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Canadian Conservatives on the Subprime Bandwagon

Canadian Conservatives on the Subprime Bandwagon

Noni Mausa

From the Canadian newspaper of record, the Globe and Mail, the Saturday, Dec 13 edition. Apparently, like Mary and her little lamb, wherever neo-conservatives go, subprime is sure to follow. Emphases are mine:



How high-risk mortgages crept north

December 13, 2008

The untold story of how elements of the first Conservative budget in 2006 encouraged the entry into Canada of such big U.S. players as AIG, creating our version of subprime mortgages

…Just yesterday, Finance Minister Jim Flaherty repeated the mantra that the government acted early to get rid of risky mortgages. What he and Prime Minister Stephen Harper do not explain, however, is that the expansion of zero-down, 40-year mortgages began with measures contained in the first Conservative budget in May of 2006.

At the time, Mr. Flaherty announced that the government was opening up the market to more private insurers.

“These changes will result in greater choice and innovation in the market for mortgage insurance, benefiting consumers and promoting home ownership,” Mr. Flaherty said.

The new rules encouraged the entry of U.S. players such as American International Group – the world’s largest insurance company – and Triad Guarantee Inc. of Winston-Salem, N.C. Former Triad chief executive officer Mark Tonnesen, who spearheaded his company’s aborted push into Canada, said the proliferation of high-risk mortgages could have been mitigated if Ottawa had been more watchful.

“There was a lack of regulation around the expansion of increased risk,” he said.

Virtually unavailable in Canada two years ago, high-risk mortgages proliferated in 2007 and early 2008 and must now be shouldered by thousands of consumers at a time when the economy is sinking quickly and real-estate prices are swooning. Long-term mortgages – designed to help newcomers get into the housing market sooner – are the most expensive in terms of interest costs, and least flexible when mortgage-holders cannot meet their payments and need extensions.

The Bank of Canada this week warned that the perilous economy could lead to a doubling of so-called “vulnerable households” – those unable to meet their debts – and perhaps cost thousands of Canadians their homes. The central bank, which is always cautious with its words, said in a report that there is the potential for “a substantial increase in default rates on household debt.”…


Harper became Canada’s Prime Minister after his party won a minority government in the January 2006 federal election. By May, he was running to catch up with the Americans.
The entire article, far longer and more detailed, is here:

TP National

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Inflation, Deflation…

by cactus

Inflation, Deflation… Where The Heck Are We Going?

Some folks are telling we are going to have deflation, what with the economy contracting and the vast disappearance of tons of cash through the implosion in value of assets that weren’t really worth what Goldman, Welfare, Queen & Sachs and the rest of ’em told us they were worth. Some folks tell us we’re gonna have inflation – after all, the Fed is printing money like mad and the Federal Government is handing out bail-outs to those who got us into this mess like there is no tomorrow.

I’ve been too swamped with my day job to have a chance to work through this myself, but it seems to me that falling prices are coming to some sectors of the economy, and the loot is going to other sectors of the economy. Perhaps the end result of this is going to be merely one big redistribution, with the change in CPI remaining within a range (say, -1% to 5%) that is not outlandish by US standards and which certainly doesn’t qualify as a problem when viewed from the perspective of countries that have faced hyperinflation or massive deflation. In other words, we may not see a monetary phenomenon (at least not until significant parts of the debt eventually become hard to service, which is not a matter of months) but rather a furthering of our travels down the road as a kleptocracy.

Like I said, I haven’t had the chance to work this out. Where do you think we’re going?
by cactus

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Links and Short Takes

Tom Bozzo

finds that insufficient blogging time is clogging up his copies of Firefox and NetNewsWire with almost-blogged articles. Here are a few things that have caught my attention recently, in no particular order…

Fascinating dispute between Cerberus and Daimler over the sale of the troubled littlest member of the Detroit Three. Shorter private equity sharps: we wuz robbed! There may be reasons to forestall Chrysler’s demise, but none to save Cerberus’s equity.

