Aristophanes

Why Doesn't Insolvency Equal Bankruptcy?

Thank for the kind words.

On Mar 06 07:30 PM EEB wrote:

> However, I just wonder if it is really possible to untangle the mortgage
> market mortgage-by-mortgage as Aristophanes suggested. These mortgages
> have been resold so many times and sliced up and bundled so much
> that I'm not sure if the banking industry or the government or both
> working together even have the the needed workers to sift through
> the mess.

No doubt it is complicated, but these mortgages can be individually reworked, even under the impending threat of bankruptcy cramdowns. Some lenders have voluntarily stepped in to alter the terms, and therefore the underlying value of the securities.

If they are re-workable, they are divisible. Compensation based on the % of ownership is just math. The contractual repercussions are no threat as items like this are unwound all the time in bankruptcy.

In any case, securitization needs to be banned for all mortgage products. They are nothing more than curbside bombs of hidden risk.

Rethinking Subsidized Finance

JohnL:

Full reserve banking in Ancient and Medieval times was anything but, and not at all comparable to modern banking systems which evolved from the later Middle Ages, spreading forcefully throughout Europe and the Near East afterwards, primarily through Venice and Genoa.

Ancient banking systems were mostly repositories for the nobility to keep the coinage of the state, corresponding to their roles as guardians of political office. Coinage and note lending was done mostly amongst the noble classes. The patrician/plebian dynamic was the real mechanism for wealth redistribution. Coinage economics were extremely rudimentary and were secondary to barter at local levels. In Rome, coinage was a way of enforcing military rule: local merchants were forced to accept the coins as presented to them by the Legions for the exchange of goods. Almost all local commercial lending was done using barter collateral, not deposited coinage, although in urban areas coinage was accepted in terms, barring a coup. Full reserve banking was an arm of the state. It was a way the military maintained central order and kept the troops loyal. Unless they were out pillaging, that's how they were paid. Coins were partially solvent in their own right, but the dissuasion to reformulate was to imprint the image of a god on them, thus making it a traitorous crime and blasphemy to alter. Of course, the Roman Emperor was that god.

Commoners use of banks was non-existent and their economic structures were closer to what we see in the developing world today, including loan sharks and other formal and informal civil agreements. Loans were made using hard collateral (rarely deposited coinage—no one trusted the Emperor du jour) and the failure to pay was punished by enslavement. The most extensive use of what we would call banking comparable to modern terms was in shipping and insurance, where the Romans in particular were ingenious in their application of merchant capital and bourses to trade risk (the nobility controlled the armies, political offices and priesthoods, but navies and the merchant marine were landless and ephemeral in power, so offer an interesting counterpoint to the baseline system).

There has never been a full deposit system that survived into modern times because the systems cracked under the stress of capital expansion, vastly outrunning the input of depositors. Political insecurity destroyed fixed location capital depositories. They were blatant targets. That is how monasteries evolved into fortresses.

In fact, the noblesse oblige arising out of the late Medieval period in all likelihood precipitated the rise of fractional reserve banking. The landed nobility, owning upwards of 95% of the productive capital of society, invested only in farmland, eschewing other productive endeavours, and only reluctantly financing exploration and new technologies. Land equalled nobility and all the political and family privileges therein. They equated banking with the state treasury and acted as such in jurisprudence (they controlled the courts) and contract law (they were the rule of law) and the ever-present taxes (they were the tax collectors).

Bourgeois urban merchants were the creators of fractional reserve banking, especially in Northern Italy. This enabled risk based on ability to take both profit and loss out of future earnings and productivity; not out of generationally hoarded caches of treasure and land attached to title, the latter of which could be used to politically "get out" of contracts. These bourgeoisie saw a need, worked the math, and created the dynamic economic structure of monetary commerce we now live in. They were oppressed by the centralized economic notions that all wealth really belonged to the state a la the Sun King mentality (there is your "embezzlement"; God said so and gave the King supreme powers). Therefore they created a system of lending that took advantage of their meagre capital reserves, multiplying the productivity of money. Their risk to reward ratio of their systemic advance easily trumped the capital gains of the nobility stuck on the same land generation after generation, fending off rising problems with overpopulation, revolt and famine.

