Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

10 October 2011

How Rick Santelli Killed the Housing Rescue

Ezra Klein is an economically trained columnist for various publications, including the Washington Post. On Saturday, the Post published his thorough review of why our economic recovery is going so slowly.

It’s the best non-book-length explanation I’ve yet read. It combines sophisticated economic understanding with political realism. So it deserves everyone’s careful attention.

Among many other things, Klein explains why our housing decline still hasn’t reached bottom. Housing was the core of the financial crisis. Virtually every toxic asset was a derivative of home mortgages: mortgaged-backed securities, “risk tranche” derivatives of mortgage-backed securities, debt obligations collateralized by packages of mortgages or mortgaged-backed securities, and debt swaps and other “insurance” on banks that held the foregoing assets.

The simple home mortgage lay at the core of it all. If each homeowner could have paid as promised, all the other assets would have had face value, and no crisis would have arisen. So the logical place to start detoxifying the assets was with the home mortgages that underlay the whole mess.

This was and is not rocket science, or even particularly sophisticated economics. It was just common sense. I myself proposed such a solution in September 2008.

The idea was and is as follows. For homeowners in default or facing foreclosure, the government would intervene and let the homeowner pay what he could, for example, by reducing the principal amount of the mortgage. Then it would reimburse the mortgage holder for the loss. The mortgage would then be good, and so would all the securities derived from it. Problem solved.

When you think about it arithmetically, this solution would have been far better than what actually happened. Most, if not all, homeowners could pay something, even if they were on unemployment. So nearly every defaulted mortgage would have been worth some non-zero percentage of original face value, and the home would still have been occupied and maintained.

What actually happened was much worse. Homeowners defaulted and had their homes foreclosed. Their mortgages became worth zero, lowering the values of all securities derived from the mortgages. Homes went vacant. Neighborhoods went downhill; and homes in neighborhoods with still-paying homeowners lost value. Everybody lost.

The government lost, too. In the “rescue” scenario described above, every home mortgage would have been worth some substantial percentage of face value, depending on what the homeowner could pay. So would all the toxic assets that derived from the mortgages. But when the mortgagors defaulted and stopped paying, the mortgages all became worth zero.

And remaining mortgages not yet foreclosed had much more uncertain value, because they were either worth nothing or face value, with unknown probability. Therefore, the government had to pay much more to bail out the various banks and quarantine the toxic assets than it would have had to pay had each each underlying mortgage been worth a known and substantial percentage of its face value.

So why didn’t this rescue happen? Enter Rick Santelli. He’s the trader on the floor of the Chicago Board of Trade whose famous tirade killed the whole deal.

Here’s how Klein describes it [search for “hideous”]:
“Rick Santelli’s famous CNBC rant wasn’t about big government or high taxes or creeping socialism. It was about a modest program the White House was proposing to help certain homeowners restructure their mortgages. It had Santelli screaming bloody murder.

‘This is America!’ he shouted from the trading floor . . . . ‘How many of you people want to pay for your neighbor’s mortgage that has an extra bathroom and can’t pay their bills? Raise their hand.’ The traders around him began booing loudly. ‘President Obama, are you listening?’

If you believe Santelli’s rant kicked off the tea party, then that’s what the tea party was originally about: forgiving housing debt.”

Klein writes that “[h]ome prices have fallen almost 33 percent since the beginning of the crisis.” How much less would they have fallen if the estimated 2.2 million homes that are now abandoned had owner occupants? How many of the additional estimated 7.5 million homeowners facing foreclosure would be secure? How many neighborhoods would not be decaying with abandoned properties, crime and crack houses?

We’ll never know. But one thing is certain. Even stringing up Rick Santelli now wouldn’t save a single home.

I mention Santelli not to make a villain, although he certainly (and briefly) played that role. Santelli epitomizes a much larger problem that has laid our country low.

