How Pimco Is Holding American Homeowners Hostage
As overlord of the fixed-income finance market, it generates billions annually in effort-free profits. Now it wants to make things worse.
According to Bill Gross, who heads what appears to be the firm’s squad of public policy front runners, the American economy can be saved only through “full nationalization” of the mortgage finance system and a massive “jubilee” of debt forgiveness for millions of underwater homeowners. If nothing else, these blatantly self-serving recommendations demonstrate that Matt Taibbi was slightly off the mark in his famed Rolling Stone diatribe. It turns out that the real vampire squid wrapped around the face of the American taxpayer isn't Goldman Sachs (GS) after all. Instead, it's surely the Pacific Investment Management Co.
As overlord of the fixed-income finance market, the latter generates billions annually in effort-free profits from its trove of essentially riskless US Treasury securities and federally guaranteed housing paper. Now Pimco wants to swell Uncle Sam’s supply of this no-brainer paper even further -- adding upward of $2 trillion per year of what would be “government-issue” mortgages on top of the existing $1.5 trillion in general fund deficits.
This final transformation of American taxpayers into indentured servants of HIDC (the Housing Investment & Debt Complex) has been underway for a long time, and is now unstoppable because all principled political opposition to Pimco-style crony capitalism has been extinguished. Indeed, the magnitude of the burden already created is staggering. Before Richard Nixon initiated the era of Republican “me-too” Big Government in the early 1970s -- including his massive expansion of subsidized housing programs -- there was about $475 billion of real estate mortgage debt outstanding, representing a little more than 47% of GDP.
Had sound risk management and financial rectitude, as it had come to be defined under the relatively relaxed standards of post-war America, remained in tact, mortgage debt today would be about $7 trillion at the pre-Nixon GDP ratio. In fact, at $14 trillion or 100% of GDP the current figure is double that, implying that American real estate owners have been induced to shoulder an incremental mortgage burden that amounts to nearly half the nation’s current economic output.
There's no mystery as to how America got hooked on this 40-year mortgage debt binge. At the heart of the matter is the statist Big Lie trumpeting the alleged public welfare benefits of the home-ownership society and subsidized real estate finance. Once the conservative party embraced this alluring but dangerously destructive idea, the cronies of capitalism have had a field day conducting a Washington bidding war between the two parties which is now in its fifth decade
During this time span all of the congregates of the HIDC lobby -- homebuilders, mortgage bankers, real estate brokers, Wall Street securitizers, property appraisers and lawyers, landscapers and land speculators, home improvement retailers and the rest -- have gotten their fill at the Federal trough. But the most senseless gift -- the extra-fat risk-free spread on Freddie and Fannie paper -- went to the great enablers of the mortgage debt boom, that is, the mega-funds like Pimco, which did little more than hang out an “open to buy” shingle as billions poured in year after year.
Sadly, there isn't a shred of evidence that all of this largese serves any legitimate public purpose whatsoever, and plenty of evidence that the HIDC boom has been deeply destructive. But the intellectual cobwebs spun by the housing cronies so obfuscate these truths that the only way to grasp them is through an examination of the contra-factual -- a postulated world without Freddie/Fannie/FHA and the $100 billion annual tax subsidy on mortgage interest.
In that world, households would be tax-indifferent as to whether they acquired shelter services through renting or owning, and appropriately so. There's simply no evidence that home ownership produces any externality or “public good,” such as making people better citizens, causing them to work harder or aspire higher, turning them into better neighbors, or even growing hair on their chests. Housing is a commodity like furniture and automobiles, and inducing citizens to buy more of it is no business of the state.
Moreover, to the extent that households prefer the cultural intangibles associated with home ownership, they'd have to bear the full economic costs. This would mean mortgage rates priced to the specific risk profile of individual borrowers rather than homogenized through the Federal guarantee machine, and down payments of 40% or more to create loan-to-value spreads capable of encompassing -- without risking the moral hazard of strategic default -- what we now know to be the true range of housing price fluctuation. It would also mean that benchmark mortgage rates would be several hundred basis points higher because a Fed not in the thrall of the HIDC propaganda on the virtue of inflating housing investment, employment, and asset prices would never dream of jamming its thumb on the scale to the tune of its recent $1.4 trillion purchase of GSE mortgages and debt.
Apart from the readily refutable canard that the massive HIDC subsidies benefit the poor (see below), the truth is that subsidized mortgage interest rates and terms confer strictly private benefits, and shower them among American households in an utterly capricious manner. Thus, there are about 110 million households in America. Among them are 35 million renters and another 30 million who own their homes debt-free. These citizens get comparatively nothing from the HIDC gravy train
By contrast, the remaining 50 million households (45% of the total) have mortgages they shouldn’t have gotten in the first place, or enjoy the benefits of a more “affordable” mortgage than the private market would provide -- meaning that they have money left over for widescreen TVs and pedicures thanks to the taxpayers. If this is justice, it's the same league as the ancient ritual of sacrificing firstborn sons.
Dismantling the HIDC subsidy system would dramatically reduce the nation’s mortgage debt burden as existing paper matures and new mortgages were written far more sparingly, and at market rates. It would also have profound, and mainly salutary affects on the real economy.
For one thing, in response to sharply higher mortgage rates and more restrictive housing credit terms, it's likely that home-ownership rates would drop from the current 66% rate to perhaps 50% or even below, thereby approximating rates in countries like Germany which don't seem to be suffering from inadequate shelter as a result.
In the process, the 4 million households with current negative equity of 50%, and probably the 9 million with 20% or higher negative equity, would likely default -- relieving them of a lifetime of debt slavery, even as they reverted to the status of credit-impaired renters. Indeed, under market-based housing finance, additional trillions of still-illusory housing asset values would be quickly purged from the economy as housing prices found an economic bottom. Letting housing prices clear the market would subtract millions more from the ranks of faux homeowners -- households whose incomes have been essentially garnished by the HIDC anyway.