Historically, fractional reserve banking is an unqualified success. The history of Western progress is absolutely linked with this evolution. Fractional reserve banking grew out of opposition to noble government by a growing middle class. You have it entirely backwards when you assert that the state "participated" in its formation. These merchants were running away from the constraints of the state. This is the same reason why fractional reserve banking is allowing developing nations the freedom to experiment and take risk based on human capital and not on fully backed deposits (unless you have the centralizing corruption of the likes of Macos, Suharto, Banana Republics, etc.). It's a powerful social contract that evolved overtime based on need. It was not at all a top-down concept. There has hardly been a "500 year opposition" to a full reserve economy because the fractional reserve system was in itself the triumphant revolution from centralized control based on a landed gentry determining what the measure of wealth and commerce were (it's gold and only gold, dang it; no, wait, tulips; no, it's whatever Louis says). The explosive advance of the European merchant class was the result. There would not be a United States without that event. If the Austrian School promotes that historical read, they've got it wrong. That is simply not how the history unfolded. You need to get out of the ideological straightjacket.

I will gladly accept a banking system where my deposits can be fractionally leveraged for investment n my citizen peers. I believe in the productive capacity of my citizen peers and know they are good for it. It's a risk factor I am entirely comfortable with even if abuses do occur. The idea that we can only lend out no more than what we deposit is defeatist and ahistorical, and frighteningly Medieval in its rigidity. Frankly, a full reserve system never going to happen. Fractional reserve banking is far too flexible and entrenched to be usurped by unproved ideologies. Any transition towards such a system would lead to extreme violent, the end of which would find no gold anywhere, it all being hidden in holes somewhere deep. Fractional reserve banking has taken on its share of crises, and the world has progressed. As for fiat currencies; their value is gained from the rule of law. That, too, has been generally progressive over the last 500 years, so I'll trust in that as well.

Thank-you for the discussion.

Why Felix Should Walk Away

The most rational outcome for you is to walk. Do so quickly and surely.

In fact, it is the only solution. Rents are dropping as housing supply rises. You would be in a market competing with everyone in the same boat as yourself if you try and rent..

The entire point of foreclosure in contract law is to take the moral arguments out of the process. The moral hazard was exceeded when greedy lenders lent to stupid people (encouraged by the government) and folk like you are the collateral damage. Being "house poor" is not your fault. Cut your losses and get away from that mortgage.

You are foolish to keep paying into negative equity. It is anti-capitalistic. Save your financial future.

Also, it is a myth that foreclosure hurts credit. Foreclosures are secured loans. Credit agencies are far more concerned about stressed out owners with negative equity ramping up non-secured credit and then declaring bankruptcy.

Finally, owning is over-rated. You are far, far better renting and banking your savings. You'll get a better housing deal with almost no risk.


On Mar 06 01:18 PM House Poor wrote:

> We put 20% down on our condo in CA as well. ($78K in our case)
> We have a 30 yr fixed rate. We've been making our payments for 4
> yrs. Now moving out of state for a better job. What do you do?
> You can't sell it without still owing money, you can't refinance
> to lower the payment. We don't want to take on the expense of trying
> to rent an out of state property when current rents don't even cover
> the monthly nut. We've lost considerably in our 401K, etc. I don't
> know what we're going to do. You can't even make an informed decision
> because the bottom hasn't hit yet. Our only sensible choice for
> financial survival may be to walk. If anyone has constructive suggestions,
> please share them.

U.S. Mortgage Delinquency Rates Setting More Records

Won't work. Evidence shows that people will simply not pay and will rationally default unless they are in positive equity. No equity and they will leave via foreclosure and drive their neighbours prices down as well. Those are the contract terms drawn up to specifically frame the process without moral terms. If you want to talk morality, go to a Priest. If the greedy lend to the stupid, then this is what you end up with.