He’s a trader. What do traders create? Nothing. What do they build? Nothing. What win-win contracts for mutual gain do they sign? None. If a trader buys low and sells high, someone else has bought high and sold low. He wins; they lose. That’s the way it is in trading: a zero-sum game.

But here’s the thing. If Santelli had thought a little more, rather than just braying like a bull about paying for his neighbor’s extra bathroom, he might have asked a simple question: “Could I, too, benefit from this program?”

As it turns out, he would have. By saving his neighbor’s home from foreclosure and abandonment, he would have protected the property value of his own home from decline and his neighborhood from blight, crime and decay. Too late, millions of innocent, mortgage-paying homeowners who probably thought Santelli was a genius learned that lesson the hard way.

Santelli represented the trader’s view of life, the Universe and everything. Someone has to lose so that someone else can win. There’s no middle ground. Life is hard; then you die. There’s no such thing as cooperation. There’s no such thing as mutual self-help. It’s always you or me.

That philosophy is why no nation that lets a place like Wall Street call the shots can ever rise to prosperity, let alone greatness. And that is why, ever since Wall Street took over effective control of our nation (1, 2, 3, and 4), we have been going straight to hell.

If that philosophy had ruled us in the last century, we would be just another struggling banana republic. The transcontinental railroads (which required government land grants) would never had been built. Ditto the Interstate Highway system. We would not have built the greatest educational system in human history. The Centers for Disease Control and National Institutes of Health would not exist. Nor would the WHO. Nations victim of pandemics would not look to us for rescue but would suffer and die with prayers and lamentations.

I could go on and on, but you get the drift. Santelli’s philosophy of life may work on the trading floor, but nowhere else. Even on the field of battle and in the sports arena, teamwork matters. You can’t build a nation, a state, a city, or a just society without it.

As it turned out—and as Klein carefully explains—the Obama Administration considered direct relief to struggling homeowners but was too timid in implementing it. There is also a crowning irony in Klein’s superb piece. Douglas Holtz-Eakin, who was John McCain’s economic advisor during the 2008 presidential campaign, also wanted to cure the housing crisis by helping the distressed homeowners who lay at its core. He even managed to convince McCain to adopt the idea. But no one else on the Republican side liked it. Klein quotes Holz-Eakin as saying, “[t]he politics on housing are hideous.”

Who’s responsible for the “hideous” politics that killed what could have rescued our national housing market cheaply and early? People like Rick Santelli. If we let them—and their like on Wall Street—continue to rule us, we are lost.

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  • At Fri Nov 04, 03:13:00 AM EDT, Blogger rad said…

    The solution you describe, which requires a government buy-out of bad loans, seems unnecessarily complicated. I think that passing a national anti-deficiency statute would accomplish much of the same purpose over time. It would certainly provide an incentive for lenders to negotiate with homeowners that currently does not exist in most states.

    My wife and I live in a non-anti-deficiency state. My wife owns the condo we live in, which is about 40k underwater. Obama's plan to ease refinancing is of little use to us because we are near to retirement and planning to scale back. Unfortunately, this is clouded by the prospect that the bank will sue my wife for all all of her non-exempt property after it confiscates 100% of her investment in the condo.

    I know that a national anti-deficiency statute would not solve all of the problems of the Economy, but it seems like a good place to start because it would require banks to reassess the values of their questionable mortgages and would permit an equitable shifting of a portion of the cost of the housing collapse to the financial institutions that could have prevented it.

    As you noted, banks are continuing to make money, even in anti-deficiency states. That is why I believe a national anti-deficiency statute might be acceptable to a majority of voters.

    I am curious why you did not hit on this as an obvious solution. Was it because you feel the banks would take too hard a hit or do you think it just doesn't go far enough?

  • At Sun Nov 06, 05:15:00 PM EST, Blogger jay said…

    Dear Rad,

    Yours is a good comment. Simple solutions sometimes work and always require serious analysis.

    Yet there is a glaring deficiency in the anti-deficiency solution.

