Thursday, December 20, 2007

Holiday Viewing and Readers Journal

Since I will be visiting family for the next five days, I want to wish you--yes, you-- a safe and peaceful holiday.

Our usual programming mix of cynical skepticism and occasional zany foolishness will resume after Christmas.

Since holidays can be stressful, watching a film together at the end of a long day can offer low-key respite/fun. We recently asked our dear Italian friend (and movie buff) Emilia for a list of some of her favorite Italian films, and in the spirit of sharing holiday "movie ideas," here is her list. To help you decide if you might like to see/rent the film, I have linked the films to's brief review and viewer comments.

Many of us have seen Il Postino and Cinema Paradiso, and perhaps the Fellini masterpiece La Strada or De Sica's The Bicycle Thief, but many of the other films are less known--for us, Christ Stopped at Eboli was a revelation, and a film effortlessly added to our "best films of all time" list.

Ladri di Biciclette) The Bicycle Thief
The Postman (there is an American film of this title as well, hence is it listed as)
Il Postino (Io Non Ho Paura)
I'm Not Scared (Cristo si e' fermato ad Eboli)
Christ Stopped at Eboli (Novecento)
The Legend of 1900 (Le notti di Cabiria) (By Federico Fellini)
Nights of Cabiria
La Strada
Cinema Paradiso
(Non ti muovere) Don't Move

Readers responded with substantive comments on the 12/18 entry Bailout: Could Government Actually Be Part of the Solution?. I think you'll enjoy the diversity of opinion. Longtime contributor Kip S. checked in with a fascinating closed-grained look at the price history and condition of a Northern California home currently for sale.

NOTE: If you have time/need a break from holiday stress, you might enjoy browsing through Readers Journal (essays listed in right sidebar), 2007 archives, or for some short fiction, the spicily named forbidden stories beckon.

Frequent contributor Harun I. made these cogent points:

I completely agree. Quickly acting to get rid of bad debt is the sensible thing to do.

The problem with bailouts: Once started, where does it end? Most are short-term fixes that do not address the fundamental issue, empirically this has led to progressively larger problems and bailouts. The fundamental issue lies in the psyche of those sucked into the delusion vortex.

To wit: Fixing the S&L crisis did not prevent the today’s crisis. Fixing the 1987 crisis did not prevent LTCM. Fixing LTCM did not prevent where we are today. The problems have progressively gotten larger because of the psychology created by bailouts that we term to be moral hazard.

There is nothing wrong with suffering. Suffering teaches valuable lessons; it forces adaptation. It is when adaptation cannot happen quickly enough that extinction occurs. The moral hazard of bailouts has now put the global financial system at risk of breakdown because the problem is now too large for successful adaptation by normal means.

In other words, the unchecked, parabolic, leveraged growth of financial derivatives far outweighing the physical output of the entire global economy has left us with no answers that can be employed quickly enough to offset the rate of change of the ensuing crisis in a way that will prevent suffering. Deflation, there will be suffering. Hyperinflation, there will be suffering. A new Bretton-Woods system, there will be suffering.

Every bad trade has taught me a valuable lesson, sometimes I needed to learn the lesson more than once. But the pain of those events taught me what not to do. Remove consequences from actions then what? Everyone wins or loses and nothing has value? Wouldn't this be the reason central planning failed?

Moral hazard, however inconvenient, is real. There is no such thing as a little moral hazard. And the lesson of Pandora's Box has to assert itself once more. Once a “little” moral hazard has been injected, how do we stop?

Next up, longtime contributor K.K.: (original entry excerpts in italics)

I am not predisposed to any bailout, but intellectual honesty requires me to recall that the much-maligned "bailout" of Chrysler in the early 1980s saved the company and tens of thousands of jobs at modest (or according to Lee Iacocca, zero) government funds.

1. The bailout did cost taxpayer funds

2. It is not the place of the government to "save jobs" since people that want to work will just get new jobs (most of the buggy wheel makers got new jobs just like most of the Chrysler employees would have got new jobs)...