Principal write-downs and affordable interest rates combined may ameliorate the wave of pending foreclosures, especially for those who hang on to their jobs and therefore have an income stream.


On Mar 06 02:57 PM stockdoc123 wrote:

> Refinance the loans for 40 years at 5% interest. This makes the payments
> more affordable.

U.K. Outlook: Nation-Sized Experiment in Regulatory Arbitrage?

That's what I love about Europe. They man the barricades and riot. They really let it all hang out. great historical theatre. In the 1970's oil embargo, Europeans took what precious petrol they had and made Molotov Cocktails. Then, after the spasms, they all sit down to terrific meals and compare notes and started making even more fuel efficient cars.

In the U.S.A. the passivity over mass foreclosures and homelessness, layoffs and investment losses is lacking any sense of anger and tragedy. Americans are so passive in comparison to the Old World. When the oil embargoes caused gas shortages, most people whined about Jimmy Carter's sweater. Then they all went out and subsidized the production off SUV's. No fun to watch.

Great article on social consequences. Thank-you.

The FDIC Is Broke...Or Will Be Soon

Just the presence of the FDIC has prevented bank runs. It's the single biggest institutional safeguard and Great Depression legacy used to weather this storm. There are adequate ways to finance the FDIC. It will be protected. That's a given.

Why Doesn't Insolvency Equal Bankruptcy?

For US domestic banks it all comes back to mortgages. These mortgages are tied up ins securities that cannot sell without destroying the banks holding them. There are an anticipated 9 million more foreclosures coming on active mortgages over the next few years, so the longer the financial institutions hang on to these securities, the worse their fall will be, and private investors will shun the banks even more. Throw in the rising tide of rational defaults and that 9 million # might go up another few million. At that point, this crisis will have eviscerated almost 20% of all mortgages, and evicted an equal number of buyers who have no prime mortgage replacement waiting to take over. The housing over-supply will continue unabated and will start crunching away at the prime mortgage base like termites.

In order to spur re-capitalization, the government needs to stop encouraging the trade in these failed securities. Break them up and sell them mortgage-by-mortgage to local and regional thrifts and re-capitalize those institutions by underwriting their ability to buy these individual mortgages The local banks can do a boots-on-the-ground assessment of the properties and borrowers and make whatever deals they need (including principal write-downs) to place these onto transparent balance sheets. Such a process would transfer assets to performing institutions and any taxpayer funds would go towards stronger institutions who would usurp the weak ones. It would also shine a light onto the CDS obligations and reveal exactly which institutions took the biggest risks and need to be wound up.

Trying to keep this securitized mortgage market alive is madness and is bleeding the banks. I am stressed just waiting for the stress tests! Go back to tried-and-true banking. We know it works.

Private Sector Solutions to the Mortgage Crisis

This type of voluntary loss or cramdown is exactly what has o happen.

The fact is, over the last decade millions of homes were built that far exceeded the supply of prime borrowers. Should they go into foreclosure there is no pool of prime mortgage borrowers available to sop up the supply. In fact, the economy is shedding more borrowers than it is is adding new workers. The supply of houses is increasing while the supply of buyers is decreasing. All this with no new houses being built.

The only way to assuage this is to have capital write-downs and lower interest reworked mortgages to keep some cash flowing. Every foreclosure due to rational default, underwater equity, or improper mortgage product evicts someone from the market for many years, but the houses stay. That cycle has to end. We need to keep these people on the property ladder.

Bank of England Ignites Quantitative Inflation: Now What?

Neither the Weimar Republic nor Zimbabwe practised Quantitative Easing. They printed money the old-fashioned way: with paper and ink.

QE has been done substantially by only one country: Japan, starting in the late 1990's. It did not lead to inflation. It did pretty much nothing as companies simply sat on the cash. In act, it exacerbated the zombie bank syndrome.

