Happy New Year So, Hows the Economy Doing?
During most of December and early January, the media was filled with hopeful reports about an economic recovery. Were those reports true?
Not according to current data. Last week the New York Times reported that 1 in 8 Americans now receives food stamps (including 1 in 4 children in the US). The Food Stamp program has become the safety net of last resort, now that welfare benefits are limited and unemployment benefits expire. About half of the unemployed dont collect any unemployment benefits; they make do on savings and food stamps, or they get by on nothing. About 6 million people who receive food stamps have no other income at all: no welfare, no pension, no disability payments, no child support, no unemployment insurance, nothing. With the abysmal savings rate in America, most of those people undoubtedly have no savings, either.
Some of them do still have a house, however. But their likelihood of staying in their homes is growing worse by the day. Foreclosures and short sales (selling your home for less than what you owe the bank) are still increasing: 1.7 million in 2008, over 2 million in 2009, and an estimate of 2.4 million for this year. We should note that the 2.4 million estimate is a conservative figure based on current economic conditions and the role that the federal governments loan modification program is playing in forestallingbut not actually preventinga lot of foreclosures.
The Obama administration program, Making Home Affordable, has not helped to keep people in their homes. By giving banks an incentive to offer borrowers trial modifications by temporarily lowering their monthly mortgage payments (by lowering the interest rates on their loans), the program has merely made it possible for some homeowners to delay foreclosure; most of them still end up losing their homes in the end and damaging their credit histories, too. Of the 759,000 homeowners whove taken advantage of the program, only 31,000 have received permanent loan modifications and continued to make payments on their mortgages. Clearly the program is not meant to help homeowners nearly as much as it helps banks by allowing them to delay writing off bad loans, which makes their balance sheets look a lot better.
Why are people still losing their homes even after the interest rates on their loans have been lowered? Because they owe more on their mortgages than their homes are actually worth, in other words, theyre underwater (a fatal consequence of falling home prices). Economists have found that unemployment is not the best predictor of who will lose their home. Instead, the best indicator of who will enter foreclosure is whether a homeowner is underwater. Currently, about 16 million households in the US are underwaterthats about one-third of all homeowners with a mortgage.
And housing prices are still falling, putting even more people at risk. In spite of a surge in home buying this summer and fall because of the first-time homebuyers tax credit, home prices have remained flat or continued to decline, which is a very bad sign for the nationwide housing market. Theres about 3.2 million homes up for sale right now, about an 8-month supply. With so many people out of work and so many folks struggling to make their mortgage payments, that supply of homes for sale could increase dramatically, driving house prices even lower. Some economists predict that prices may fall another 10-20%.
Of course, house prices must fall because they were artificially inflated to begin withthats the nature of an asset bubble. Rabid demand combined with low interest rates and lax lending standards drives prices up to unsustainable levels. When reality hits and the bubble bursts, prices have to return to reasonable levels. The questions is: who should take the loss, homeowners or banks?
George W. Bush and his economic team decided that homeowners should take the loss, and so far the Obama team has agreed. Hence we have a failed federal program that merely drags out the foreclosure process with the false promise that lowered payments will help homeowners stay in houses they will never be able to afford. A rational, humane, democratic (as opposed to Democratic) solution would be to force banks to take the losses, since it was the banks and big mortgage lenders who provided risky loans to people without checking their credit histories first. And it was banks and mortgage companies that colluded with the real estate industry to artificially inflate house prices. It was big investment banks that used their weight with the ratings agencies to hide the risk of mortgage backed securities. Therefore, banks and their shareholders should pay the price.
Of course, the scale of the fraud is so big that forcing banks to take the hit all at once could bring down the entire banking industry and irrevocably destroy the US economy in one fell swoop. This was the fear that motivated enormous government bailouts at the end of 2008 and early 2009. But there are ways to spread out the pain over time and avoid an immediate collapse.
One obvious way to do this would be to give bankruptcy court judges the ability to write down mortgage balances the same way they can write down other consumer loans. But the Obama administration and Democrats in Congress have resisted this solution at the urging of banking industry lobbyists, whove been throwing around record amounts of cash in DC over the past year.
One of the reasons big banks have so much money to throw at lawmakers is because the federal government has been shirking its duty to address the problems that caused the economic collapse in the first place. The Fed is still providing cheap loans to banks with zero or extremely low interest rates. Congress has yet to pass any new bill to re-regulate the financial industry, while the Fed and other banking regulators havent imposed tough capital requirements on banks or tried to limit bonuses for bank CEOs and upper management. In short, banks are still able to operate the same way they have over the past decade.
Which means were still in the middle of the crisis, with no end in sight. Its just a matter of time before the next bubble emerges: in gold prices, in commodities, in the stock market, in some type of derivative nobodys ever heard of beforewho knows? We just know that all the conditions for an asset bubble exist right now: lax regulation, extremely low interest rates, and demand (from banks, hedge funds, large pension plans, and rich investors) for investments that earn double-digit rates of return.
This year well see if Congress is up to the task of reining in the US financial industry, because so far the Obama administration hasnt even tried.
Sources: Millions out of work, living on nothing but food stamps, Jason DeParle and Robert M. Gebeloff, The New York Times reprinted in The Seattle Times, 1/2/10; This Years Housing Crisis, The New York Times, 1/5/10; Mortgage Modifications Are Seen as Adding to Housing Woes, Phillip Diederich, The New York Times, 1/2/10; Contracts down: Is housing headed for double-dip? Alan Zibel, Associated Press, 1/5/10; Some at Fed See a Need to Do More for Housing, David Streitfeld and Jack Healy, The New York Times, 1/7/10; and Top banks invited to Basel risk talks, Henny Sender, Financial Times (London), 1/6/10.