G2Rad
23rd September 2010, 08:19 PM
A loan by any other name: the borrower's liability is the lender's asset
After you take out a mortgage loan for $200,000 you wind up with a $200,000 liability on your household balance sheet. You owe the $200,000 in principal plus interest over the term of the loan, usually 30 years.
To the lender, your $200,000 liability is its $200,000 asset. You debt represents a flow of principal and interest payments from you to the bank. Your liability is a bank’s asset.
Multiply millions of mortgage loans by hundreds of thousands of dollars and you have trillions of dollars in liabilities of households that are trillions of dollars of assets of banks.
Now, housing prices are normally determined by local incomes, but trillions of dollars of mortgage debt today is fictitious, left over from the asset inflation of the housing bubble era. It does not represent home price increases justified by rising income levels. Now that the housing bubble has deflated for four years, the relationship between home prices, home equity, and the mortgage debt owed on homes looks like this
http://www.itulip.com/images2/housingwealth.gif
At the top of the housing bubble over $10 trillion in housing debt was owed on $24 trillion
in housing “value.” As of October 2009, according the Federal Reserve, housing "value"
declined to $16 trillion but households still owed more than $10 trillion on it.
While households are still paying mortgages as if their homes were worth as much as during the bubble, and mortgage debtors owe more than their home is worth – they have negative equity – two key benefits of the inflated home price have vanished. One, the wealth effect of feeling richer by the amount of the home’s equity, and two, the ability to borrow against the value of the home.
The trillion dollar debt cut
http://www.itulip.com/images2/mortgagepce1980-2010.gif
As of July 2010, personal consumption expenditures (PCE) for US households totaled
$10.3 trillion year to date. Of that $2.3 trillion of went just to pay just the interest, and
none of the principal, on mortgages.
If home values are permitted to decline another 20% to pre-bubble levels, and mortgages are written down to pre-bubble levels, US households will have approximately $1 trillion dollars more to spend annually.
Just imagine the kind of stimulus that will provide. It’s the equivalent of a $1 trillion per year tax cut, and without reducing pension liabilities, military spending, raising taxes on the rich or anyone else.
This is the debt overhang that is killing the US economy. It is owed to the politically protected banking industry by the increasingly politically impotent American voter. It is curiously framed as a left versus right issue, but the real battle is between creditors and borrowers, and between debtors and saver, and the interests that represent them.
The banking lobby has effectively engaging conservatives in the cause of securing their assets. They argue that debtors should be held responsible for bubble era debts. The mortgage debt is the responsibility of the borrower, they say. This is true, so far as the debtor is contractually on the hook to pay back the money. However, determining the creditworthiness of a borrower is always the lender’s responsibility. Capitalism can’t work otherwise. Anyone who thinks for five minutes about personal loans they have made to friends that were not repaid knows this. Whose fault was is that the loan to your brother-in-law was not paid back? Only your own. You should not have lent him the money, and you did not go looking for someone to blame.
That’s where the buck stops, with the lender. Mortgage lenders who cannot competently determine the creditworthiness of borrowers should go out of business, just the way the incompetent venture capital firms did after the technology stock bubble collapsed in 2000 to 2003. Thankfully, no VCs were bailed out by the government. Those that made poor investments were allowed to fail. Stock of companies in the portfolio that had value was sold to other investors at pennies on the dollar. The same principle applies to mortgage lenders. Sell the assets of the poorly run banks to the well-run banks. Too big to fail? Then let the Fed take them over and sell the assets off and write down the fictitious value over time. The process is not at all complicated.
Of course, the free market solution to the US balance sheet recession will not be allowed to happen. The banks don’t want to take a loss, and as long as they have as much political influence they do today, they won’t have too. Instead, we will continue to get this:
http://www.itulip.com/images2/consumerdebt1967-August2010.gif
Private credit continues to contract debt overhang. Balance sheet recessions are not like other recessions.
As consumer credit outstanding continues to contract, a corresponding rise in government borrowing to compensate for the decrease in private sector borrowing is required to keep the money supply from imploding. If that happens the economy will enter a brief deflationary crisis before an extreme debt and currency crisis
http://www.itulip.com/images2/QEvsNetGovtSaving2006-June2010.gif
Government spending is expanded to borrow money into existence when the private
markets don’t. Let up on the spending, and down it goes as in 1938 in the US and in
Japan in 1996. Again, balance sheet recessions are not like other recessions.
Until the bubble era debt is written down to the lower prices of the homes in some orderly way, the US balance sheet recession will continue, and the fiscal deficit will continue to grow, until one of three following scenarios occurs.
A. The US runs out of credit, leading to a debt and dollar crisis, and self-reinforcing downward spiral of rising interest rates, economic contraction, a declining dollar, and rising inflation.
B. The second Peak Cheap Oil Cycle pushes the US back into recession, leading to A.
C. The financial oligarchy loses influence over bank reform legislation, the housing bubble era debt is written off, and the TECI Economy is developed as the FIRE Economy is phased out.
The reason why the gold price keeps climbing is that the probability of scenarios A or B is rising since the appointment of Summers, Rubin, and Geithner to head up economic and Treasury policy. With Obama’s recent nomination of sub-prime lending apostle and all around housing bubble cheerleader Austan Goolsbee chairman of the Council of Economic Advisers, the disastrous bailout of the FIRE Economy will continue.