Fiscal Fission: The Economic Failure of Nuclear Power” (warning PDF, via Grist), a Greenpeace-sponsored report on nuclear power subsidies — using authoritative sources notwithstanding the interested sponsor. I’d been looking for quantifications of nuclear subsidies after a MR post accused wind producers of subsidy farming and Alex Tabarrok suggested that the obvious green power solution is nuclear. I can countenance expanded atom-smashing for some reasons, but freedom from explicit and implicit subsidies isn’t one of them. Related: a European Union report (PDF) on external costs of electricity production.

Here’s Yochal Benkler at TPMCafé on bringing fiber to the home so Americans in general can enjoy first-world intertubes, and an older post by Pitt’s Martin Weiss on Verizon’s policy of cutting FiOS subscribers’ copper loops. Modernization is an element of the Obama economic plan; both posts raise interesting issues regarding infrastructure ownership. Seems obvious to me that there’s a big divergence between social and private returns for fiber to the home, and little evidence of coherent policy on infrastructure financing and/or ownership. Also: the chicken-vs-egg problem for 100Mbps home internet.

James Wimberly has smart grid do’s and don’ts at the RBC, given that any such technology must be robust to dumb users. I dunno if the payoff to having smart appliances negotiating with the smart grid is generally worth the hassle versus just pursuing obvious efficiencies through standards (lighting, older appliances, energy vampires) — cf. Ezra Klein. Most of the needed smarts are already in the systems many utilities use (and market to widely varying degrees) to shed hot-day peak loads by briefly cutting off air conditioners. The same technology could keep future car chargers from kicking in at economically undesirable times. Remember, a lesson from old-style regulation is that the best way of dealing with unsophisticated consumers is simplicity.

Chris Clarke brings a report on the Bush Administration’s efforts to undermine the Endangered Species Act. What saints. Don’t let the shoes hit you on the way out.

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(Posted a little late but for comment on the usefulness of such a post pinned to the top when I figure out how. Please comment on the potential and how you would add to the service. Much of the post would be below the fold is one thought, but is above this time for ease of viewing.)


Details below the fold.

Daily contributions encouraged throughout the day.

______________on the fold_______________


Economic Forecast – This week

Economic Forecast – Next week

Economic Indicators – Government Reports


12/11 – U.S. Household Net Worth Fell Most on Record in Third Quarter


12/11 – Jobless claims jump to 573,000, a 26-year high
Continuing claims spike by 338,000 to 4.43 million

12/11 – Jobless claims at 26-year high

12/11 – Government Report – Unemployment Insurance Weekly Claims Report


12/10 – ‘False bottom’ for housing ahead?
Pent-up sellers could flood inventories, stall recovery

12/11 – How to fix the housing mess


12/07 – Retail sales dropping like a rock
Economic weakness ‘feeding on itself,’ analysts say


12/11 – Auto Bailout Clears House but Faces Hurdles in Senate

12/11 – Auto Bailout Appears Dead in Senate as G.O.P. Resists

11/20 – Which Senators Have Auto Plants in Their States?

11/02 – U.S. Automobile Sales – November 2008
Sales and Share of Total Market by Manufacturer


12/11 – U.S. Economy: Trade Gap Widens, Jobless Claims Hit 26-Year High

12/11 – Import prices plunge 6.7% on global slump
Big price declines seen in petroleum, nonfuel industrial supplies

12/11 – Government Report – U.S. International Trade in Goods and Services – October 2008


12/11 – Boeing again delays 787, shakes up jet division


12/11 – The economic consequences of Herr Steinbrueck


12/11 – North Asia summit to show symbolic unity on crisis

NOTE: Further contributions by readers throughout the day are encouraged. Add your subjects and links in the comments section.