    In several essays on this blog, I have argued that (1) there is nothing seriously wrong with the US economy outside of finance and (2) the cause of all our recent and current problems is rampant gambling by banks which, when they invariably lose, manage to shift the ordinary risks of their business to governments and taxpayers. See (1, 2, 3 and 4). They do this through their overt and covert control of governments in so-called capitalist countries.

    The anti-deficiency solution would solve most problems of innocent homeowners. But it would not solve the larger economic problems. Either the banks would all go under, causing a general economic collapse, or the government would bail them out yet again, thereby encouraging more gambling and leading to yet another economic crisis in short order. Nothing leads to recklessness quicker than being able to gamble with other people's money.

    That said, I think national anti-deficiency laws could go a long way toward preventing future crises of this kind, but only in the sector of finance related to mortgages. Anti-deficiency laws could cause mortgage bankers to become prudent again, i.e., to take sufficient down payments and require sufficient verification of borrowers' income and assets to protect their loans. But these laws wouldn't solve the problem of banking casinos like Goldman, Sachs encouraging banks to take undue risk by offering to "insure" them against it with derivatives like credit-default swaps.

    Today, something or someone still has to address the $600 trillion dollars of outstanding derivatives (no, that's not a typo), which are nothing more than roulette wheels that attempt to shift the normal risks of the banking business to other banks, and ultimately to you and me as taxpayers. Fixing that problem will require a much more robust and unprecedented solution, such as: (1) a buyout and liquidation by government of toxic assets and firms that hold them, and (2) regulations that severely limit (and tax!) such gambling in the future, perhaps restricting derivatives to such traditional instruments as commodities futures.

    That brings me to the last point. I have never advocated bailing out banks except as a temporary, interim measure to avoid imminent economic collapse. Bailouts just make banks horrendously expensive welfare queens, undermine capitalism, and encourage more gambling that could ultimate destroy the global economy.

    What I have advocated is bailing out innocent depositors in banks (and other innocent creditors), which we have done since the Great Depression, and letting the banks fail. In that case the government might have to step in and print money to avoid economic collapse, but the shareholders' of reckless banks would lose everything, and their management would be out on the street with soiled resumes. That's called capitalism. (See my posts linked above.)

    The anti-deficiency solution would shift risks from innocent homeowners back to banks, which should bear them. But it wouldn't solve the biggest problem of all, namely, government bailouts, which shift the risks of bank gambling to the public and encourage banks to gamble even more.



  • At Mon Nov 07, 08:45:00 PM EST, Blogger rad said…

    Dear Jay,

    Thank you for giving serious consideration to my proposal. If I may be so bold, I would like to continue arguing in favor of a national anti-diversity statute.

    I am advocating this not only because it would provide a minimal "safety net" to a relatively small but statistically significant class of distressed homeowners (including my wife). It would also, and at no cost to taxpayers, require banks to adjust down the inflated values of underwater mortgages, but only in amounts that would not be ruinous to the banking industry.

    In Arizona, California, Idaho, Minnesota, Montana, Washington and Wisconsin, anti-deficiency statutes are the rule and not the exception. I do not believe the banks can get away with claiming that these laws are immoral. On the contrary, when I talk with ordinary people about this issue, most of them say that it is immoral for banks to pursue defaulting homeowners for additional assets after they take possession of the homeowner's house.

    Like people in the occupy movement, I am tired of our Pepsi-Cola/Coca-Cola two-party form of government, which only protects the wealthy. I would seriously consider pledging my vote to any respectable candidate, third party or otherwise, who vows to support anti-deficiency legislation on the state or federal level. I feel that anti-deficiency legislation would make an excellent first plank should the occupy movement ever put forth a legislative agenda.

    Again, my sincere thanks to you for providing a forum to express these views and for your intelligent insights.