After you take out a mortgage loan for $200,000 you wind up with a $200,000 liability on your household balance sheet. You owe the $200,000 in principal plus interest over the term of the loan, usually 30 years.
To the lender, your $200,000 liability is its $200,000 asset. You debt represents a flow of principal and interest payments from you to the bank. Your liability is a bank’s asset.
Multiply millions of mortgage loans by hundreds of thousands of dollars and you have trillions of dollars in liabilities of households that are trillions of dollars of assets of banks.
Now, housing prices are normally determined by local incomes, but trillions of dollars of mortgage debt today is fictitious, left over from the asset inflation of the housing bubble era. It does not represent home price increases justified by rising income levels. Now that the housing bubble has deflated for four years, the relationship between home prices, home equity, and the mortgage debt owed on homes looks like this
http://www.itulip.com/images2/housingwealth.gif
At the top of the housing bubble over $10 trillion in housing debt was owed on $24 trillion
in housing “value.” As of October 2009, according the Federal Reserve, housing "value"
declined to $16 trillion but households still owed more than $10 trillion on it.
While households are still paying mortgages as if their homes were worth as much as during the bubble, and mortgage debtors owe more than their home is worth – they have negative equity – two key benefits of the inflated home price have vanished. One, the wealth effect of feeling richer by the amount of the home’s equity, and two, the ability to borrow against the value of the home.
The trillion dollar debt cut
http://www.itulip.com/images2/mortgagepce1980-2010.gif
As of July 2010, personal consumption expenditures (PCE) for US households totaled
$10.3 trillion year to date. Of that $2.3 trillion of went just to pay just the interest, and
none of the principal, on mortgages.
If home values are permitted to decline another 20% to pre-bubble levels, and mortgages are written down to pre-bubble levels, US households will have approximately $1 trillion dollars more to spend annually.
Just imagine the kind of stimulus that will provide. It’s the equivalent of a $1 trillion per year tax cut, and without reducing pension liabilities, military spending, raising taxes on the rich or anyone else.
This is the debt overhang that is killing the US economy. It is owed to the politically protected banking industry by the increasingly politically impotent American voter. It is curiously framed as a left versus right issue, but the real battle is between creditors and borrowers, and between debtors and saver, and the interests that represent them.
The banking lobby has effectively engaging conservatives in the cause of securing their assets. They argue that debtors should be held responsible for bubble era debts. The mortgage debt is the responsibility of the borrower, they say. This is true, so far as the debtor is contractually on the hook to pay back the money. However, determining the creditworthiness of a borrower is always the lender’s responsibility. Capitalism can’t work otherwise. Anyone who thinks for five minutes about personal loans they have made to friends that were not repaid knows this. Whose fault was is that the loan to your brother-in-law was not paid back? Only your own. You should not have lent him the money, and you did not go looking for someone to blame.
That’s where the buck stops, with the lender. Mortgage lenders who cannot competently determine the creditworthiness of borrowers should go out of business, just the way the incompetent venture capital firms did after the technology stock bubble collapsed in 2000 to 2003. Thankfully, no VCs were bailed out by the government. Those that made poor investments were allowed to fail. Stock of companies in the portfolio that had value was sold to other investors at pennies on the dollar. The same principle applies to mortgage lenders. Sell the assets of the poorly run banks to the well-run banks. Too big to fail? Then let the Fed take them over and sell the assets off and write down the fictitious value over time. The process is not at all complicated.
Of course, the free market solution to the US balance sheet recession will not be allowed to happen. The banks don’t want to take a loss, and as long as they have as much political influence they do today, they won’t have too. Instead, we will continue to get this:
http://www.itulip.com/images2/consumerdebt1967-August2010.gif
Private credit continues to contract debt overhang. Balance sheet recessions are not like other recessions.
As consumer credit outstanding continues to contract, a corresponding rise in government borrowing to compensate for the decrease in private sector borrowing is required to keep the money supply from imploding. If that happens the economy will enter a brief deflationary crisis before an extreme debt and currency crisis
http://www.itulip.com/images2/QEvsNetGovtSaving2006-June2010.gif
Government spending is expanded to borrow money into existence when the private
markets don’t. Let up on the spending, and down it goes as in 1938 in the US and in
Japan in 1996. Again, balance sheet recessions are not like other recessions.
Until the bubble era debt is written down to the lower prices of the homes in some orderly way, the US balance sheet recession will continue, and the fiscal deficit will continue to grow, until one of three following scenarios occurs.
A. The US runs out of credit, leading to a debt and dollar crisis, and self-reinforcing downward spiral of rising interest rates, economic contraction, a declining dollar, and rising inflation.
B. The second Peak Cheap Oil Cycle pushes the US back into recession, leading to A.
C. The financial oligarchy loses influence over bank reform legislation, the housing bubble era debt is written off, and the TECI Economy is developed as the FIRE Economy is phased out.
The reason why the gold price keeps climbing is that the probability of scenarios A or B is rising since the appointment of Summers, Rubin, and Geithner to head up economic and Treasury policy. With Obama’s recent nomination of sub-prime lending apostle and all around housing bubble cheerleader Austan Goolsbee chairman of the Council of Economic Advisers, the disastrous bailout of the FIRE Economy will continue.