Update: Links are fine

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Most generous welfare program in history

by cactus

Bush, The View From 2004

In 2000, I ran the numbers and it was obvious to me GW’s economic plan was complete BS, so I assumed the rest of what he was telling us couldn’t work either. But I can understand why many people voted for him. 2004 is a bit harder for me to understand – after all, you didn’t have to work through what his plan was going to do, all you had to do was look around and you could see what his plan had done. Then there were minor details like Afghanistan and Iraq; in the former, we had secured an area 20 miles around Kabul and essentially turning over the rest to warlords, thugs, kleptocrats and fanatics, and in the latter we had a quagmire. (In fairness, Iraq has since developed to the point where its more stable, having been essentially turned over to warlords, thugs, kleptocrats and fanatics, just about all of whom are on the US taxpayer’s payroll, and even most neighborhoods in Baghdad have been ethnically cleansed so the “need” for violence has diminished.)

What I don’t understand I’ve never understood why Bush was re-elected in 2004. Here is GW himself telling us what he was planning to do:

To create jobs, my plan will encourage investment and expansion by restraining federal spending, reducing regulation, and making the tax relief permanent.

How’s that reduced regulation working out in the financial sector these days?

And this promise has since gone by the wayside:

Thanks to our policies, homeownership in America is at an all-time high. (Applause.) Tonight we set a new goal: seven million more affordable homes in the next 10 years so more American families will be able to open the door and say: Welcome to my home.

There’s another success story.

But now my favorite line is this one:

I support welfare reform that strengthens family and requires work.

As it turns out, reform apparently meant putting all of Wall Street on what has gotta be the most generous welfare program in history.

But most of his speech is on the military, and how freedom is on the march. It all bears reading. And whether you voted for him or not, its worth asking yourself: how much of what came to pass should have been obvious from 2004.
by cactus

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Shorting state finances after being bailed…good for profits, but….???


Hat tip ataxingmatter for the link to this matter in Bloomberg:

Dec. 10 (Bloomberg) — Goldman Sachs Group Inc., one of the top five U.S. municipal bond underwriters, is angering politicians and public-finance officials in New Jersey, Wisconsin, California and Florida by recommending that investors purchase credit-default swaps to bet against 11 states’ debt.

In the three months since the New York-based securities firm recommended “shorting municipal credit,” the value of the Markit MCDX index of the derivatives’ price more than tripled, to as high as 278.33 basis points from 87.75. A basis point on a credit-default swap protecting $10 million of debt for five years is equivalent to $1,000 annually.

Bets against public debt, once unheard of on bonds considered safe enough for retirees, have soared as the National Conference of State Legislatures projects recession-fueled budget crises will cause $97 billion of shortfalls nationwide over the next 18 to 24 months.

It’s “disturbing” to advise investors to bet against the financial health of a state whose bonds Goldman helps sell, Assemblyman Gary S. Schaer, a Democrat who chairs the Financial Institutions and Insurance Committee, said last week in a letter to Chief Executive Officer Lloyd C. Blankfein.

“New Jersey needs to maximize its presence in the credit markets, not to see its presence undermined.” Schaer wrote.

Goldman responded on Dec. 5, said Andrew Schwab, a spokesman for Schaer. The assemblyman was discussing the firm’s letter with state Treasurer David Rousseau, he said. Michael DuVally, a Goldman spokesman, declined to comment.

‘A New Reality’

Short sellers borrow securities to sell, betting their value will decrease. Credit-default swaps, conceived to protect bondholders against default, pay a buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to debt agreements. They increase in value as perceptions of credit quality deteriorate.

“Shorting municipal bonds — the world is a new place,” said Patrick Born, chief financial officer for the city of Minneapolis. “There’s a new reality, at least for a while.”

The appreciation in municipal credit default swaps came as borrowing costs rose, with tax-exempt yields as measured by the Bond Buyer 20-bond index reaching 6.01 percent on Oct. 16, the highest since January, 2000. The index is now 5.58%.

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Barter part 1

sort of an op-ed by rdan

I have noticed from Yves Smith that the Baltic Dry Index is tanking*, and that letters of credit cost 3-4% to establish instead of the lower 1% or so. Trade has relied on ‘letters of credit’ to keep goods flowing. Correspondingly ‘sovereign bartering’ between governments is increasing as pricing becomes increasingly difficult due to the volatility and fears about once stable currencies.

