austindefender

“Does it benefit anyone to force another family into foreclosure, out of their house, put another home on a housing inventory that is overburdened with excess supply?”

–Sheila Bair, FDIC Chair

Yes.  It does.

It benefits every single person who’s looking to buy a home.

It may also benefit the folks who’re getting foreclosed.

And it definitely benefits everybody else.

There’s this thing, called “supply and demand.”  When there’s too much of something, prices fall.  When prices fall, people buy more.  It’s how markets “clear.”  It’s how broken markets fix themselves.

When markets don’t clear, they remain broken.

In other words, when market prices are artificially propped up, transactions that otherwise would have occurred don’t happen, hurting everyone, and prolonging the problem.

In the US right now, 6.7% of all houses are vacant.  That’s 19 million homes.  That’s more than… ever.  At least since they started keeping track.

Why?  For the same reason there’s ever excess inventory in anything.  Because sellers aren’t willing to sell for prices buyers are willing to pay.

Every one of those houses represents an opportunity lost.  There is a family, somewhere, who’d like to live in each and every one of those homes.  19 million families, in fact.

But the sellers won’t sell them, because they can’t get the price they’d like.  So the homes remain vacant, depreciating while squirrels, squatters and looters and bad weather take their toll.

The process that drove houses to unsustainable levels in the first place is what caused the problem, and it process was driven by greedy, dishonest brokers and lenders, and speculators who got to play with free money.

It’s the process that caused the problem.  What’s happening now is the fix.

This plan will prolong the problem, while hurting those who had nothing to do with it.  In other words, if you’re looking for a house, this plan takes your tax dollars and uses them to make the house you’re looking to buy less affordable.

When housing prices fall to a level that approximates what they’re actually worth, houses will sell again.  But not until then.

In the meantime, let’s look at what causes foreclosure.  First of all, if the house is worth more than the amount of the loan – the amount that’s owed on it – there would be no foreclosure.  Instead, the owner would sell it.  He’d take the profit.  Or, at least avoid the hit to his credit.

If the house is worth less than the amount that’s owed, on the other hand, you have to wonder why an owner would even want it.

If the house is worth $250,000, and the debt is $350,000, it’s owner’s net is -$100,000.

This owner can become $100,000 richer simply by mailing the keys to the bank.

In other words, he’s better off after the foreclosure, than before.

Continuing to pay is a financial mistake.  (It may be the moral thing to do, but that’s a different issue.)

It’s like purchasing a car for $35,000, when the sticker price is $25,000.

When a business (rather than an individual) has a negative net worth, the owners liquidate the business, and the creditors lose out.  The chance that the business will fail is the chance that you take when you loan money to a business.

Anyway, the point is that keeping someone in a home that’s worth less than the mortgage is not necessarily doing him any favors.  In fact, it could be costing him a whole lot of money – especially if he’s going to wind up in foreclosure eventually anyway.

So if propping up home prices doesn’t help buyers, and may not help sellers (and why should the government favor one group over the other anyway?) who does it help?

The one group of people it definitely helps is the same group that caused the problem in the first place.

Bankers.

Banks are run according to the following simple equation:

Assets (including reserves) = liabilities + equity.

Assets are anything that has value.  In the case of banks, it’s mainly the money they’ve lent out, plus the interest they hope to collect on it.  It also includes reserves, the bit of cash they keep on hand to cover day to day operations.

Liabilities are whatever the bank owes to others, including all the deposits it’s collected from you and me, plus whatever other money it’s borrowed.

Equity is the variable.  It’s what’s left over after liabilities have been subtracted from assets.

Equity = assets – liabilities.

Equity is the bank’s net worth, and because it’s net worth, it’s also the part of the bank that belongs to the shareholders.  Everything else belongs to somebody else – either depositors or shareholders.

If assets less liabilities is zero, or less than zero, then the bank is insolvent.

You can think of a bank as two towers of money, each of which must always match the other. If the value of one changes, so must the other.

Assets = Liabilities + Equity

To take a simple example, suppose a bank buys a pile of gold for $1000, with money it’s borrowed from the public.  The value of its assets, then, is $1000, the same as its liabilities.  If gold increases to $1500 per pile, then the bank gains $500 in equity, which its accountants will duly note in its records.  If gold later falls to $500 per pile, then the bank is insolvent.

This is the simple case.

Suppose, however, instead of buying gold, the bank makes loans to the public.  In that case, the bank’s assets are the same as the value of the loans it’s made.