Printing money as Weimar, Zimbabwe and Latin America have done is different than QE because the former did so to pay state bills. The Weimar Republic tried deliberately to inflate its way out of the terms of the Treaty of Versaille and its pension obligations to veterans; Zimbabwe to purchase imports for a corrupt regime; and Latin America through the 1970's to 1990's to pay back international loans, mostly to the IMF.

The QE proposed here is different in that it is not being used to finance government spending, rather increase both the quantity of money and its velocity.

QE is not being used to stimulate imports or rectify the balance of payments. In fact, quite the opposite. QE is being used here to keep the Sterling low in order to combat unemployment and stimulate exports (as happened in the examples of Latin America and Japan, and largely successful).

The point that this might spur other nations to do the same is well made, but again, this did not happen when Japan—the world's 2nd largest economy—practised QE for over a decade. This would be the one symptom worth watching.

There is is a risk of inflation with any over-stimulus of the monetary supply. However, the historical and statistical record from Japan's massive experiment in QE shows that inflation is not an unavoidable by product of the practise. There is simply no proof of this. Any evidence there is points the other way. Over a decade after Japan's initial QE manipulation, their economy is again slipping into a deflationary spiral.

And, the historical record of Japan shows that QE did not cause interest rates to rise. In fact, the opposite happened. They stayed persistently low. So low in fact that a Japan-specific carry trade developed.

It's a grand experiment, for sure. But to state there is an inevitability towards "much higher inflation and interest rates", and that other nations will follow the trend, not borne out by the prior example of Japan. I would be very cautious in advising investors to see these as foregone conclusions. The "dismal science" evidence is simply not there. There were the same concerns when Japan went down this path, and they were wrong.

Why Felix Should Walk Away

Houses are not below their rightful value because there is persistent deflation. Therefore the real value can also decline, as it did in the Great Depression.

Felix should walk precisely because he will never recover his value. He has already paid for his house with his $300k. Anything after that is utter foolishness.

There were millions of homes in the US built to be be sold to non-prime borrowers, like Felix. The only way the supply and demand can be brought to balance is if deflation stops, and if millions of borrowers who are in arrears already foreclosed, or about to enter rational default are replaced by prime worthy borrowers. Those borrowers are not readily available and the economy is actually shedding them faster than they are entering the workforce.

In the Great Depression (and in Japan still) housing prices took decades to recover and the cost of housing (buying land, building, permits) declined along with it. It is happening again.

Why Felix Should Walk Away

Don't walk, Felix. Run. Run as fast as possible.

It's a rational default and would be a far better allocation of your capital and productivity. The golden rule of capitalism is to maximize your returns. This house is a negative return and it would be against the principles of capitalism for you to stay. There is no moral quandary here. Your prime commitment is not to your neighbours, but your own financial well-being. Paying into negative equity is anti-capitalist.

Landlords are desperate for your business. You will have plenty of more affordable housing options and in the end may be able to purchase your dream house back at a price more in line with its real market value.

Rethinking Subsidized Finance

It doesn't mater what the "banked" commodity is. It could be gold, jade, US$, koi, or cattle. It depends on the local store of value. If you then issue a note against that value, you've created a currency. I've been in African countries where photocopied US $20 bills were traded at half value (US$10), and they had a better store of value than the local currency.

There are no bank deposits in a system where barter is as valuable as monetary transactions. Why expose yourself to accounting rules and the taxman, the whims of a corrupt government, skimming bank managers, or the Forex market when you can avoid these institutional pitfalls? Or, why lend in any currency when real collateral and generational debt have far more tangible payback? The lack of faith in fiat currencies kills commerce in developed countries because they cannot leverage their deposits against future earnings but against present capital accumulations only. Fractional reserve lending builds in a risk tolerance towards default with the expansion of credit, roughly based on demographics and human productive ingenuity, not how much of a precious metal is mined in some far off place.

That is why there is an IMF and World Bank. They basically use the world's reserves currency (the US$ and reserve drawing rights) to finance development. This is the germ as to why the Euro came into being. When a decline occurs in a fractional reserves system, the majority of losses are taken against future earnings.

