The View From 20,000 Feet? Many Folks Could Use a Head Slap
Have you ever had a member sit across the desk from you because they're finances are a bloody mess thanks to self-inflicted wounds? What you really want to do is reach across the desk and slap them upside the head. How could they not see all this coming?
Some analysts would like to do a little head slapping of financial institutions themselves.
Among them is Max Wolfe of New School University's Graduate Program of International Affairs in New York, whose insights during a recent breakfast hosted by the Filene Research Institute left one wondering how anyone could say they were surprised by the collapse of the markets (especially mortgage-back securities) and the deep recession when there were bright, red flags snapping loudly in the wind.
Offering what he called a view from "20,000 feet on how we got here," Wolfe said "'here' is an an unpleasant place and a place we wish we hadn't traveled to. It's a rising mismatch of three key elements: assets, liabilities, and income."
Economists always have a capacity for being scary, but Wolfe managed to be wry, too, noting that today we have an "unfortunate constellation of events in which everything that could go wrong did, and things that never could go wrong, also did."
"Anytime you see the price of assets rise that quickly there should be a sense of skepticism, and there wasn't, and no place was this more apparent than real estate," he observed. "We began to build and plan a future based on these high prices. I think we passed the financial rubicon as a society when we decided asset inflation was a good substitute for income."
Loans were made by banks in particular, he said, with a goal of getting rid of them as "quickly as possible," often within 72 hours.
It all seems so obvious the cliff was approaching when Wolfe points out, "American households believed their house appreciation would substitute for the savings they weren't doing, and their tech and telecom stocks would substitute for the income growth they weren't having. It's not a few people who made mistakes, it's a pattern and a structure in the economy."
Between 2002-08, Wolfe said there was more than $4.7 trillion in liability growth, and more mortgage paper was written than all previous outstanding mortgages prior to 2002. "And it turned out that even though it's not a matter of morality or social justice, but old-fashioned silly thinking like a FICO score or ability to repay that were thrown out," he said.
Perhaps not aware just how close his audience of CUs and corporate were to the issue, he then added, "Everyone was celebrating assets, and no one was noticing that enormous liability growth was behind these assets. The money people borrow is fixed; the value of that for which they borrowed is not fixed."
Americans did prove to be very good at one thing: importing money. In 2007, the U.S. borrowed 42.9 cents of every globally available dollar, down from 61 cents one year earlier. The rest of the world proved to be very good at something, too: loaning it to the U.S. "They lent it because we spent it—on their products. We have 4.5% of world population, and do about 22% of world's wealth production, and 32% of the world's consumption. The problem we have in in the world economy now is the reason they lent to us; there is no easy place to go to replace one-third of world economy.
Much of the "hangover" the world is now feeling, observed Wolfe, stems from America's ability to develop securitization of debt, and foreign countries' assumption about America's consumers: that they were safe and lucrative.
"The housing boom in the U.S. was really part of a global economic imbalance, something we don't hear much about," Wolfe told credit unions. "(Asset-backed securities) allowed you to look like you had reworked risk. A series of inequalities and fragilities developed between assets, liabilities and income. What became the focus was how much appreciation can we get on the assets. The linchpin assumption in the entire housing boom was that it was relatively safe to lend, because foreclosures were relatively low, and who cares if you ever have to reach in and grab the house because housing values would always be appreciating. That's a strange assumption, and one that has cost us rather heavily."
Household debt, said Wolfe, has all but gone "virtually virtual" after 2001 when viewed on a chart. "The obligations are spiraling out of control among Americans compared to the income pattern," he said.
All of that leads to the big question: Why did no one see this coming?
"A lot of people did see it coming," responded Wolfe. "A lot of people saw the pattern coming. You could see that in order to borrow this much money you needed assets to continue to appreciate and you had to assume that income would be there; nothing could go wrong."
Of course, much did go wrong—or right, depending on your point of view. From 2004-06, there was a trillion dollar per annum increase in spending. During those same years, he said, "home equity withdrawals put more money in American pockets than did the total increase in wages and salaries. That was pretty good, because those years were good for wages and salaries." He added that data shows consumers were taking money out of their houses even faster than the houses could appreciate in a 'soaring bubble."
"This is a story with no happy ending," he told credit unions. "No skid marks. Off the cliff."
For many Americans, and likely a fair number of CU members, too, the bad news is they now own significantly les of their house. Wolfe said in 2003 Americans owned 57.4% of the equity in their homes; today that figure is 44.3%.
As for Americans becoming better savers, he observed," Nothing helps you spend less like having no money."
What of the future for mortgage lending? "My humble opinion is unless we have a government-sponsored refinancing program, you're going to be waiting for a long time for that to come back," said Wolfe, even though credit unions have been strong mortgage lenders. "But taking a long time to get back to a place you shouldn't have been, is probably not a bad idea.
For the country, Wolfe is calling for a move toward a "long term decline in new debt issuance, imports and spending, while keeping macro vitality. There is the challenge of the decade and the new millennium."
For credit unions and all "prudent lenders," Wolfe sees some bright spots. "The credit union community has not been addicted to getting its deposits at extremely low rates from offshore," he said. "You are not really luring in members with your trust services, and you don't attract clients with a fancy rate of return. Much of the public with money is looking for capital preservation, and many banks are now ceasing to be with us."
Wolfe predicted there will be "reputation effects" for banks for at least the next 10 to 15 years as a result of the bailouts and other troubles. "Credit unions may be last institutions standing with reputation and trust," he said. "I think you are in the right place at the wrong time, but you could help make the future the right time."
He expressed some empathy with the mark-to-market rules confounding some corporates' balance sheets, saying, "I do think FASB 157 is particularly poorly aligned to some of these exotic instruments, because they are illiquid assets never meant to trade…But I think it not right to blame the accounting."
As for the Obama Administration's overall fiscal stimulus plans, Wolfe has concerns. With total Treasury and Fed debt now in excess of $10 trillion, he said eventually it becomes impossible to "take care of" whatever the problem du jour is. He believes it is a "mistake to go backward in time to bail out MBS."
"I think the mortgage response is a good idea, but should have been done 12 months ago. But with the stimulus, it's better late than never."
Frank J. Diekmann can be reached at email@example.com.