Secondly, dismantling the HIDC would stem the current wasteful misallocation of societal resources, and perhaps just in the nick of time. America is a rapidly aging nation that's become hopelessly incapable of paying its bills in the world economy. As a result of importing roughly $8 trillion more in goods and services than we've exported over the last three decades, we've sent abroad a frightening share of the nation’s value-added output and employment.
In July, for example, the BLS reported 68.3 million jobs in goods production and the core private business service sectors such as retail/wholesale transportation, information technology, the professions, FIRE and business support services. That figure represented virtually no job gain at all from the December 2009 bottom; a reduction of 8 million jobs (11%) from the December 2007 cycle peak; and an even larger contraction from the nearly 77 million high-value jobs reported in these categories way back in January 2000.
The HIDC subsidy system, then, has been doubly perverse. Whereas the nation lived way beyond its means by saving too little at home and borrowing too much abroad, even the meager savings we did generate were artificially channeled into the least-productive investments. Thanks to the pervasive HIDC subsidy system we now have big, new houses and small, aging factories.
Nor should the magnitude of this resource misallocation be gainsaid. In the post-war years prior to 1980, single-family construction, home improvement expenditure, and real estate broker commissions typically amounted to about 3.5% of GDP on a combined basis. By contrast, at the peak of the housing bubble in 2006, these activities added up to nearly 6% of GDP. This means that $300 billion of GDP was going into enlarging the stock of housing, increasing average square footage, adding marble countertops and churning the turnover rate.
When these kinds of outcomes are the fruit of Mr. Market at work, they are, of course, unobjectionable. But when they're gifts of the state, trouble eventually comes, and now it has with a vengeance.
At the end of the day there are upward of 15-20 million American households that can't afford their current mortgages or will be strongly disinclined to service them once housing prices take their next -- and unpreventable -- leg down. But Pimco’s gold-coast socialism is exactly the wrong answer. Rather than having their mortgages modified or forgiven, these households should be foreclosed upon, and the sooner the better. In that event, there's absolutely no danger that impacted families will go without shelter. The supply of rental units is swelling by the day and rental rates will come down further as speculators buy up REO and recycle back to the rental market.
Stated differently, pulling the plug on HIDC will rescue millions of households from mortgage-payment slavery and put them into a buyer's market for rented-housing services -- a social welfare gain under present circumstances. To be sure, they'll loose their credit and probably their credit cards in the process. But the days of living off the housing ATM and bank-issued plastic are over for the American people anyway. Creating an honest financial environment where households are required to rebuild their balance sheets and consume within their means isn't a disservice or injustice to anyone.
Likewise, millions of additional families that can, in fact, service their mortgages or that own their homes debt-free will face a further shrinkage of their paper wealth. The $16.5 trillion of household real estate value reported by the Fed in its Flow of Funds for the first quarter of this year was already down about 30% from the 2006 peak, and could readily decline by another 20%. But would the implied $3 trillion loss of paper wealth be avoidable in any event?
The fact is, there are about 78 million baby boomers inexorably heading for their next to final final berth in a nursing home. Given the shambles of the American economy, who is going to buy their over-valued castles anyway? Certainly it won’t be their downwardly mobile children. So why not purge this phony wealth now and let boomers began to plan for their golden years based on reality, not illusions.
Additionally, the great wave of foreclosures that would result from pulling the plug on HIDC will cause the enablers of the housing debt boom to suffer huge losses on the outstanding mortgage paper. Admittedly, much of that loss will accrue to the $5 trillion or so of mortgages guaranteed by Freddie/Fannie/FHA. But the taxpayers are on the hook for those losses already, and crystallizing huge write-downs now would actually have a very salutary effect. The voters would get in unmistakable terms a reckoning of the massive harm inflicted on them by the congressional housing princes such as Barney Frank and Chris Dodd and their crony capitalist paymasters. Hopefully, the result would be a thorough-going purge of the political system, too.
As to the enablers in the world of fixed-income managers, they'd get their just desserts as well. They'd be forced to absorb hundreds of billions in write-downs on impacted private-label residential and commercial mortgages -- perhaps sharpening their eye for credit risk in the future. But more importantly, pulling the plug on HIDC would eliminate in its entirely any new issues of federally guaranteed housing paper and the no-brainer spreads that the likes of Pimco have harvested from it for decades. Indeed, in a HIDC-free world, the great fixed-income fund managers would be transformed from parasitic enablers of financial bubbles to old-fashioned credit risk managers -- surely a gain to society, if not to their bonus accounts.
Finally, flushing out underwater mortgages and faux homeowners will create the greatest renter's market of all time, permitting lower-income households to rent shelter services at better prices than they've ever been afforded. Indeed, propping up HIDC actually works against the economically disadvantaged because the whole purpose is to keep housing asset values artificially high and foreclosed properties off the rental market.
To be sure, it could be accurately observed that there are millions of lower-income households that can't afford adequate housing services even at these prospective bargain-basement rents. But Milton Friedman pointed out long ago in one of the instances where he was dead-right that this is a problem of too little cash income, not of insufficient housing. And he proposed to address the social problem of inadequate cash income for housing, food, clothing, and all the other necessities of life, with a mechanism to efficiently supply disadvantaged families with additional cash -- the negative income tax ("NIT”).
Needless to say, the crony capitalists of America have never been interested in the negative income tax because it would produce only social justice, not artificial economic windfalls to privileged suppliers of subsidized goods and services. Having loudly professed his heartfelt concern for the plight of the less advantaged, perhaps now would be a good time for Bill Gross to swap out his Fannie for a NIT.
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