July 11, 2008

Spare Change

Prescient: Here's Noriel Roubini in August 2006:

The scariest thing is that the gambling-for-redemption behavior and problems of WaMu are not the exception in the mortgage industry; they are instead the norm. There are good reasons to believe that this is indeed the norm as lending practices have become increasingly reckless in the go-go years of the housing bubble and credit boom.

If this kind of behavior is – as likely – the norm, the coming housing bust may lead to a more severe financial and banking crisis than the S&L crisis of the 1980s. The recent increased financial problems of H&R Block and other sub-prime lending institutions may thus be the proverbial canary in the mine – or tip of the iceberg - and signal the more severe financial distress that many housing lenders will face when the current housing slump turns into a broader and uglier housing bust that will be associated with a broader economic recession. You can then have millions of households with falling wealth, reduced real incomes and lost jobs being unable to service their mortgages and defaulting on them; mortgage delinquencies and foreclosures sharply rising; the beginning of a credit crunch as lending standards are suddenly and sharply tightened with the increased probability of defaults; and finally mortgage lending institutions - with increased losses and saddled with foreclosed properties whose value is falling and that are worth much less than the initial mortgages – that increasingly experience financial distress and risk going bust.

One cannot even exclude systemic risk consequences if the housing bust combined with a recession leads to a bust of the mortgage backed securities (MBS) market and triggers severe losses for the two huge GSEs, Fannie Mae and Freddie Mac. Then, the ugly scenario that Greenspan worried about may come true: the implicit moral hazard coming from the activities of GSEs - that are formally private but that act as if they were large too-big-to-fail public institutions given the market perception that the US Treasury would bail them out in case of a systemic housing and financial distress – becomes explicit. Then, the implicit liabilities from implicit GSEs bailout-expectations lead to a financial and fiscal crisis. If this systemic risk scenario were to occur, the $200 billion fiscal cost to the US tax-payer of bailing-out and cleaning-up the S&Ls may look like spare change compared to the trillions of dollars of implicit liabilities that a more severe home lending industry financial crisis and a GSEs crisis would lead to.

Spare change. Reagan and Papa Bush with Greenspan's help created the Savings and Loan bailout. Baby Bush with Greenspan's help threatens to makes that bailout look like spare change.

Roubini believes bailing out Fannie Mae and Freddy Mac would be the epitome of a moral hazard.

Let me now elaborate on those insolvency predictions, discuss what happens next when Fannie and Freddie go belly up and discuss why they should not be fiscally bailed out; rather - on top of wiping out their shareholders - their creditors/bondholders should also take a haircut to avoid the “mother of all moral hazard bailouts” …

No wonder they call him a bear.

Posted by Mary at July 11, 2008 10:04 PM | Economy | Technorati links |

lol, mary, i linked to the same roubini post, too!

Posted by: skippy at July 15, 2008 08:26 PM