Spawning a Mortgage Disaster: The Birth of the Adjustable Rate Mortgage in 1982. California Confidential. A Budget Mess and Massive Cuts. S&P 500 Stock Market Speedway.
After looking at the Alt-A and option ARM disaster, many readers have been asking what in the world created the toxic ecology for these mortgages to spawn. You really have to go back to 1982 when the Garn-St. Germain Depository Institutions Act of 1982 was passed. This bill was sponsored by Congressman Fernand St. Germain, Democrat from Rhode Island and Senator Jake Garn, Republican from Utah. The bill passed with an overwhelming vote of 272-91 in the House. This one act played a large role in the S&L debacle but also laid the foundation for toxic adjustable rate mortgages. Title VIII specifically allowed for adjustable rate mortgages. Here is a part of the remarks from President Ronald Reagan at the time of signing the bill in 1982:
“(University of Texas) Now, this bill also represents the first step in our administration’s comprehensive program of financial deregulation. I particularly want to commend the leadership of the chairman, Senator Garn, and Chairman St Germain, along with Secretary Regan and his fine team at Treasury. They did a remarkable job forging a consensus within the Congress and among affected industries in favor of the bill’s deregulatory provisions. I’d like to also thank Congressmen Stanton, Wylie, and LaFalce for their assistance.
What this legislation does is expand the powers of thrift institutions by permitting the industry to make commercial loans and increase their consumer lending. It reduces their exposure to changes in the housing market and in interest rate levels. This in turn will make the thrift industry a stronger, more effective force in financing housing for millions of Americans in the years to come.”
As we all know, the S&L industry became a wild casino and brought the United States economy to its knees. Little did we know that only a few years later we would create an even bigger housing bubble that would bring the world to the verge of a new global recession. I highlight this piece of legislation because this allowed for more creative financing but is really the mother of the Alt-A and option ARM disaster we are now facing. With no adjustable rate mortgages there would be no Alt-A or option ARM problems. That is the bottom line. And without the Gramm-Leach-Bliley Act repealing the Glass-Steagall Act in 1999 there wouldn’t be the behemoth too big to fail institutions. The Gramm-Leach-Bliley Act allowed commercial banks, investment banks, and securities firms to consolidate. Now what could possibly go wrong with all this in place and a corrupt and crony Wall Street using the U.S. Treasury and Fed as their personal loan shark? You can almost mark it on the dot when the U.S. debt market exploded especially for consumers:
And keep in mind what major debt induced problems occurred during this time. We had the S&L Crisis followed by the technology bubble and finally the epic housing bubble. The historical record shows that when the U.S. government tries to get involved in cahoots with Wall Street bad things happen for the American consumer. From 1945 to 1982 boring 30-year mortgages seemed to do well for our country. Since that time we have bounced from one bubble to another. Here in California some are celebrating because the state government has come to an agreement on how to balance the $26.3 billion deficit. Why are some cheering? They are doing their job and if you look at the agreement, it will mean more pain for the state. More cuts and more borrowing. How does this bode well for a state with 11.6 percent unemployment? The reason California finds itself in such a challenging budget situation is a gigantic portion of the revenues brought in where completely based on a housing bubble.
You look at uber subprime mortgage lenders like New Century Financial that at one point had 7,200 employees and a market cap of $1.75 billion and you come to realize that some companies existed purely to feed the toxic mortgage industry. I wonder how much money the state got in 2005 when New Century had a net income of $417 million? Hundreds of these kinds of operations kicked the state down with funds brought on by financing people with subprime, Alt-A, and option ARM junk. At this point the state has failed to acknowledge that a large portion of those revenues will never come back (unless we have another bubble). California was the hub for toxic mortgage lending. The state pioneered the way for ultra-toxic mortgage all-stars like California based Countrywide Financial.
So when people try to understand the fall in revenues, it is hard to say what the true bottom is. We have been at the center of the last two epic bubbles. Without the technology bubble and the housing bubble it is hard to say where our true equilibrium is. How much of the revenues brought into the state were based on bubble industries? And now, the stock market is on a tear yet the fundamentals are still horrific. We have yet to see the commercial real estate fallout. The Alt-A and option ARM wave will rip into the mid to upper tier of the markets. These are multi-trillion dollar problems. Unemployment is still ticking up. Yet the stock market rallies on like a runaway train.
