year prove true, America will have experienced its worst four consecutive growth years of GDP in the Bureau of Economic Analysis' data going back to 1930.
There can't be anyone even remotely thinking the Fed's, or Obama's, policies are a success, here's just a few facts:
- Medium household income has declined
- Inflation is climbing much higher and faster than officially reported statistics
- Few Americans own any significant amount of financial wealth
- Housing has not recovered
- U.S. Employment rate is not recovering
- Consumer goods prices are not stable
- The number of Americans living in poverty has now reached a level not seen since the 1960s. There are 50 million poor people in America
- There are over 47 million Americans on food stamps
- U.S. national debt is $16+ trillion
- Adjusted for inflation markets are lower than they were in 2000
- Student debt totals over $1 trillion
- The Federal Reserve's balance sheet is plus $3.2 trillion and the Fed is continuing to purchase assets at a rate of $85 billion a month
- Consumer sentiment is at crisis levels last seen in 2008
- The banking system backs $7.4 trillion in insured deposits with $32 billion, that's just .43 percent - when the U.S. was on the gold standard your dollar was backed 40 percent with gold
- The largest city bankruptcy in US history was just announced for Stockton, California - population 300,000
Blue Collar Man
Give me a job, give me security
Give me a chance to survive
I'm just a poor soul in the unemployment line
My god, I'm hardly alive
Is it fair to say the Federal Reserve has failed America? I was watching TV the other night when an ad came on touting some drug. The disease could be cured by diet and exercise, of course most today would rather take a pill then responsibility. Anyway the announcer started reeling off all the side effects of this drug, it wasn't long before I was staring up at the ceiling and the speakers voice had become Lucy's teachers voice, yada yada yada blah blah blah, cancer, stroke, heart disease. I found myself thinking I'd rather have the disease then take the cure, it was fixable with some lifestyle tinkering.
The next thing I thought of was the Gold Standard was like the disease - not so bad compared to the drug. The Gold standard was fixable and amenable to today, it would work, and it's certainly preferable to the cure, the pill represented by fiat currency, the Federal Reserve, stock market crash's, banking and sovereign crises, yada yada yada.
I think we all need to ask ourselves if the U.S., and the world, were better off when the dollar was backed by gold, and politicians, along with their bankster brethren, had to operate under the burden of gold's chains of fiscal discipline. Or are we all doing so well now, are things so great, has the Fed with its limited monetary policies worked out so well that we don't need gold backed money?
Perhaps we don't need the Federal Reserve, maybe what we need are gold's chains of fiscal discipline. Perhaps the fiscal discipline of a gold standard needs to be imposed on our dear leaders. This question should be on all our radar screens. Is it on yours?
If not, it ought to be.