Though it was obvious the Savings and Loan collapse in the 80s was caused largely by Reagan-era deregulation of an industry which simply requires some regulation--

The S&L crises was caused by 1. Changes in the tax laws that lowered the value of real estate, 2. Poor underwriting by a government insurance company (no private company would have insured $10mm of deposits with very little capital or lending restrictions)...

L.S. recommends that people under threat of foreclosure try to work it out with their lenders.

Great idea, but if you lied about what you make and borrowed more than you can ever pay back there is not much to "work out"...

Today (12/15-16)'s WSJ cites the proposal of "Center for American Progress, a liberal think tank ... that the government buy some mortgage-backed securities and create a new agency, the Family Foreclosure Rescue Corp. [to] issue new, more affordable fixed-rate mortgages for those facing foreclosure whose homes are worth less than what they owe.

No surprise that a "liberal think tank" thinks that it is a good idea to tax responsible Americans to help dumb Americans who have too much debt...

3. We can safely assume about 25% of distressed buyers were speculators who never occupied the house, i.e. "flippers."

ALL the distressed buyers were "speculators" (but not all were "flippers"). No one would pay more to "buy" a home than rent a home if they didn't "speculate" that the property values were going to go up...

Let's guesstimate that another 50% of distressed properties were purchased by buyers with little or no "skin in the game," i.e. down payment. The S.F. Chronicle study found that about 70% of subprime buyers in 2005-2006 put no money down. Thus, these people will lose virtually nothing in foreclosure because they brought nothing to the party in the first place.

Almost all of the people in trouble have little or no "skin in the game" since values have not gone down very much (yet) anyone who made a down payment can still sell and walk away...

From one view, it can be argued that since government enabled the entire bubble via lack of lending/investment banking oversight (once again), it should be part of the solution.

The bubble was caused by dumb buyers and dumb lenders (and bond buyers)… If the government does nothing it will be the dumb buyers, dumb lenders (including their dumb stockholders) and dumb bond buyers that pay the price...

I am talking about a government-sponsored auction of debt and properties along the lines of the Resolution Trust Corporation which cleared up the S&L mess in the late 80s/early 90s.

The RTC sucked up billions of tax dollars...

Frequent contributor Michael Goodfellow made these comments:

What killed the S&L's was not lack of government regulation. They were all in the business of taking short-term deposits and lending long-term mortgage money. When interest rates spiked in the 70's and early 80's, they were in an impossible position -- getting 6% on mortgages while forced to offer 8% on money market accounts. If that situation lasted long enough, they were doomed.

The government should be blamed for putting them in that position by mismanaging the money supply and creating the huge inflation of that time. The government did finally raise interest rates enough to kill inflation, but it took years too long. In the meantime, the government insurance of individual accounts made it possible for the S&L's to speculate risk free.

Since they couldn't lose account money, the S&L's moved into really stupid investments. chasing higher rates of return to make up for their losses on mortgages. That eventually failed and created the S&L "crisis." Eventually, the government come in and formed the RTC to clean up what was left of the industry. I'm not sure who took all the loses, but some of it went on the taxpayer's tab.

A sad story all around, but I wouldn't characterize it as lack of government oversight.

After I suggested inflation was only rampant in the early 80s, Michael added these notes:

This page is a bit of a mess, but has 11% inflation for 1974, 9% for 75, then lower figures. 11% again in 79, 13%, 10% for the years after.

Also, I think it's unfair to say that government guarantees like the $100K deposit insurance don't count as "regulation." A much lower deposit insurance, or a max per depositor, not per account, would have introduced a lot more caution into the system.

I agree that the S&L's were looted in many places, but I think that was the end of the bubble, just as the "NINJA" loans were more prevalent at the end of the housing bubble. Once common sense goes out the window, the criminal actions get much more brazen.