S&P 500 Not Cheap
The only reason people are diving into the stock market, especially the turbo capitalism based financials is because of the bailout backstop. The S&P 500 has gone up a stunning 41 percent since the March low! This rally is based on Wall Street smoking the bailout crack provided by the taxpayer. Without the taxpayer, they’d be toast. As you can tell, bailing them out did nothing for the real economy. It just allowed them to bet more rounds at their roulette table with your money. At least we know who the U.S. Treasury and Federal Reserve work for.
If we look at the fundamentals of the S&P 500 we find a grim reality:
That is right. At the end of last month the P/E ratio for the S&P 500 was 134! That is not cheap by any stretch of the imagination. When you put this on a chart it literally flies off the paper:
We are much higher than the tech bubble peak but hey, this is crony capitalism and who really cares about profits in the real economy. All we care about is whether Goldman Sachs can hedge their bets and short the American people with their own money for the sake of capitalism. This is not capitalism. This is crony corporate welfare at its worst. The real economy is in the dumps. Those that jump for joy seeing Goldman Sachs rally suffer from a serious case of Stockholm syndrome. Don’t fall in love with your captors.
California Budget Deal
Before jumping for joy, the California budget kicks the can down the road once again. It is a painful budget. The cuts are deep and the state will feel the repercussions. Yet the major thematic problem with how the agreement is proposed is no one is acknowledging reality. And that is, much of the revenues from this past decade were bubble based. They are not coming back. The tone of the budget deal is such that “we’ll be back to happy days in no time.” If you know about therapy you will know that in Gestalt therapy one technique often used is the “empty chair.” The client is asked to pretend someone is in the empty chair (maybe a father or mother) and to speak to the chair. The therapist will observe the conversation and make notes at times guiding the client. This helps to externalize thoughts that may be repressed and bring dialogue into the open. What we need is to give California some solid Gestalt therapy. If California citizens were asked to tell “California” their thoughts it would definitely reflect a very different reality. They would probably tell the state to get real and create a budget that is based on non-bubble based revenues. The state however isn’t having anything to do with the intervention.
Some deep cuts:
$6 billion to K-12 and community colleges
$3 billion to the UC and CSU systems
$1.3 billion to Medi-Cal
$1.3 billion through 3 day furloughs
$1.2 billion from state prisons
$528 million to CalWORKS
You’ve added it up and only see roughly $14 billion in cuts. Another $4.7 billion will be taken from cities and counties and another $2 billion will be in good old fashion borrowing. So this celebration should be more somber in tone because these cuts will have repercussions in the real economy. Yet what else can you do? You can only balance the budget in two ways. Cuts (which are being taken) and more revenues (taxes). That is it. Borrowing is basically pushing the problems down the road. If you look at the Alt-A and option ARM problems, a gigantic issue that is largely centered with California housing will be in the dumps for many years. Where is the money going to come from?
“The State started the fiscal year with a $1.45 billion cash deficit, which grew to $11.9 billion on June 30, 2009. Borrowed money from special funds provided enough cash to fund State operations through June 30. The Controller faced a large cash shortfall at the end of July, forcing his office to begin issuing registered warrants or “IOUs” to any General Fund payment that was not protected by the State Constitution, federal law, or court decision. Without IOUs, the State would have run out of cash and begun missing those protected payments at the end of July.”
This is a statement from the State Controller’s Office. So we went from $1.45 billion to $11.9 billion in 6 months? That means the state is leaking $2 billion a month. And if we look at even a monthly estimate you will see why:
And a chart that is over 1.5 years old:
If you have a hard time figuring out what you bring in each month how are you going to plan out for one fiscal year? The state is in a really tough bind. All these signs point to a prolonged housing slump. Those jumping in to buy right now simply are choosing to ignore the Alt-A and option ARM reality and the fiscal situation of the state. A good round of fiscal therapy may help.
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