*(Hat tip Naked Capitalism for Yves post on the Baltic Dry Index plunge and some connection to “Letters of credit” used in the banking system for centuries in order to maintain the flow of trade).

One impact of the at least perceived relative scarcity of rice (in nations whose populations that rely on rice for survival) is the ‘value’ of rice as a commodity appears to have risen to the level of ‘currency’, much as oil has done. Governments are by-passing currency considerations and swapping product in increasing quantity, especially commodities.

There is perhaps some threshold in quantity of such trade that will impact the ‘value’ of the US dollar as it is bypassed (and the sudden possible trillions of dollar influx of extra dollars even if re-couped over time) and possible hyper-inflation pushes the volatility further. Remember that $13 trillion is roughly the GDP of the US for the year, and dollars are being added as we speak…we are at 76% debt/GDP ratio approximately without considering state and local debt.

There is also an synopsis of an interesting book on all this….why and how.

Contracts in Trade and Transition: The Resurgence of Barter

“the authors find that counter-trade accounted for perhaps 10 percent of
total world trade in the mid-1980s and that barter deals accounted for approximately half of industrial sales in Russia and Ukraine in the late 1990s. The authors argue that the simultaneous existence of imperfect capital markets and problematic contract
enforcement create conditions in which a non-monetized transaction is Pareto improving relative to the most likely alternative, which is no transaction at all. Central to their argument in explaining both counter-trade in the 1980s and barter in the 1990s is illiquidity. In theformer case, illiquidity came about through the debt crisis of the early 1980s. In the latter case, illiquidity exists in the FSU countries because the banking sector is reluctant to provide capital.”

“Thus the non-cash economy helps to maintain output that would otherwise
collapse due to imperfect input and credit

Some more: Iran and Thailand bartering. Iran is under an embargo so is not a typical example?

Philippine trading manager placing a barter/counter-purchase offer in an
Estonian trade site.

China and Russia have recently increased use of a barter system on some items for commodities and oil.

ASIAN commodity and currency markets could be plunged into chaos after Malaysia threatened to abandon standard trading in favour of a barter deal.

With Malaysia struggling to shelter its people from the steep rise in the cost of rice and desperate to expand its painfully diminished “buffer” stockpile, its Minister for Plantation Industries and Commodities said the country would swap palm oil for rice with any rice-producing nation willing to make the trade.

The highly unusual offer marks a significant “no confidence” vote in commodity markets by a country that owes more than a quarter of its GDP to exports of crude oil and palm oil.

“Thailand is our main supplier of rice, but we are ready to offer palm oil to any exporting country that is ready to give us rice of suitable quality,” Peter Chin said.

Recent volatility in food prices and the emergence of rice as an asset – now thought by some to be on a strategic par with crude oil – have shaken many countries’ faith in the ability of global markets to price food properly.

Several large rice producers have curbed exports for the sake of domestic calm, and various barter deals are thought to have been struck behind the scenes. None has been as open as Malaysia’s offer, which could be imitated.

The barter makes some sense because Malaysia is a leading world producer of palm oil and is reliant on imports for about a third of its annual rice consumption. Palm oil prices have soared amid increased demand from China and India.

Commodities experts fear that similar deals would be unsettling to orderly markets if other raw materials, such as rubber or rare metals, even energy, were moved around in a series of large off-market deals with no formal pricing.

Commodity traders in Tokyo said that Malaysia’s decision to barter was a clear sign that food as an asset class was in crisis.

Kenji Kobayashi, a commodities analyst at Kanetsu Asset Management, said: “What is worrying is that these barter deals, which should only be for truly terrible situations like the Iraq oil-for-food program, are going to increase in size and number from here.

“We are now seeing all the hidden mistrust in the markets being expressed through barter.”

Stormy asks:

This post raises an interesting idea:

What happens in a world where the actual value placed on the monetary unit suddenly no longer corresponds with the actual goods?