Knowledgeable reader L.S., whose initial comments were reprinted in the 12/18 entry, offered this follow-up account:

Robert Roth wrote:

"L.S. recommends that people under threat of foreclosure try to work it out with their lenders. I have read in several places that that approach is problematic because in many (most?) cases, the people who collect the payments don't even know who holds the mortgage -- that precisely the complexity and opacity of the securities backed by these mortgages makes impractical the old-fashioned way of addressing the problem that L.S. suggests. If I'm wrong about that, I'd love to hear it, and wish someone would say so and why."

If you’ll indulge me, I tell you my story about the last real estate downturn and why I think my comments are not as naive as they may sound.

Newly married in summer 1990 and panicked that we would be priced out of the market, my bride and I skimped on our wedding so we could come up with the deposit for a condo. Since we only had an 18% down payment instead of the preferred 20%, we had to carry PMI (mortgage insurance), but we got in with an 8.875% 30-due-in-7 loan.

My wife was attending college and selling real estate, but by late 1990 the crashing market wiped our her income. A ruptured disk in her spine further reduced her ability to work so we struggled through 1991 just on my income.

In January of 1992, my employer announced they were closing their Southern California division and consolidating in Florida. By February I was unemployed. This was during the aerospace downsizing, and like many others in the engineering field, I was having trouble finding work. I quickly blew through my small severance pay on the mortgage and overpriced COBRA payments since a new medical policy would have excluded my wife’s now pre-existing back problems.

While I eventually got another job, and my wife worked at some low paying retail and real estate assistant jobs, we had lost a lot of ground financially and were constantly playing catch up with our bills. I’ll never forget calling the finance company from a hospital waiting room, begging them not to repo my wife’s 5 year-old second-hand Volkswagen, as she was undergoing emergency surgery. Two weeks later when I chased down the repo men, they told me if I gave them the remote it would cost $100 less in fees. That was our good car.

We had listed and relisted the condo for sale, each time reducing the price. We said goodbye to our down payment. We got a broker friend to handle it without a sellers side commission. No luck. We were stuck.

I called the lender numerous times, begging for some relief. Could we roll the late payments into the balance? NO. Could you lower the payment temporarily? NO. Could you change the interest rate temporarily? NO.NO.NO. At one point after receiving a notice of foreclosure, I begged them to take the two and a half payments I scraped up with a promise to deliver the remaining half in 10 days. Nope – full amount or we foreclose.

But even if we had received an offer on the condo, it wouldn’t have mattered. The owners had been moving out and renting their units. When we moved in, it was 80% owner occupied – just above the 75% minimum required for loan approval. Now it was 80% rental. And the renters were not always good neighbors – like the gang member whose buddies came over to drink, one of which we saw showing his gun to another as we sat in our living room. When I asked the owner how he could have rented to this guy, he replied – I kid you not – that he thought the gang member was a good credit risk because he was getting a big settlement from the police after being shot at a traffic stop. There’s more, lots more.

Then I learned the world is a dynamic place.


Up to that point I assumed if you owed money to a bank, that was one step below owing it to God. There was little question of you paying it back.

In 1993 my wife started working for a small property management company that had recently secured a contract to dispose of REO’s from Fannie Mae and a number of their client banks. Every week there would be a fresh batch of listings on the fax. They would go and trash out the property, change the locks, install smoke detectors, and list it on MLS. If it was occupied, offer 500 to 1000 bucks cash for keys or start the eviction. Usually these were renters. Owners nearly always had split.

I went to many of these properties and was astounded at the money loaned against them on seconds and even some thirds! I mean, what were the banks thinking? One with an $80K first was literally a shack on a hillside. One wall of the bathroom was dirt with tree roots protruding out of it! Some properties had additions that looked cobbled together with scrap material, yet had a $200K-$300K second!

The banks insisted these properties be listed for the loan amount, which meant they wouldn’t sell. So month after month, another 10 to 25K was shaved off the price until it moved. Fannie Mae even started paying $8K per property for paint and carpet to get them to move.

This office was also doing short sales. Never would I have imagined a bank would settle tens or even hundreds of thousands of dollars less than it was owed. But it was an event I witnessed many times, as my wife, who had reactivated her license, handled these transactions. Pretty soon lenders were even allowing short sales between family members.

