Solutions to the mortgage problem

Quick links to a few of the suggestions out there on what to do about pending mortgage defaults.

Bill Gross, founder of the PIMCO bond fund, thinks we need a federal bailout to help those who acquired mortgages that they can’t repay (via Economist’s View):

In the early 1990s the government absorbed the bad debts of the failing savings and loan industry. Why is it possible to rescue corrupt S&L buccaneers yet 2 million homeowners must be thrown to the wolves today? If we can bail out Chrysler, why can’t we support American homeowners?

Yves Smith rather effectively demolishes this idea:

The US did bail out Chrysler, but not at any explicit cost to the taxpayer. The government guaranteed a Chrysler bond issue, and orchestrated a cram-down of other Chrysler creditors….

As for the Resolution Trust Corporation, that entity came into existence not to line the pockets of S&L buccaneers but to liquidate failed S&Ls in a orderly fashion. Let me stress that point: failed. The US government was on the hook for payouts to depositors, since these banks were members of the Federal Deposit Insurance Corporation. The RTC had conflicting objectives: to minimize its burn rate (it took working capital and walking around money to manage the assets the RTC absorbed), maximize returns, get the assets sold as quickly as possible (the overhang of bad thrift assets, particularly real estate, was a threat to sound institutions in the same geographic area as the failed thrifts).

…what Gross calls for is a massive redistribution from taxpayers as a whole to people who bought near the peak of the bubble.

Former Treasury Secretary Larry Summers thinks Fannie and Freddie must solve the problem (again via Economist’s View):

I am among the many with serious doubts about the wisdom of the government quasi-guarantees that supported the government-sponsored entities, Fannie Mae … and Freddie Mac … But surely if there is ever a moment when they should expand their activities it is now, when mortgage liquidity is drying up. No doubt, credit standards in the subprime market were too low for too long. Now, as borrowers face higher costs as their adjustable rate mortgages are reset, is not the time for the authorities to get religion and discourage the provision of credit.

Greg Mankiw has this perspective on Summers’ suggestion:

This reminds me of Saint Augustine: “Oh Lord, give me chastity, but do not give it yet.”

I’ll be offering some of my thoughts at the Federal Reserve conference in Jackson Hole this weekend. But in the meantime, I’m interested to hear from our readers– what do you think we should do?



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50 thoughts on “Solutions to the mortgage problem

  1. T.R. Elliott

    What should be done? Probably nothing. Let the process play out. “Homeowners” will become renters. Bond holders will lose money. Hedge funds will unwind.
    People should pay a price (moral hazard), and unless the entire system is going to collapse, bringing us all down, those who pay should be those who made unwise decisions.
    But I wonder how Greenspan will pay. Not for the low interest rates–maybe that was the right thing to do. Who am I to say. But for the recommendation that people should continue to take out ARMs. Why did he do that? Seems like he just wanted the system to keep going while on his watch. I never understood that.

  2. Buzzcut

    I just got a 5 year ARM at 6%. I can reset once before close, and I’m hoping that it drops to 5.5% before then (probably unlikely).
    I’ve got an excellent credit score, plenty of assets, and a conforming mortgage. But still, is 6% the end of the world?
    This is a crisis?
    Sure, I’d prefer the 5.375% of the mortgage that this replaces (also a 5 year ARM). But it’s not that big a difference. I’ve also had 5 years of raises and inflation. The difference in monthly payments is not all that great.
    So, what do we do? How about nothing? Or maybe a small easing in rates, maybe a half a point at the next meeting. Not much beyond that.

  3. Rationalist

    Professor,
    I am against any bailout. Nobody bothers about people who knowingly take risks in the stock market and then lose a lot of money; and why should real estate be any different?
    One cannot preach free market and let society play according to the rules of the market, and then change the rules of the game halfway. Doing so will be unfair to the vast majority of people who make rational decisions based on the rules of the game.
    There should be no intervention by the government except for a thorough investigation of any fraud and misrepresentation in lending. The people who committed fraud should pay for compensation to their victims, if any.