Now loans, just like gold, have a market, and the market value of loans changes, just as it does for gold.

When the value of a bank’s loans (or “portfolio”) goes up, the bank is quick realize the change, and quick to tell everybody about it.  It’s a bit slower, on the other hand, the move happens in the opposite direction.

In fact, if the move is significant – enough to wipe out the bank’s equity – the bank may choose not to recognize it all.  Perhaps there’s “no market,” for the loans.  Maybe the markets are “distressed.”  Or perhaps the bankers have chosen to hold the loans “to maturity,” so the market value doesn’t matter.

In any event, it’s the bankers themselves who decide.

And as a practical matter, there’s nothing to stop them from losing money indefinitely, so long as they have the support of a central bank, or the government.

Alan Greenspan (1966):

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value… The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.

Money – whether in the form of gold, or of currency – is a claim on a proportionate part of the productivity of an economy.  Put another way, it’s a claim on the product of people’s work.  If you want to consume, without working, money is the way to accomplish it.

When people talk about money as a store of value, this is what they mean – the ability to consume, without producing.

Money is, and always has been, however, only a temporary store of value.  This is because it is not wealth itself, but only a token.  And like all tokens, its value is subject to change.  It can even go to zero.

As an example, consider a nation, all of whose people save up vast sums of money for the day when they can all retire.  When the day comes, however, they find that all of their cash (or gold, or whatever) is worthless.

It’s worth nothing, because real wealth is the ability to induce other people to do work for you.  If there are no workers, there is no wealth. Money may be a store of value, but it’s only a store.

The work must be done by real people in real time, and the work itself can’t be stored up by any method, much less in gold bars.  There is no “safe” method of saving up the work of other people, because their willingness to do the work depends on a social contract, the terms of which are perpetually subject to change.

Moreover, a social contract, the terms of which require one group of people to do the work, another group reaps the rewards, is not likely to last.   And the more unbalanced the situation becomes, the less likely it is to continue.

The mistake Alan Greenspan made in 1966 (and I think he’d repudiate it, today), was to confuse the form with the function.  Gold is only the symbol of the thing.  It is not the thing itself.

***One other note: Gold is no protection against inflation.  Anytime anyone finds another nugget, the value of all other gold is reduced proportionately.  The only way to protect against this form of inflation (or “confiscation”) would be to prohibit anyone anywhere from finding any more gold.

Bloggers and other pundits are pretty sure we’re about to experience crippling deflation, or hyper-inflation, but they’re not sure which.

According to the Quantity Theory of Money, the actions of the Fed, and of the US Treasury, ought to create a huge amount of inflation.

As a visual aid, this chart represents the total borrowing of US banks from the Fed, through December 2007.

Total Borrowing Through Dec. 1, 2007

This chart represents total borrowing through December of 2008.

Total Borrowing Through Dec. 1, 2008

As you can see, they’re not on the same scale.  The Fed is has loaned exponentially more money into the economy than it ever has before.

Meanwhile, the Treasury prepares to finance a trillion dollar deficit, and the Fed threatens to monetize the debt.

According to Monetarists, this ought to lead to inflation.

On the other side, Nouriel Roubini, among others, continues to predict deflation.

What does it say about the state of economics when economists can’t agree on something so fundamental?

The other day Timothy Geithner, Obama’s new Treasury secretary, accused China of manipulating its currency, and caused a minor kerfuffle.

Here’s the thing, though.  There’s no debate that China manipulates its currency.  Of course it does.  The question is whether it’s good or bad for us.

China, like the US, has the ability to make unlimited amounts of its own currency.

Suppose it decides to use some of that currency to purchase somthing of ours – American currency, for example, or US Treasury bonds.  What is the effect of that?

It increases the demand for US dollars while simultaneously increasing the supply of Chinese yuan.  That makes the dollar rise, and the Yuan fall.  That’s good for Chinese exporters.

Not only does it make Chinese products cheaper, China effectively manufactures demand for its products by selling yuan into the market.  Because the yuan is ultimately good for only one thing – buying Chinese goods and services – every yuan must eventually find its way back home.  When it does, it creates jobs for Chinese workers.

Sounds good, right?  China gets to accumulate dollars, while creating employment for its people.

Here’s the problem, though.  The US just like China, can create unlimited amounts of its own currency.  And the US dollar, like the yuan, is ultimately good for only one thing – purchasing goods and services from its country of origin.

Imagine, for a moment, that that wasn’t so – that dollars don’t have to make their way home.  What happens to them then?  Do they sit in China forever?

