Friday, September 19, 2008

Week Round Up - Financial Crisis

This week I for the first time got a little passionate about policy. In these posts,
1. The Depression in the Financial Markets – The Solution is Wage Inflation via Tax Policy
2. More on the Financial Crisis
My approach is to actually look at the root of the financial problems. Look beyond deregulation and the need for more liquidity to why are people defaulting on their mortgages.

What the government has done is protect money market mutual funds which is absolutely essential to assure that these safe havens are sustained. These are funds that many companies use to hold cash that ultimately is needed to make payroll. But this is only an emergency measure. The root causes are not yet being deeply and honestly discussed.

Here is a fact -

The pricier loans in the jumbo category racked up delinquency rates that are more than triple what they were just a year ago, and those overdue payment statistics may quadruple before the end of 2008. - Sept 2, 2008

Jumbo prime mortgages are foreclosing. The definition of a jumbo is a loan that is beyond the limits for Fannie Mae and Freddie Mac (which is $417,000). The real reason the mortgages that are failing are jumbos is because jumbo loans are needed to buy houses in the market since the housing boom of 2002-2006. But nonetheless, the people failing these types of mortgages are prime borrowers.

Also what is happening is that due to inflation MANY people are forced to take out HELOCs to pay the bills. This puts the first mortgage at risk. All this comes back to wages and inflation.

Everyone normally looks at the "the mortgage crisis" but seemingly ignores at least one side of the mortgage problem: low wages with respect to inflation and the middle class squeeze. Everyone seems to think the only problem with the low value of mortgage backed securities is the sub-prime problem, but this is not the source. These fire-priced mortgages that Lehman owned were not sub-prime but "alt-A" and "prime Jumbos". What happened is that these specific types of securities were being downgraded from the "AAA" rating. This downgrade forces money market mutual funds to sell as these funds are required to only hold "AAA" assets.

Why are alt-A graded loans failing? An alt-A is really a loan to a person with a credit score of 580-680 (below 580 is sub-prime)? It has to be because these people's wages didn't grow as expected in a normal cycle. The current statistics are worse than normal. Folks, this has to be wages.

I still hold to wages and inflation being at the root of the problem. The thing to look out for in the policy of a given candidate is what policies will be put in place to deal with the following:
1. Out-sourcing
2. Middle class tax cuts
3. Alternative ways to incentivize wage growth


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