  • At Tue Nov 08, 04:48:00 AM EST, Blogger rad said…

    Dear Jay,

    I think my list of the names of anti-deficiency states was incorrect. The states are Arizona, California, Iowa, Minnesota, Montana, North Dakota, Oregon, Washington and Wisconsin.

    Best regards,

  • At Sat Dec 03, 05:19:00 PM EST, Blogger jay said…

    Dear Rad,

    I think you meant “anti-deficiency statute,” not “anti-diversity statute,” in your penultimate comment above.

    While I sympathize with your wife’s plight and the plight of people stuck in “underwater” homes, national anti-deficiency legislation would solve only the asset- value problem. For people who want to stay in their homes, it would not solve the income problem, i.e., income too low to make the present mortgage payments. Only renegotiation of the loan and mortgage could do that, although anti-deficiency legislation would give banks additional financial incentives to do so.

    The big problem, as I said above, is that anti-deficiency legislation would do little to solve the epidemic of gambling in our financial sector. It might help damp gambling in the mortgage sector by tying mortgage-backed securities’ values more closely to market values. But it would not do a thing to reduce the rampant gambling in other financial instruments.

    Gambling (in the form of financial derivatives of mortgages) caused the Crash of 2008. Gambling (in the form of more primitive speculation) caused the Great Depression. There are $600 trillion of gambling instruments still outstanding, and anti-deficiency legislation would do nothing about them except perhaps make some more precarious.

    So by all means, propose and support national anti-deficiency legislation if you like. If adopted, it would help some homeowners and reduce the range of gambling in future mortgage-backed instruments. But it wouldn't solve the key problem overhanging the Western part of the global economy: a rogue banking sector that has become a gigantic casino.

    Thanks for correcting your list of anti-deficiency states. I have not checked it. Readers who wish to do so, or to investigate the status of their own states, will have to resort to their local law libraries, many of which have multi-volume treatises on the real-estate laws of the fifty states. I’m not aware of any authoritative online list.



  • At Sun Dec 04, 09:33:00 AM EST, Blogger George Carty said…

    I know you have little time for Marxism, but what do you think of the Marxist claim that profit rates under capitalism inexorably fall, and that the gambling epidemic on the part of the banks (and the asset price bubbles) were caused by a dearth of investment opportunities in the real economy?

  • At Sun Dec 04, 11:17:00 AM EST, Blogger jay said…

    Dear George,

    That’s a great question, and the answer is an emphatic “no!”

    There is no dearth of investment opportunities in America today. Our excellent “ABC Companies” are doing a booming business, and winning in tough competition, all over the globe. And there are even more investment opportunities if you count infrastructure and education as candidates for investment.

    Without progress, any society stagnates. Like any economic system, capitalism succeeds only by making progress.

    Capitalism progresses by what Joseph Schumpeter called "the perennial gale of creative destruction." Unfortunately, we Yanks have lately neglected both the destruction and the creation. We have allowed obsolete or obsolescent industries like coal, oil and gas-driven cars to dominate our economy for far too long. And we have neglected modern industries like wind, solar, and nuclear power. We also have allowed research to lag in nanotechnology, computer hardware, genomics, materials, production engineering, and basic sciences. We have put all our eggs in the baskets of finance, software and pharmaceuticals, neglecting the fundamental inquiries that ultimately produce breakthroughs in those and other fields.

    As I’ve said many times, capitalism works. (1, 2, 3, and 4). It works best when it's heavily regulated in the public interest and the regulation is constantly tweaked in a zen-like quest for unattainable perfection. It works worst—and can cease functioning—when it becomes a religion and whole sectors of an economy escape its discipline. (1, 2, and 3).

    Our “Yankee disease” has little to do with capitalism, except that it has taken hold in an obscenely self-promoting society that believes itself to be the prophet of capitalism. What ails us is the same thing that has ailed every human society in decline: age, complacency, laziness, self-indulgence, softness, thoughtlessness and a failure to invest in what really matters. Our financialization is just one symptom—probably the worst one—of that decline.




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