  4. James I. Hymas

    Mainly nothing. However …

    - strongly encourage formation of “workout groups” at the servicer level, that have discretion to alter mortgage terms to maximize recovery.

    - go after the clear-cut cases of fraud. The leafblower guys who wrote down $100,000 p.a. income can get an amnesty (they’ve suffered enough), but not those who willfully or negligently encouraged them; and not those who engaged in deliberate fraud.

    - review the due-diligence, investment suitability and prudent-man compliance of the entire investment chain (right up to trustees of pension funds!). Take away a few licenses.

  5. jg

    Have a nice visit to Wyoming, Professor.
    I say, government, stay out of the way. We need to feel the pain of our reckless investment, write down the value of our homes and loans, understand that we have a lot less in our investment and pension accounts than we thought, and get back to being thrifty and ingenious, instead of spendthrift and foolish. Otherwise, if government gets involved to ‘save’ us, we will have a protracted depression, instead of a quick one.
    Yep, only time and clear, cold thinking will allow us to come to grips with the all-time high in residential vacancy rates — which are going nowhere but up — that we have now.

  6. bailey

    THE time for Gov’t. intervention has long passed. Am I the ONLY one who read Dean Baker way back in 2003?
    Let’s stop pretending this problem just dropped out of the sky catching us all unaware. For the most part those caught are greedy shortsighted “players”, in a game that’s way beyond their abilities.
    Instead, let’s remember it was largely the same culprits you’re ready to call to provide a bailout who facilitated this travesty. They weren’t doing their job when they refused to intercede, & interceding now would prove they are still not doing their job.

  7. Lord

    Some small number of homeowners may have improved their credit rating and stand to be refinanced but most are far beyond saving. What is important is preventing the spread of the disruption, for that, a modest lowering of the funds rate to a more neutral stance should be sufficient. This would allow an increase in spending by those not involved to make up for the drop from those deeply involved.

  8. mh497

    Death to the housing bubblers!
    Just like the Internet bubblers, basically. Nasdaq down 80%.
    You takes your chances…

  9. SkepMod

    But I thought all the liquidity was supply driven. I thought there was all that money floating around because the Chinese couldn’t find anything better to do with it. If that is the case, then this liquidity crunch can only be temporary…as long as the trade gap continues to grow and China continues to manipulate its currency, right? The money can sit on the sidelines only that long.
    I am not an economist, so forgive me if I have missed something simple.

  10. Bob

    I’m not sure bailouts are in order. One would have to define it first.
    Nevertheless, the Fed must provide liquidity. That’s
    their job.

  11. Anonymous

    In my estimation there is no solution, simply throwing money at the problem via bial-outs will incurr its own set of unintended consequences. Havent we had enough of those?
    There are more than economic implications in any apporach that must be evaluated through due diligence (which is more than we can say for the parties involved)
    MOST importantly dont forget the fiscally responsible MAJORITY who have much to loose (being permanently priced out of the market–SD avg household income is still around 65k) if we support the status quo “housing allways appreciate”, if you still believe that look at the latest Case-Shiller HPI data for June in SD county.

  12. DickF

    Professor,
    First, the FED should stop playing games. They should make a statement that implies that in September they will lower the FFR by .25, maybe .50. In no uncertain terms they should let the market know that they have determined to stop attacking economic growth.
    Then they should come out with a strong statement that they favor congress making the tax cuts permanent and that if the Democrat congress does this they should receive credit for the resulting improvement in economic conditions.
    This would give citizens increased income to pay their bills and those who need to refinance would find more affordable rates. You get these two things and the market will take care of the problem with a combination of lower rates and economic growth. By December you would not be hearing anything about mortgage problems and inflation would once again be in decline, and as a bonus the budget would be balanced sooner than forecast or expected.

