Thursday, 7 February 2008

The begging begins....

I have to confess to a sordid fascination with the US housing market. The crisis over there is now transforming; it started out with a rising default rate, but it is now sliding into a banking crisis.

As the banks have begun take the hit, many bankers are now putting forward housing rescue plans. The International Herald Tribue produced a particularly stupid one this morning. Howard Milstein - CEO of the New York Bank and Trust - wants the US government to guarantee the principal of mortgages for 15 years. In return, banks would freeze mortgage interest rates on sub prime loans.

Old Milstein knows that this idea does not have a hope of flying if he presents it for what it really is, namely a government bail-out of the almost certainly insolvent US banking systen. Instead, he feigns concern for the little people, in particular those hard pressed new homeowners that ended up with those subprime loans. Milstein says that his strategy would "ensure that fewer families would lose their homes, that fewer neighborhoods would deteriorate because of abandoned housing, and that as a consequence, there would be less downward pressure on real estate prices and property tax revenues".

This newly found social conscience lacks a certain credibility. In the past, banks have shown little concern about the personal consequences of foreclosure. Banks have steadily repossessed unfortunate families who could not afford their payments.

Unsurprisingly, Milstein offers no estimates for the costs of this little scam. Next year, around $600 billion of sub prime mortgages will see their teaser rates disappear. Currently, around 15 percent of these loans are defaulting. Even if this scheme cuts the default rate by half, the US government will end up with billions of defaulting loans on its books.

Yet the cost of this scheme is not the main reason to reject this type of crude bail-out. Once the banks safely offloaded their sub prime loans onto the government, they would go out and start recklessly lending again. They would keep the profits from high risk lending private. Wait a few years, and we would see the same kind of credit difficulties we see today.

So what has this got to do with the UK housing bubble? We are fortunate insofar as we are two years behind the Americans. As such, we have a head start exposing the stupidity and crass self interest behind ideas like this. When our crash really gets going, we will have our very own Milsteins crawling out from the banking system, pleading for a bailout and tarting it up their demands for government assistance with social concerns about the poor.


Andy said...

In most industries, new products are required to undergo tests for safety and utility before being marketed. For example, cars must pass stringent crash tests, toys must not have small detachable parts, electrical equipment cannot have live exposed wires..

Most reasonable people would agree that this is acceptable, as it is very hard for consumers to choose safe products absent 3rd party standards and tests. As long as the standards apply to all equally, they don't affect markets.

For some reason, however, such testing is absent from financial markets. No third party conducted tests on CODs or their likely effects; no third party was looking at insanely lax lending criteria, use of leverage or off balance sheet tricks.

All I ask is that makers of financial products are held to the same standards as everyone else.. prove that a product is safe BEFORE putting it on the market. No proof, no sale.

Anonymous said...

Andy: "For some reason, however, such testing is absent from financial markets."

Caveat emptor!

I sympathise with you desire for consumer protection, but look what it has led to. Poeple with no knowledge of what they are buying, buying something because a lot of other people are buying it too. THAT, by and large has been the sole criteria in any investment decision.

They have done this because no one is ever made an example of in the market any more. People are 'protected' and consaquently they have become ovine. The market is not thought to be a risky place, we all suck on the tit of government protection, yet even Gordon Browns' lawyer admits government promises is worthless!

It is time people grew up, do not just make a decision, make an informed decision.

Don't buy *just* because the other sheep are buying, buy because you have evaluated your purchase along criteria important *to you*.