Friday, December 21, 2007

Vignettes on the sub-prime crisis

The losses associated with the sub-prime crisis are now being estimated to be US$500b. Lenders are now being overly careful about who they lend to ('shutting the gate after the horse has bolted') and generating talk of a US 'liquidity trap' that prevents credit market transactions occurring even though official interest rates are set low. Mining ventures in Australia with sound business prospects are facing difficulties getting finance because of inept US lending policies.

I was interested in one vignette on the crisis by George Anders from the Wall Street Journal. It was in Thursday's The Australian - I cannot find the link.

Anders points out that there is an emergent class of new US home owners who are 'owners' in name only. They bought houses on typical low or zero deposit loans and hence have almost no equity in their properties. Their solution to the sub-prime crisis and crashing property prices: walk away. Many couples are defaulting on mortgages but keeping credit card payments up to date. Simply walking away from a property whose resale value is less than the outstanding debt turns out to be the simplest way of restoring their troubled finances.

Lenders end up being stuck with the housing as a consequence of their lack of prudence in lending policy, cheap credit-rating data and their 'herd mentality' for market share.

While one might feel a certain sense of satisfaction that the outcome reflects poor business decision-making the costs will generally not be borne by those executives with poor foresight hungry for a quick buck. Moreover, as phenomena such as 'walking away' intensify capital losses, the costs spill over into other sections of the credit market to home borrowers with substantial equity and to potential borrowers with sound business prospects.

These external costs provide a convincing case for macroeconomic intervention in these markets to restore better lending practices. This again is to a large extent 'shutting the gate after the horse has departed' but helps prevent a distant repeat. Self-interest alone in economies populated by quick-buck merchants where ownership is separated from control and where other types of credit market 'agency problems' abound will not drive sensible behaviour.


Bring Back CL's blog said...

the major problem now is the prime market where people are walking away frorm their homes NOT because of changing interest rates but because of falling homr prices and they have further to go.

Great video on both caculated risk and on Mankiw's blogs showing KRuggers talking about this. goes for 50 minutes but well worthwhile

Anonymous said...

Walking away is a less attractive option in Australia, because lenders can go after defaulters for any shortfall after they've sold up their house.

Anonymous said...

Very interesting, Harry. But more interesting is Haneef has been given his visa back. There was no basis in law for it being suspended. Given your fervent support for an action many saw as pre-election hate mongering, your reading public would like to see your response. Perhaps a big heaped serving of humble pie?

Anonymous said...

Come off it Shlomo. Just because four federal court judges have said that Andrews had no grounds to cancel Haneef's via doesn't mean that Andrews had no grounds to cancel Haneef's visa.

And, FFS, Haneef is, at this very moment, in Mecca, doing the Hajj. That proves he is a communist terrorist, sorry, Muslim terrorist who if there was any in justice in the world would be in Guantanamo Bay having his genitals bitten off by a large dog, with rabies.

Just ask Harry.

hc said...

Shlomo, Spiros - compliments of the season - I'll wait to read the judgment. My view was that Kevin Andrews acted appropriately under the Migration Act.

Anonymous said...

Harry, happy Christmas and best wishes for the new year.

Bring Back CL's blog said...

Our Arry thinks cousins should be locked up if another has committed a crime.

It is a shame our Arry is not a conservative

Anonymous said...

Habib squares the ledger, but Hicks still leaves the experts here well behind, but as Harry points out, if Haneef was a bikie you'd all be happy with Rann stripping him of his colours and paraphernalia and locking him up for flouting SA's new bikie laws and then sending him packing.

Back to the topic at hand. We don't need nanny state laws to protect lenders and borrowers, but only need caveat emptor, providing our central banks don't kickstart these giant pyramid schemes by rolling the printing presses. What did they expect the finance sector to do with all that cheap money, other than go looking for more and more dodgy risks to find a home for it all?

hc said...

Observa, As I have discussed before with you I agree that the loose money thing is an issue but not sure it drove the crazy lending policies.

Is caveat emptor plausible when the US finance sector faces $500b in losses?

In credit constrained lending markets it was unnecessary for the borrower to take care but in free markets where people will lend anything at the going rate there is a problem. Partly people borrowed too much because they forgot about the possibility of macroeconomic instability.

kipwatson said...

The American law that home owners can walk away from their home without additional debt is an excellent one. Australia should copy it. It's a shame the USA unjustly restricted consumers' right to declare bankruptcy, though.

Lenient bankruptcy laws are a good response to bad lending practices.

Anonymous said...

Well perhaps I might accept some notion of informed caveat emptor expressed here
As for slack banktuptcy laws allowing crooks and shucksters to walk away from their obligations, I'm much more skeptical.

As for the $500bill in US finace sector losses, I'm extremely skeptical that would ever be the case if lenders were lending real savings rather than the funny money pumped out by central banks over the last decade. If money was actually increasing in value, say by 1-2% p.a. rather than the other way round customarily, it's hard to imagine savers being so blase' about who they lend to, or who they give it to to lend out and as such the giant pyramid scheme would never have got off the ground IMO.