  13. T.R. Elliott

    DickF wrote: “By December you would not be hearing anything about mortgage problems and inflation would once again be in decline, and as a bonus the budget would be balanced sooner than forecast or expected.”
    And soon after the human race will enter Nirvana. Peace, love, lower interest rates, and tax cuts to one and all.
    Signed,
    Supply Side Hippy Guru

  14. Name

    What kind of corrupt ogre would claim a bailout is for the endebted. At the debt loads in question, by which I mean max conforming 30-year mortgage at a risk-adjusted premium, a full point drop is only a few hundred dollars a month, less than 10% median household income.
    The bailout would be most helpful to financiers whose passenger cars cost 3xmedian household income.

  15. d_rumsfeld

    The main problem is that housing price appreciation has far outpaced wage increases over the last 10 years. Reducing short-term interest rates may not help to stem the problem if foreign central banks stop buying our large debt offerings. The long-term solution is to return home prices to levels where wages can support the payments and rental rates are in line.
    Assuming the solution can only come from the federal reserve, they can either let the transition occur and watch the ensuing credit destruction and possible deflation until housing prices drop around 40% of their real value or they can drop interest rates and try to inflate wages and rental prices while keeping nominal housing prices stable. I think the second choice is what they will aim for but they might be stymied by foreign central banks refusing to buy our debt. If long-term interest rates decouple from short-term rates and go in opposite directions, we’re in for a world of hurt.

  16. jalrin

    The situation may still be manageable if the following steps are taken:

    1. Congress must immediately re-work the bankruptcy laws to give the bankruptcy courts expanded power to cramdown workouts in those cases where they are appropriate and to prevent deficiency judgments from interfering with such vital expenditures as child support and basic needs spending.

    2. The Federal government must also convene full court investigations into every mortgage entity that may have been involved in fraud. If any of these companies have been engaged in systematic fraud, then civil/criminal actions up to and including TILA/antitrust/RICO actions where warranted must be used to get their ill-gotten gains back. This should also be done for the ratings agencies and investment banks that got rich selling junk if they broke any laws doing it.

    3. An immediate expansion of the Section 8 rental voucher program to help struggling families rent affordable housing (at reasonable rates) and keep down the number of vacant units.

    4.Finally, the government needs to adopt a major program to repair and replace infrastructure that is outdated to provide an employment cushion until the economy can readjust (there is enough deffered maintenance that will have to be do at some point anyway to keep a signifcant fraction of the displaced employed until this nightmare ends).

    These proposals should be contain the suffering caused by the crisis without creating a moral hazzard problem.

  17. knzn

    The least we should do is to loosen monetary policy to compensate for the widening credit spreads and the widening “shadow credit spreads” implicit in non-price rationing of credit (unless, of course, monetary policy was too loose to begin with, but I don’t think it was).
    But don’t get me started…. Just click on my name: 7 of my last 9 blog posts are on this subject (and probably 7 of the next 9 as well).

  18. ed

    I’m having a hard time understanding some of the rhetoric around this issue.
    Buyers “thrown to the wolves” means “required to find housing on the rental market.” Like I do, and like they should have done all along.
    People “losing their homes” usually means “having to leave a house they’ve lived in less than two years, that they never should have bought, and that they obtained with little or no money down and never had much equity in.”

  19. pat

    Professor:
    First, enjoy Jackson Hole!
    As to your question, I think Summers’ idea is unsound.
    Say a homeowner put zero to 5 percent down and got an adjustable rate mortgage for the past 2 years and it’s time to reset and she can’t find a new mortgage: exactly what has she lost? The down payment as well as the amount of her monthly payments that were in access of comparable rents, after adjusting for the tax savings — assuming she lives in California. For most homeowners, I would guess the loss is modest and has already occurred. They may have to find an apartment now. But many renters have to do so as well, why the previous home owners deserve a bailout but not the renters? The loss to the lenders can be more significant, but I haven’t seen anyone arguing for a bailout of the lenders.
    So is there anything lawmakers can do to help? Yes, copying California and phasing in the “no recourse” rule to all real estate loans will be a good idea, so that we can limit the loss to the homeowners and ensure that there won’t be many “zombie” homeowners in the US this time as the Japanese zombie firms in the 1990s.