In the developing world where barter is relatively available as a substitute for currency transactions (Southeast Asia during the 1997 crisis saw an explosion of regional bartering), debt is registered as collateral at extremely usurious rates. In a fixed commodity system, if you want to add a productive second milk cow, the rates are absolute. You cannot break down a cow into parts so you have to put the entire first cow up for collateral. If cow two dies before the milk can be sold to pay for the purchase, you also lose all of cow one. That's how famines happen. We have a term for it—betting the farm. (And what happened to the Okies in the 1930's—sharecroppers had no credit to purchase seed, so when they lost a crop, they were evicted from their subsistence farming and starvation ravaged America). In a fractional reserve system it is entirely possible to lend with no collateral (almost unheard of in developing countries until micro-lending came along) because the risk pool is evaluated against the possibility of future earnings. Who cares how much the the pegged commodity is worth? The only thing that counts is the faith in the productive capacity of the recipient. If they know cows and have no collateral, you can still lend them money because they know cows. That's the value. Forget about basing their worth on the last ten generations ability to hoard gold. That agenda is counter-productive and in areas of high population growth, leads to enormous disparity in wealth.

Indians store gold as a safeguard against crop failures and infertility (generational support), not as currency. They'd never forego their seed money. As such, gold is not leveraged for risk, but is hedge against risk. It is insurance. Using it as a standard to underwrite currency as with a gold standard risks all deposits to the aforementioned corrupt government, or invader, etc. This lack of risk taking is severely inhibiting to commercial development. That is why micro-lending has been so successful there. It breaks the cycle of reliance on gold and introduces risk-taking based on the community measure of individual productivity. Failure is built into the model in terms of higher rates, but there is no need to peg the value to a family's gold. That is specifically excluded as collateral precisely to increase the assessment of productivity, not against generational wealth accumulations. It breaks the caste system and its roots in primogeniture. It's a very interesting development because it moves local commerce beyond the commodity-fixed, Medieval, economic architecture.

Fiat currencies and fractional lending liberate transactions from physical repercussions. That is how bankruptcy evolved to replace debtor's prisons, and before that slavery, serfdom, sharecropping, the caste system, and so on. Yes, fractional reserves are risky as we see now with liquidity traps, hyper-inflation, and sub-prime idiocy. All systems are. Today's crisis is about how banks, lobbyists, those in favour of de-regulation (starting with the whole Reagan/Thatcher "government is the enemy" agenda), broke the social contract about acceptable systemic risk and abused leverage to the detriment of the body politic. This about good governance gone bad.

The Road to Economic Hell

You mean Bob Roberts wasn't real?!

Oh, wait. He's gained weight, can walk again (when he's not on drugs), and changed his name to Limbaugh.


On Mar 05 01:36 PM Tesa wrote:

> Aristophanes, do you really think there is an actual John J Wall.
> I am not so sure.

The Road to Economic Hell

Better a lucid agenda than a "misunderestimated" one.


On Mar 05 01:48 PM cash wrote:

> Bush was unfortunately a vacuous idiot. Unfortunately, Obama has
> an agenda

Rethinking Subsidized Finance

Thanks guys. The Austrian school can spot a bubble a mile away and I respect them for their clarity. They also have a healthy disrespect for formal modelling within the "dismal science", and that's been proven accurate of late. Years ago when Bernanke spoke about the "end of the business cycle" the historian in me cringed. He's supposedly a historian! Yet Peter Schiff clinically nailed the coming housing bust with textbook accuracy.

That said, the posited Austrian solutions are simplistic, rigid, unproven, poorly modelled themselves, and ahistorical. Like Marxism, they make a great tool for critical analysis, but lousy rules to live by. When the Austrian Schools tries to be the conventional wisdom, they fail. They are better off on the outside looking in.

Other examples of conflict caused by commodities: the Boer War and the current, horrific conflict in the Eastern Congo.

Also, in my long rant I left out the term Hawala system, after "famous".