Friday, July 3, 2009

Mortgage Market Management

Punditry is slowly returning to the immensity of the disaster that presently confronts the US housing market. Understanding that no progress will be plausible until that sector is convincingly stabilized, commentators are how backing down from other positive news out there. In short the rest of the economy is rebounding as both expected and reasonably. The housing market however is slowly grinding wealth out of the financial system.

There is a lot of false mythology around the concept of market that confuses both policy makers and users when crisis develops. So perhaps it is time to address that issue.

First of, there is no such thing as a free market per se in which some deity provides an invisible hand. Markets are managed and marketed as efficiently as possible at all times. It may lack central authorities but that does not matter. All participants are acting from the same playbook and decisions are made primarily on price and the availability of capital.

Thus cheap access to capital allows a single operator to consolidate a single market and maintain better margins. Too much capital and a competitor will leap up to grab a piece.

The real estate market was driven by both access to cheap capital for qualified buyers and a williness of governments to support first time buyers. This time around they went overboard in a number of ways, but mostly in not gaming out the consequences of many of the policies and measures enacted. It was way easier to pretend that the market was someone else’s responsibility.

When you do that, you have a race to the bottom as rising prices mask the steady decrease in quality. For example, how easy would it have been to progressively pull the land value component out of the equation as demand and process began to rise? It would be simply a matter of accepting only land values set in say 2000 for lending purposes. The drag would have halted speculative leveraging in its tracks. Today deleveraging is reducing those same land values to something approaching zero in a new market in which value is assigned to the replacement of the building and available rents.

This example alone shows us that a market can be readily managed and secondly, it must be managed to optimize results.

A short out of control binge has destroyed the wealth of tens of millions and thrown millions out of work around the globe and it is a long way from been over yet. This was also done in the run up to the great depression with the same consequences. For forty years we avoided that fate and for twenty years we had prosperity based on a clear understanding of the management of government finance thanks to Reagan. Then the young and simply greedy took over and produced the present disaster.

Today we have a housing supply side choked with unsold inventory and a contracting market brought on by the contraction of the lending industry. To manage this market it is first necessary to sweep all inventory out of the market. This is what the government printing press needs to be used for. Once done, and done in ways I have already suggested, a restored buyers market starts bidding up prices and creates a liquid market in which the surplus inventory can be disposed of. A profit may even accrue.

Failure to do this will simply mean that a huge section of the population, if not most of the population will be much poorer as salaries begin to drop and equity continues to be destroyed.

In the end, for the sake of fast bucks, Wall Street dived into the banking business and impoverished all citizens and weakened their country. Conventional banking is a very boring and modestly profitable business. It was never meant to be anything else. Go-Go profitability has never had a place in banking. If a bank decides that they should speculate, then they should always set up a wholly owned subsidiary and capitalize it with a direct equity investment thus alienating the capital as a contribution to the bank balance sheet.

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