  20. T.R. Elliott

    I second what Ed said.
    Plus: If interest rates must go down, to maintain price stability or the economy goes into recession–fine. But housing seems overpriced in many respects and the solution is for home prices to drop.

  21. bad news bear

    Nobody deserves to be bailed out of this crisis. But to rescue the economy, we need runaway inflation for a decade, then austerity.

  22. Magne

    I really cannot understand the urgent need for any government assisted bail out. First and foremost, who exactly would we be bailing out? Investment banks who continue to create complex investment products for duped European and Asian investors and not to mention all of the insurance and pension funds that need to do something with their premiums and trust funds. Nobody told all of these investors to buy CDS, RMBS,ABCP,CPDO’s and so on and so forth, but the hunt for yield in an ever so tightening “quantitative” environment. It seems as if nobody has learned their lesson with Computer based modeling and the fact that it still relies on imputed human data and historical pricing, not to mention a valuation that is usually based upon another “quant” model by the same institution, well if you were that stupid to fall for the banana in the tail pipe and you trusted your prime brokers to tell that an investment was actually worth whatever they modeled it against, then you didn’t do your due diligence. Now throw in the likes of the rating agencies and get them on board to rate your garbage backed securities so that you can pawn them off “legitimately” and you have a system that works, until one of them lets the cat out of the bag and the investor wants their money back early! So the hunt for “alpha” has turned into a hunt for return not “on” capital, but a return “of” capital, as investors run for the exits. sorry to go off of the tangent but we should all take a good look at Minsky’s Credit cycles to gain further insight to exactly what has transpired here. The ponzi scheme of credit has evaporated and when one part of the system is not complying, well the game is over, such as the case here. It is pure capitalism at its best and the weeding out of the excesses is a normal business occurrence. The FED will not be able to stop the slide, even if they cut rates, it is too late. What is occurring is an adjustment of excess that the FED was too late in recognizing and still are too late to the game, Inflation created out of credit is far worse than inflation created out of actual dollars, of which the majority of Americans have little of…..like Gross I to would tell the FED that if they want to do something cut rates 100bp and let the bond market and the investors tell you where to go, because it is apparent that the current regime, is not fast enough to compete with the world investors, in fact the FED does not have anywhere near the control the once had, we mine as well call it the PBOC…..
    As far as housing and people, it will be a shame that people will lose their homes and will have to move and probably rent and their credit will be ruined, but even though that is a tragic reality, I don’t think the human nature aspect of wanting can be controlled, at least not by many. I see far too many people living beyond their means and this reality has to be rectified and the restriction of credit is just what is needed. Not to mention that credit card companies would be the first people on my list to regulate, I have never seen a more outright scam in all of my life, invite everyone to borrow money and then charge them worse rates them my local shark, nice…good thing they have a great lobby though, not only can they get away with charging shark rates but they can garnish wages, what next, can they take your house? Democracy at its finest………

  23. James I. Hymas

    My previous comment (and those of many other commenters) was focussed more at what the various government agencies should do .. but on reflection, I guess you’re really more interested in what the Fed should be doing.

    So far, I think they’ve done a great job and should do more of it. The discount rate cut was great, the clarification of acceptable collateral was great and the ongoing lifting of loan limits to broker subs is great.

    They should formally ease at the next meeting, but only because the market will go into cardiac arrest if they don’t. Accompany the ease with some tough talk about how they’re itching to boost rates again.

    Continue the free hand at the discount window, but warn all participants that the party will be ending shortly and that while illiquid participants will be accomodated, insolvent ones will not. And the illiquid participants had better make some really good faith efforts at liquidating their positions.