Not sure that makes sense. Try it this way. The dollar is high in part because of the world’s debt must be paid in dollars. The world’s currency (the dollar) is seriously out of whack. Actual asset value is plummeting-that is what is happening with other commodities, oil, for example. Oil producers will eventually have a
problem: They will not be able to produce oil at cost! Why? In part because of the strong dollar…which is the exchange currency. In part because production costs are measured in dollars-Are the actual field workers going to lower there salaries? Are those who supply the machinery going to lower their costs in dollars?

The barter system begins to come into play. I need oil…you need rice
just as bad. Ok…let’s trade. Forget about dollars.

No expert here – but until debt in dollars has been wrung out of
the system-and the dollar crashes (it will)-and some other kind of unit of
exchange arises, we are in trouble.

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The Alpha and the Omega of mid-2007

Sometimes, Blog Posts Write Themselves: Cleaning up a hard drive of old files, I ran across these two articles from the middle of last year.

First, the WSJ, arbiter of business sanity and purveyor of a positive meme whenever one is to be found, on 28 July 2007—nine months after the general supply of securitizable mortgage loans went away, at least six months after even those with their own origination capacity realised the game was over, and about two weeks before Bear Stearns would issue bonds at the then-junk-bond-area yield of 245 over:

The economy grew at an annual rate of 3.4% in the quarter, reversing the anemic 0.6% growth in the first quarter, the Commerce Department said. Increases in exports and government spending drove much of the improvement. A rise in commercial construction spending and building of inventories offset a drag from housing and sluggish consumer spending.

But the positive drivers aren’t expected to persist, and recent indicators cast a darkening shadow over the rest of the year. The latest readings for spending on plant and equipment, which grew at a tepid 2.3% pace in the quarter, are disappointing. Rising inventories of unsold homes, falling prices and tighter lending terms on subprime loans for marginal borrowers offer little hope that housing is stabilizing. The downturn in stocks crimps Americans’ wealth, and turbulence in credit markets is sparking fears that loans will be costlier or harder to get….

Some business executives expect things to get worse. “This idea that there’s been no spillover from housing into other segments is just faulty,” Mike Jackson, chief executive of auto dealer AutoNation Inc., said in a conference call. “I think it’s extreme economic distress out there right now. It’s one of the toughest environments I’ve ever seen since I’ve been in the business.”…

Some forecasters say the gloom is overdone. As long as businesses continue to hire, the jobless rate remains near its current low 4.5% and energy prices don’t go higher, they say overall consumer incomes should be strong enough to support a healthy level of consumer spending. In a favorable sign, the University of Michigan said Friday its consumer confidence index rose to 90.4 in July from 85.3 in June.

Corporate earnings outside of financial services remain robust, although companies have been worrying for months about higher input costs crimping profit margins. “The real risk for consumer spending is if for some reason companies slam on the brakes and stop hiring,” said Brian Bethune, an economist at Global Insight. “The employment market is still reasonably solid.”…

“The big picture is that you’ve got an inventory problem in both markets — you’ve got too many homes for sale and too many bonds for sale,” says Mr. Kiesel. “So prices need to adjust: You need lower house prices and much bigger credit spreads. It means the economy is going to slow.”

Downward revisions to growth from the first quarter of 2004 through the first quarter of 2007 added to concerns because they offer more evidence that the pace of productivity growth has slowed, and with it estimates of the speed at which the economy can grow without higher inflation. Economists at Bear Stearns, for instance, said that estimates of the economy’s potential growth rate are likely to fall below 2.5% a year.

Let’s ignore for the moment the delusion that it was All About Subprime—even though some idiot on CBC was making exactly that claim Friday, trying to explain Why Canada is Different. (I’ll take Stephen Gordon’s analysis, instead.) This is an attempt at being positive: in the wake of an annualized 3.4% growth rate, that should have been much easier. But the harbingers had landed by then.