By 1994 the flood of REO properties showed no signs of receding and lenders were starting to do loan modifications. One was for the guy who did the trash outs for the company. He had been trading up properties during the 80’s and was underwater on the last purchase. My wife handled the transaction. She got the lender to knock $150K off the balance and give the guy a new loan. Astounding.

Not long after that we did a short sale on the condo. We bought a foreclosure which Fannie Mae had graciously painted and carpeted, and was offering for only 3% down, and without PMI since they were carrying the loan.


So what’s the point of this long, boring story?

Robert Roth wrote:

"L.S. recommends that people under threat of foreclosure try to work it out with their lenders. I have read in several places that that approach is problematic because…"

This is what I directly addressed in my original comments. Opinion mixed with some fact gets repeated until it becomes the conventional wisdom and discourages people from acting. In the late 80’s, who would have imagined the banks would be doing short sales by the early 90’s? And only a madman would suggest that a few years after that, banks would be doing no doc, 100%, sub prime loans to farmworkers for half a million dollars. Don’t assume any avenue is closed just because you hear it often repeated or because it’s true at this very moment.

One other point is that not all these loans have been securitized, whatever that may imply. The banks still hold a bunch of them as regular loans. Citibank just moved $49B worth back onto it’s balance sheet. Does that help untangle them? Who knows. You think the borrowers are under pressure? The lenders are going to feel it by orders of magnitude greater and will have to act.

And here is longtime contributor Kip S.'s account of a classic Eichler-designed and built home in richly overpriced Northern California:

(For those unfamiliar with the name Eichler, he was the 1950-60s-era builder of the quintessential "California Ranch" style home, a design largely inspired by Frank Lloyd Wright's low-slung Usonian houses.)

Again, thanks for the detailed response to my renovation question. The house I mentioned (1400 sq ft 3br 2ba 1955 vintage Eichler in the San Francisco Bay Area) was open yesterday and I did a walkthrough.

I’m not a professional builder but have done some renovation work over the years (e.g. kitchen, bath, built interior walls, etc) and I was amazed at the condition of the place. Some of the highlights that your $630,000 brings: Non-functional heating; non-functional solar hot water heating (on roof), bathrooms with collapsing walls (I touched a shower wall and pieces literally started falling); no kitchen; bad roof; rotten carpet, mold, and apparent water damage to the structural wooden beams. That’s in a 10 minute walk through by a non-professional. In my humble opinion, the entire property should either be a) leveled, or b) gutted down to the studs. At least the listing agent is honest and just says “As-is. Bring all offers”. I don’t think they’d like my offer.

The reason why I’m writing today is because of another house (about the same size and vintage) that I saw in the same neighborhood that is both an apparent flip gone bad and what exemplifies everything that went wrong during the bubble. This second one has new Pergo type floors, 2 nicely but bizarrely renovated bathrooms, new kitchen cabinets with granite countertop (naturally!), and a high end range hood (GE Monogram). However, this work is coupled with a 10 year old stove, and 10 year old dishwasher, a broken garage door, peeling wallpaper throughout the house, dead garden, etc. Now here’s the kicker – I looked it up on Domania (great website) and it shows 3 sales in the last 7 years:

April 2000 -- $495K (seemed high even then, but it was the peak of the dotcom bubble)
March 2006 -- $920K (!!); August 2006 -- $985K (!!!!).
It’s on the market (just reduced) for $730K. Fair price – probably under $400K.

I keep harping on this because of the collateral damage done by the bubble. The area I’m referencing is a small (maybe ½ by ¾ mile square) neighborhood of Eichler homes (200 or so) in an OK area. A traditional development. How many individual were coerced by the propaganda of the RE industry to mortgage their lives for a house that in a non-bubble market would sell for one-half or less than the price that they paid?