    I understand that repos of short term securities are a little easier to come by lately; outright sales and re-openings should be considered to ensure a normal market in short term governments.

    And – this isn’t really a Fed matter, but they do have an interest – I imagine that Tier 1 Capital ratios are becoming strained for some banks, particularly the ones that have had to provide emergency lines to ABCP issuers, Countrywide and the like. Preferred shares are one method of bolstering Tier 1 Capital without diluting equity, but it is my understanding that there is a lot of confusion over whether certain issues are eligible for the US dividend deduction. Issuers should be enabled to learn for sure if their current issues are eligible; rulings should be available in advance to assist in issue design and planning.

  24. Ken

    There have been a lot of good comments so far. I agree with the “no bail outs” camp in general. However there are mortgages that can be saved and made reasonable, but right now it’s really tricky to make any adjustments. So I like the idea of “workout groups” that can adjust the terms within limits. However there will be a lot of people who are pushed out of homes and mortgages, folks who should have never been in them in the first place. Sorry but that’s just going to suck and they’ll be out in the rental market again.
    There’s also the question of rational and realistic prices based on people’s actual incomes. For all of the folks who said that you could never lose money in real estate, no matter how much I tried to get them to see the bigger picture, well you’re going to lose money unless you stick around for a while. That’s part of the cost of making a bad decision. We gotta learn somehow.

  25. James I. Hymas

    And one more thing!

    It’s way too early to do anything yet, because the data isn’t available. But the Bank Risk-Adjusted Capital rules should be reviewed with care to ensure that all the off-balance sheet stuff doesn’t endanger the system.

    To be frank, I don’t know what provision must be made in determining risk-adjusted capital when an agreement is made to provide emergency liquidity to ABCP conduits. I would, however, like to know that the level has been re-assessed and re-modelled in light of recent events (and if anybody ever wants to send me a link to a discussion of this, I’ll be grateful!).

  26. DealBreaker.com

    Opening Bell: 8.29.07

    Cheyne May Liquidate Commercial Paper Unit Amid Market Rout (Bloomberg) Tremors in the commercial paper market scare as more than anything else, since commercial paper is like the oil that keeps the gears of commerce spinning. Without it, everything…

  27. DickF

    The FED created the problem by attacking growth to fight an imaginary inflation. They assumed inflation was coming because we were having growth and they assume growth leads to inflation. But the numbers did not support their conclusion.
    As the FED pushed up FFR rates the economy began to tighten, yes, but this does not mean monetary tightening. The monetary situation became more inflationary because of their actions. The FED began to create their own vision of inflation and their statistics began to indicate it.
    Now the FED is trapped. They are facing inflation of their creation and their policy approach does not allow them to reverse the very actions that have created the problem. The economy is struggling, but the FED persists in its attacks of high interest rates. Inflation is creaping in and the FED doesn’t feel it can lower rates because they believe that would be inflationary.
    This has happened in the past and the FED held to its policies until the economy finally forced them to move against their policies and economic beliefs. Sadly, it appears the same thing is playing out again. If the FED does not lower the FFR we will continue to have problems. As I stated earlier until the FED stops attacking economic growth the economy will continue its struggle against the “visible hand” of government intervention.

  28. kdp

    The Fed should hold the line on rates until there is evidence that unemployment will be adversely affected in a significant fashion. Historically, a housing crisis has been caused by high lob loss leading to people being unable to make their mortgage payments. However, this seems to be a purely a financial problem caused by poor risk analysis on the part of the financial industry. People are going to lose their homes because they can’t afford the mortgage payment, but so long as they still have jobs, it is hard to see a larger crisis from this. In fact, renting might actually save the prior homeowners money, and thus be a better thing for the economy in the long term.
    As for the Fed riding in to save the markets, please consider that the markets have had a great run recently. A 20% bear market pullback from the July 2007 highs would leave us at roughly the July 2006 stock market levels. Wiping out a little over one year of gains is hardly a major market crisis.
    I also see no need for new legislation at this time. We have plenty of laws on the books and many programs in place to handle foreclosures and bankruptcy. So far they seem to be working.
    One final comment would be that this housing price re-evaluation that is taking place will, in all likelihood, play out over many years. Both homeowners and state governments have a vested interest in keeping housing prices as high as possible. Both will only grudgingly accept that housing prices truly have declined.

