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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