And if so, wouldn’t that be a pretty good deal for us?  I mean, dollars cost us nothing to create (paper currency costs a bit, but the kind that sits in bank accounts is free – it’s just zeros and ones on a hard drive somewhere.) And we can create an infinite supply of them.

As long as we knew the Chinese would always be content to accept dollars for actual real goods and services, we could all retire, and live off of them instead.

Of course, that’s not going to happen.  At some point the Chinese will realize they’ve accumulated enough dollars, and that they need to start buying stuff with them.

When that happens, the dollar will fall, the yuan will rise, and the Chinese will become buyers of American products – putting American workers back to work again.

In other words, we’ll be working for them, instead of them working for us.

The weird thing about it, though, is that that because they’re manipulating their currency, the price they’re paying for US dollars is more that what it should be, or more than what it otherwise would have been.  (That’s the point of doing it.)  In other words, they’re paying too much for what they’re getting.

Not only that, but when they go to sell, they’ll get less than what they should get, simply because they’ve accumulated so many of them.  (Think in terms of a ‘dollar glut’.)

So despite all the rhetoric, it’s not at all clear that their manipulation of their currency hurts us.  In fact, they’re arguably getting the raw end of the deal.

Maureen Dowd:

In an interview with Maria Bartiromo on CNBC, Thain used the specious, contemptible reasoning that other executives use to rationalize why they’re keeping their bonuses as profits are plunging.

“If you don’t pay your best people, you will destroy your franchise” and they’ll go elsewhere, he said.

Hello? They destroyed the franchise. Let’s call their bluff. Let’s see what a great job market it is for the geniuses of capitalism who lost $15 billion in three months.

John Thain, if you remember, was the guy at the helm of Merrill Lynch, who spent a million dollars redecorating his office while his company was going broke.

Ever wonder how you spend $1.2 million on an office?

Apparently it involves spending $35,000 for a commode.

The people who keep track of such things (the BEA) have a specific definition in mind when they talk about saving.  It’s “personal disposable income minus personal consumption expenditure.”  Or, what people make, but don’t spend.

Intuitively, it makes sense.  It’s problematic, though.  For one thing, some people object to the fact that capital gains do not count as income.  If the value of your house goes up, they argue, the government should count that as part of your savings.*

For me, the consumption side is a problem.  Do you “consume” a house, by living in it, or does your monthly mortgage payment count as a kind of savings?  What about home improvements?  Does education count?  (The government says “no.”)

Moreover, what do savings really mean, on a national level?  What if we buried half the money in America in the ground, to “save” it for later day?  (Perhaps the day the baby boomers all retire.)  What, if anything, would that accomplish?

It’s easy to mistake money for wealth, since money is wealth, in the world in which we live every day.

But at the national level, money is not wealth.  (If it were, Zimbabweans would be the richest people on Earth.)

It seems to me the issue is not savings, but investment.  What are we building, or designing, or making, that will have value not just now, but well into the future?

_________________

They say that because they misunderstand markets.  A market is not a place where money goes, or stays for a while before coming back out again.  It’s a place where money changes hands.  At the end of every market day, regardless of whether prices go up or down, the sum total of all money held by all market participants is always the same as it was at the beginning of the day.  Individuals can win or lose money in the market, but collectively no money is ever made, or lost there.

Not long ago I read another one of those articles about how Americans don’t save enough.

Which got me thinking about something I read a long time ago – that nations can’t save.

Consider:

Suppose there’s a country where everyone is the same age.  All their lives, the people work hard, and save.  They accumulate stocks, and bonds, and real estate, and cash and bank accounts.  And then they retire.

What will they buy with their money?  To whom will they sell their stocks?

Or, suppose there are young people, just not as many as those who are about to retire.  The old ones have piled up savings, and expect to retire based on their wealth.

But when they retire, who will produce the goods and services they expect to consume?  Who will do the cleaning, and build the cars, and put groceries on the shelf?

The remaining young people will have to do it.  But if there are few of them, they will not be able to make the same quantity of goods and services as before.  The demand for those goods and services, however, will go up, as the elderly liquidate their savings in order to consume the goods and services they’ve put off consuming until now.

There are are two ways this can play out.  Either the price of goods goes up, or the value of assets declines.

Either way, savings are wiped out, in proportion to the number of young people relative to the elderly they’re expected to support.

All of the goods and services people hope to enjoy in the future must be (for the most part) produced in the future.

Saving up pieces of paper does nothing to change that.