  29. Rationalist

    DickF: “The FED…assumed inflation was coming because we were having growth and they assume growth leads to inflation. But the numbers did not support their conclusion.”
    Can you post the statistics that you are referring to in support of this claim?
    The FED was wrong in saying that there was no housing bubble, wrong in its assessment of the impact of loose lending, but from the data I have seen, I think they are right on inflation.

  30. Anonymous

    Rationalist,
    The FED uses the FFR to attack the economy and growth.
    Recognizing that the normal indicators (CPI, other) are seriously lagging, the most current indicator of inflation/deflation is the price of gold (POG). Below is a comparison of the FFR and the monthly average spot POG. The inflation/deflation indicated by the POG is manifest in the lagging indicators 6 to 12 months after being seen in the change in POG depending of economic circumstances.
    It is better to use a weighted algorithm than the spot price as I have here, but I do not have access to these numbers right now. The average spot price will illustrate the trend.
    Month POG FFR
    Jan-04 413.99 1.00
    Feb-04 405.33 1.00
    Mar-04 406.67 1.00
    Apr-04 403.02 1.00
    May-04 383.45 1.00
    Jun-04 391.99 1.25
    Jul-04 398.09 1.25
    Aug-04 400.48 1.50
    Sep-04 405.27 1.75
    Oct-04 420.46 1.75
    Nov-04 439.39 2.00
    Dec-04 441.76 2.25
    Jan-05 424.15 2.25
    Feb-05 423.35 2.50
    Mar-05 434.24 2.75
    Apr-05 428.93 2.75
    May-05 421.87 3.00
    Jun-05 430.66 3.25
    Jul-05 424.48 3.25
    Aug-05 437.93 3.50
    Sep-05 456.04 3.50
    Oct-05 469.90 3.75
    Nov-05 476.67 4.00
    Dec-05 509.76 4.25
    Jan-06 549.86 4.50
    Feb-06 555.00 4.50
    Mar-06 557.09 4.75
    Apr-06 610.65 4.75
    May-06 676.51 5.00
    Jun-06 596.15 5.25
    Jul-06 633.77 5.25
    Aug-06 632.59 5.25
    Sep-06 598.19 5.25
    Oct-06 585.78 5.25
    Nov-06 627.83 5.25
    Dec-06 629.79 5.25
    Jan-07 631.17 5.25
    Feb-07 664.75 5.25
    Mar-07 654.90 5.25
    Apr-07 679.37 5.25
    May-07 666.86 5.25
    Jun-07 655.49 5.25
    Jul-07 665.30 5.25
    Aug-07 665.09 5.25

  31. HZ

    Two ideas:
    1) I agree that individual homeowners who made bad decisions should not be bailed out. However governments should do whatever in their power to keep hard hit areas from becoming blighted. Contain the contagion so it does not hurt the bystanders.
    2) A home’s basic function is to provide shelter, the need of which is constant and shouldn’t dramatically fluctuate. The speculative element is the value of land. How about we transition to a system in which mortgage is only allowed on the replacement cost of the home (using home insurers’ number, e.g.)? Homeowners have to come up with separate funds for land. This could clamp down on rampant speculation that causes these booms and busts. Speculation on land is a zero sum game.

  32. Joseph Somsel

    Let’s not forget an important set of “victims” – those who are just entering the house purchasing market.
    The prices here in Silicon Valley are difficult to believe. In part this is due to speculation and over-extension on the part of resident and non-resident house buyers. In other words, cheap and easy money has inflated prices beyond the local wage and salary base.
    I say, let the crash crunch prices. I can wait for a more realistic price before I buy, maybe when a speculative purchase gets called and has to be liquidated.
    I would think that credit availablity needs to be assured. Right now I understand that few loans of any sort are being offered but I suspect that this is a temporary phase while the politics settle.