Next, the guy who keeps getting slammed in comments here and elsewhere, often for no good reason (or, in the case of Stanley Fish, in the throes of full hypocrisy). Larry Summers about a month later, 27 August 2007, in the LA Times. First, he gives the lie to the “once a century” meme:

Over the last two decades, major financial disruptions have taken place roughly every three years — the 1987 stock market crash, the savings and loan collapse and credit crunch of the early 1990s, the 1994 Mexican peso devaluation, the Asian financial crises of 1997, the Russian default and Long Term Capital Management implosion of 1998, the bursting of the technology bubble in 2000, the disruptions of 9/11 and the 2002 post-Enron deflationary scare in the credit markets.

This record suggests that, by the beginning of 2007, the world was long overdue for a major financial disruption. And sure enough, the difficulties around sub-prime mortgages “went systemic” in the last month as the market seemed to doubt the creditworthiness of even the strongest institutions and rushed to buy Treasury debt.

Soon, he gets to the heart of the matter:

[A]s investors rush for the exits, the focus of risk analysis shifts from fundamentals to investor behavior. As some liquidate, prices fall, then others are forced to liquidate, driving prices down further. The anticipation of cascading liquidation leads to still more liquidation, creating price movements that seemed inconceivable only a few weeks before. Reduced credit feeds back negatively on the real economy.

Eventually — sometimes in a few months, as in the U.S. in 1987 and 1998; sometimes in a decade, as in Japan during the 1990s — there is enough liquidation and price adjustment to make extraordinary fear give way to ordinary greed, and the process of repair begins.

It is too soon to draw policy lessons from the current crisis or to determine exactly where in the cycle we are now. But it is not too soon to highlight the questions it points up. Three stand out.

From that point on, the article goes downhill:

First, the current crisis has been propelled by a loss of confidence in rating agencies, as large amounts of debt that had been very highly rated has instead headed toward default….But there is no doubt that, as in previous financial crises, the rating agencies have dropped the ball.

In light of this, should bank capital standards, Federal Reserve discounting policy and countless investment guidelines still be based on credit ratings? What is the alternative? What if any legislative response is appropriate?

It seems more likely to assume that rating agencies are lagging, not leading, indicators of credit crises, as investment products develop based on iterative variations of current products, whose risk profile is therefore (definitionally) somewhat less well defined, and (again definitionally) are likely to have thicker tails that will not be captured by standard modeling. (See Robert’s discussion here.)

Summers continues:

Second, how should policy respond to financial crises centered on nonfinancial institutions? A premise of our system is that banks accept much closer supervision from public authorities in return for privileged access to the Federal Reserve payments system and its “discount window,” which allows banks to borrow directly from the Federal Reserve. The problem this time is not that banks lack capital. It’s that the solvency of a range of non-banks is in question because of cascading liquidations and doubts about their fundamentals. In an old-fashioned phrase, central banks that seek to instill financial confidence by lending to banks or even by reducing their cost of borrowing may well be pushing on a string.

With the admission of insolvency of the financial institutions still at least six months away, Summers was already discussing the limits of liquidity provision.

His third point is only slightly less prescient:

Third, what is the right public role in supporting credit to the housing sector? The lesson learned from the S&L debacle was that it is catastrophic to finance home ownership through insured institutions that borrow short term and then offer long-term fixed-rate mortgages. Now a system reliant on adjustable-rate mortgages and non-insured institutions has broken down.

I might argue Summers took the wrong lesson from the S&L crisis, which grew in large part from primarily Texas-based S&Ls that loaned large amounts of money based on the idea that some barren desert land was valuable because it had oil under it. It does not seem coincident that the first wave of housing market collapses (ca. mid-to-late 2006) were all in similarly-desert areas—Phoenix, Lost Wages, the tracts of land near I-5 between LA and SF. But at least he knew what not to do:

[I]f there is ever a moment when [Fannie and Freddie] should expand their activities, it is now, when mortgage liquidity is drying up. No doubt, credit standards in the sub-prime market were way too low for way too long. But now, as borrowers face the reset of adjustable mortgages, it is not the time for authorities to get religion and encourage the denial of credit.

The next time someone tells you that “no one predicted” this phase of the current crisis, point them to Larry Summers fifteen months ago. Or even, in broad outline, the WSJ.

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