In my quick review of Domania, there were at least 50 transactions in the past 3 years -- ranging from $600-900K. Now there may be multiple sales of the same property, but it's still a lot of transactions. For all of the discussions of CDOs, unscrupulous mortgage brokers, shady real estate agents, etc. the real damage will be done to those poor souls who paid $850K in January 2007 for a house that sold for $298K in January 2000. What are they going to do? The amounts involved are what one commentator called “whoo-whoo” money: a number so large that it’s not realistically conceivable to have for most people. It will NEVER be paid back.

This is an ugly, ugly situation for which there is no simple solution. We have had a combination of an utter abdication of government and regulators coupled with a get rich quick/money for nothing mentality permeating our collective national psyche compounded with a generation of quasi-sociopaths participating in the scheme (see Casey Serin). I think that how we collectively respond to this crisis (and despite what the media and government say, it will be a crisis) will profoundly influence the US for the next 50 years.

Many commentators assume that we can simply inflate our way out of this mess. They look back to the 1970’s and the era of “stagflation” and presume that that is our path. They think we can (and will) walk that inflation path again. Inflation was rampant and pervasive then but so were wage increases. There is nothing (NOTHING) that leads me to believe that there will be a commensurate increase in wages if (when?) inflation occurs. Unions existed and had COLA clauses; when the union wages went up, so did everyone else’s.

Today, it’s too easy to ship work to China, India , Singapore , Vietnam, etc. or to bring in cheap labor from Mexico or Central America (I hate to say it, but it does sound like Marx’s reserve army of the unemployed). If inflation comes without commensurate wage increases, the traditional income/price ratios may return – but most families will need every dollar to pay for food, shelter, taxes and other day to day necessities. I’m most worried that if we’re not careful in how we respond (and I have no faith that we will be careful), we risk impoverishing the entire nation except the upper 1-2%. Virtually no one will be exempt.

If you watch the comedy “That 70’s Show” and look past the humorous interplay between the teenagers, there’s a tremendous undercurrent of angst. Red (one of the main characters) loses his good, full time job working in manufacturing and goes to work for a “superstore” at substantially reduced wages. Mom works. The neighbor owns a furniture store: he goes bankrupt, loses his store and home and then gets divorced. Cars are old. Clothes are plain. Meals are cooked at home. The kids hang out in the basement and watch TV for entertainment. No BMW’s. No designer clothes. No expensive restaurants. No exotic vacations. It’s actually quite realistic of how it was – and a warning of the true standard of living that stagflation and the initial stages of de-industrialization wrought. It could also be a harbinger of our stagflationary future.

Kip later added this price history and note:

I checked Property Shark (an even better website than Domania) on the second house I mentioned. Here's the transaction history:

7/97 -- $295K
4/00 -- $495K
3/06 -- $930K
8/06 -- $985K
7/07 -- $833K

The last transfer was to First Franklin Mortgage, so it appears to be a default on the 8/06 sale.

Excellent commentaries one and all, with a wealth of thoughtful points well made. Thank you, Harun, K.K., Michael, L.S. and Kip.

I would like to add one point not mentioned elsewhere here, which is that the majority of failed thrifts were located in Texas. Why did so many fail? Some causes have been listed above, but another is oil: specifically, the collapse in oil prices in the mid-80s which gutted the Texas economy and made all those condos, subdivisions and commercial buildings which had been thrown up with all that easy S&L money essentially unsellable at anything but truly fire-sale prices (10 cents on the dollar, etc.).

Which is to say that the long tentacles of coal/petroleum extend into all places on the planet, and have since the mid-1800s.

Readers, please be safe if you're traveling this holiday season, and I'll rejoin you here on the 24th or 26th.

Holiday gift bonanza:

Recommended Books and Films, many of which have been recommended by readers. (Here is the URL: )There are over 250 titles and films organized into topics ranging from finance to Hapas/mixed-race Americans to World War II to world history to China to Italian cooking to gardening to novels to ideas to you-name-it, plus a number of wonderful films, many recommended by fellow readers.

Thank you, Don E., ($10), for your astonishing ninth contribution to this humble site. I am greatly honored by your readership, film recommendations and support. All contributors are listed below in acknowledgement of my gratitude.

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