  33. John Thacker

    Let’s not forget an important set of “victims” – those who are just entering the house purchasing market.
    They should perhaps rent. One of the problems that fed the bubble is the idea that renting is “throwing money away.” When prices are going to increase, yes. Not if prices are going to fall or be stagnant. Not when renting is cheap compared to owning.

  34. PrefBlog

    August 28, 2007

    Whoosh!
    Just when you thought you were safe …
    I was most impressed today by the DG.UN suspension of redemptions, a made-in-Canada $1.4-billion whoopsee, when in comes news of S&P’s downgrade of Cheyne, a $6-billion oopsy-daisy. Accord…

  35. MT57

    Bill Gross’s comment is one of the dumbest I have ever heard. The govt in the early 90’s did not bail out the “corrupt S&L buccaneers” – it indicted them. It changed the rules of valuation and accounting and threw all the S&L’s into receivership, took over the S&L’s loans and ENFORCED them for the benefit of the public or sold them to private investors who then enforce them. In no way does that support bailing out borrowers in 2007.

  36. HZ

    Our current system subsidizes the speculation of land value intangibles. It also creates pressure on Fed to maintain housing prices in case this very important source of liquidity dries up. This conflicts with its other goal of price stability since rent is not as strongly correlated with home prices in the short term. If first lien mortgage is tied to replacement cost or a multiple of rent, these mortgages will be a lot safer and can enjoy an even lower rate. And credit risk can be taken out by allowing subprimes to pay for insurance on collection cost. The intangible portion (land) of the loan has to settle for second or less lien. This part will be harder to securitize since the appraisal is more subjective and harder to quantify and interest rate should therefore be much higher. Thus we could both encourage home ownership and discourage speculation.
    Note GSE conforming loan limit is already doing something along the same line for high land cost states, but it is one size fit all and not entirely fair. This would also allow GSEs to make low cost loans to everyone (not just primes) on the structure as long as subprimes pay insurance for collection. In essence we subsidize the utility portion of the home ownership but not speculative intangibles.

  37. TedK

    DickF,
    I am not an economist, but looking at gold prices alone to measure inflation doesn’t seem sound to me at all.
    Any sound measure of inflation should calculate the purchasing power for a good majority of citizens in leading their normal lives.
    Gold as a commodity does not meet that criterion?

  38. HZ

    Re: pressure on the Fed
    Judging from the quick spread of credit risk premium and the responses from the central banks over the world, one can only imagine what it will be like if there is a panic over GSE mortgages. This is a systemic risk that the Fed and the administration have been correctly playing up to the Congress’s deaf ear. On the other hand if GSE mortgage collaterals are more strongly tied to the rental value of properties shoring up GSE during a time of crisis will be a lot more consistent with the Fed’s goal of price stability and alleviate much of the moral hazards.

  39. Anonymous

    TedK,
    To anyone who wishes to understand the importance of gold let me suggest you read the book “Gold: The Once and Future Money” by Nathan Lewis. For those concerned this is not a late night informercial book. It is one of the most thoughtful and best books on the importance of gold as an indicator, past and present. It can be understood by non-economists and even a few economists. :-)
    You can find it at Amazon here.
    http://www.amazon.com/Gold-Future-Money-Nathan-Lewis/dp/0470047666/ref=pd_ts_b_62/102-9388057-3758559?ie=UTF8&s=books

  40. DickF

    TedK wrote:
    I am not an economist, but looking at gold prices alone to measure inflation doesn’t seem sound to me at all.
    Any sound measure of inflation should calculate the purchasing power for a good majority of citizens in leading their normal lives.
    Ted,
    Thanks for the reply.
    How would you calculate the purchasing power for a majority of citizens? Normally this is done by taking an average of a basket of goods. Now to get an exact purchasing power your basket would need to contain all goods in the quantities at which they sold. This amount would give us what I call the pure or imaginary numeraire. Obviously this is an impossible number to calculate and even if you could it would change from moment to moment. So what do we do?
    We look at the basket of goods to reduce it to a manageable selection of goods. We see that there are non-monetary effects on the prices and quantities of some goods. We can come closer to a representation of the pure numeraire by eliminating those goods that distort other goods that have more purely monetary characteristics. As we eliminate goods with less monetary characteristics we finally come down to one good, gold. Adding any other good to gold to determine purchasing power actually distorts the monetary signal that gold gives.
    Also recognizing that gold is more monetary than other goods we can see that gold is less of a lagging indicator than other indicators. This is why gold alone is the best indicator of monetary value. It is not perfect but it is the best.

  41. Mike Laird

    DickF, you need to go to the grocery store and the gas station more often, buy items, and keep track of prices. The price of gasoline and weekly grocery purchases has gone up over the past 6 months. I am not the only person who perceives this. The price of gold has gone down. Six months is a reasonable time period to average out random moves. So is inflation up or down?

  42. TedK

    DickF,
    Thanks for your explanation. But I have some problems with it. Let me add a couple of thoughts. Gold is often bought and sold by central banks and is subject to more speculative buying and selling than many other goods. Doesn’t that distort the prices more? Also, as an article of ostentation, its supply-demand behavior does not follow that of essential goods.

  43. Anonymous

    Mike,
    Inflation is not an increase in prices. Inflation is a degradation of the monetary standard. If you do not understand the difference you could actually promote policies contrary to your intention.
    Ted,
    Thanks again for the comment and question. Gold bought and sold by central banks is almost totally monetary in nature rather than for commodity use, such as gold purchases by industry (wire, printed circuit boards, etc). Central banks actually still attempt to use gold to stabilize their currencies so thankfully we have not totally broken with gold.
    Think about the behavior of other goods that are not what you call ostentatious. Would wheat make a good monetary commodity considering it is perishable and dependent on weather? Would housing make a good monetary commodity since it is so expensive, is not very liquid, and the quality of homes are not consistent? What other good would you suggest? As you think about this remember we desire to consider a monetary good as our indicator so think of how the non-monetary characteristics would effect the price of the good.

  44. DanInKansas

    Late to the party, but being in the mortgage and lending industry, there MUST be some accountability for the widespread fraud that put us into the situation. People who weren’t engaging in fraudulent or corrupt practices watch hundreds of thousands of dollars fly into the pockets of those who pushed appraisals into the stratosphere, stated incomes that were twice the borrower’s actual earnings, or put borrowers into 1 or 2 year fixed rate loans with 3 year prepayment penalties.
    Not to mention the number of people I’ve run across who got into negative amortization loans without a clear understanding that the loan increased their actual debt.
    The absolute number one problem I’m running into are people who got into loans that are killing them and simply don’t have the equity to refinance out of them, because the appraisals were pushed so hard. Every day I talk to one more victim who, for example, was told his house was worth $120,000, and usually he still believes that. A quick search reveals that the county has it appraised at $87,000. Even if the county is off by 15% — not uncommon — the man is still upside down in his house.
    This is why we’re not even close to the end of the story, because there are so many cases like this.

  45. bill j

    Dick is in good company in seeking to use gold as the ultimate measure of value;
    “Gold, as gold, is exchange-value itself. As to its use-value, that has only an ideal existence, represented by the series of expressions of relative value in which it stands face to face with all other commodities, the sum of whose uses makes up the sum of the various uses of gold.”
    Marx Capital Volume 1
    http://www.marxists.org/archive/marx/works/1867-c1/ch03.htm#S2a

  46. DickF

    Yes, thanks bill j. Most people do not know that Marx was actually a classical economist.
    He got a lot of things right but got the most critical wrong.

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