10/13/08 – Stan Liebowitz – The Scott Horton Show

All right, y'all, welcome back to Antiwar Radio.
It's Chaos 92.7 in Austin, Texas.
We're streaming live worldwide on the Internet at chaosradioaustin.org and antiwar.com slash radio.
Our next guest is Stan Lebowitz from the Independent Institute.
He's a professor at the University of Texas at Dallas, a managerial economics.
And, oh, he's got a new book coming out.
The Independent Institute book coming out includes this essay.
The book is called Housing America, Building Out of a Crisis.
And the article is available in PDF format at the Independent Institute's website, Anatomy of a Trainwreck.
This is how we got into this mess with the housing bubble.
Stan Lebowitz, welcome to the show, sir.
Oh, thanks for having me.
Well, it's very good to have you here.
And I have to warn you, I'm coming at this topic from the point of view of a layman.
And not only do I not have your kind of economic expertise, I don't even have any money to buy a house and have my own experience in this kind of thing.
So at the same time, I think, I hope that's valuable for the audience who probably also aren't a bunch of economics experts either.
So I really like this article.
You really give a lot of context to how this mess was created in the subprime market, I guess, or not just the subprime market, but the entire housing market.
And I guess if you could just give us your fundamentals, ABC, on how we got this giant bubble, and then I'll try to ask the best follow-ups I can.
Okay, it's sort of a long story, but I'll see if I can do it quickly.
Yeah, no problem.
Take your time if you want.
That's right.
Basically, the government, the federal government decided in the early 1990s that they needed to loosen up lending standards.
And the reason for doing that was to increase the loans that were going to poor and minority potential homeowners because they felt that they weren't getting enough mortgages enough.
They weren't getting into houses as frequently.
There was some data that was quite compelling that indicated that minorities were rejected far more frequently than whites were when they applied for a mortgage application.
Assuming that their incomes were about equal.
Well, even with their incomes equal, it was true that they still were rejected more.
But they didn't have equal credit histories, and they didn't have equal other economic characteristics, so that it wasn't clear just from that single statistic whether or not there was, say, discrimination going on against minorities or not.
Then the government at the Boston Fed in particular did a study where they claimed that they had demonstrated, because they had more information about the loan applicants that, in fact, minorities were discriminated against.
And they published a study.
The problem with that study turned out to be that they never looked at their data, and they had made hundreds of errors transcribing the data and writing the numbers down.
And all you had to do was look at the numbers for a few minutes to know that there were all sorts of errors.
And you mentioned in your article that at the time you and a partner went back and checked their mathematics when that report first came out and debunked it.
That's right.
But it didn't really matter.
The government had decided that the minute they announced it, the study had been done.
And, you know, it's like the next day they're quoting people high up in the government, all of whom are sort of saying this is the greatest study in the world, we finally know the truth.
And they even made the statement that we don't need any more studies to look at this.
And it was reading that at the Wall Street Journal and discussing it with a colleague of mine over lunch that we were, like, joking about the study that was so great that nobody ever needed to do another one.
That's not the way that I usually make progress in any sort of science, even social sciences.
I usually look for more people to do more work and find out whether or not the first study is actually right.
Okay, now we can see.
And they took the result and said, well, now we know the truth.
And they said, now we have a justification for going in and trying to alter the mortgages.
Right, now we could see how, you know, just from kind of a, you know, I don't know what to call it, urban myth point of view or whatever, general understanding kind of point of view, that, hey, that's probably true, right?
That blacks and whites with comparable income, comparable credit history, all things being equal, basically, that black people probably do get discriminated against.
It sounds plausible, right?
I mean, that's the history of this country.
Well, it sounds plausible.
If you actually go back to the context, there have been two or three years of very negative publicity where banks were shown to have a higher rejection rate for minorities.
They've gotten lots of bad publicity.
There were lawsuits.
And remember, banks are regulated.
They're highly regulated by the government.
And they really just want to do their business.
And this is the case where if they discriminate against the applicant, they lose money.
In some instances, lots of people engage in discrimination, but there's no financial penalty in doing that.
Here, the bank is just going to give the mortgage or not, and then it's sort of out of their hands to some extent.
And they were starting to use credit scoring software at this point, and the people making the decision never even saw the applicant.
So it would be unclear that you'd really expect that there'd be discrimination.
There'd be discrimination all over the place in other aspects.
But at this point in the mortgage world, you wouldn't expect banks to be engaging in discrimination that they knew about.
And we're talking about large firms here in many cases, big banks that really wouldn't want that type of publicity getting out would do what they could to try to remove any discrimination if they knew it existed.
Okay, so then basically what happened was they had to rewrite the rules in order to accomplish all these social goals.
Well, that's right.
The banks were trying to figure out how could – they were under a lot of pressure to increase loans to people in those neighborhoods that had lots of minority and poor people.
And they couldn't do it with the normal underwriting standards.
They just – they wouldn't find enough people who qualified.
So discrimination or not, even if you got rid of discrimination, it still wouldn't take care of it.
So they needed to weaken the lending standards.
And the government helped them with that by coming out with a little booklet explaining how you can make loans to poor people and the will to actually qualify.
And the way to go about doing that is to not have very strict underwriting standards.
Essentially throw out the old manual and come in with a new playbook.
And the old manual said if you didn't put 20% down, you had to pay mortgage insurance.
And you wouldn't get the loan if the monthly payments were more than 28 or 36% of your income, depending on whether we're including all your loans or just the mortgage loan and a bunch of other conditions, whether or not you had a good credit history.
And this manual sort of said, well, you don't really need a credit history.
That really doesn't count.
Maybe you pay everything by cash, and therefore you don't have any real credit history.
And maybe this and maybe that.
And they wound up coming up with explanations for why these mortgage standards should be weakened.
And then there was a big push in 94 where a bunch of the government agencies, HUD and Fannie Mae and Freddie Mac, which were quasi-government agencies, and the Federal Reserve and a few others all got together and said, yeah, they were going to do what they could to increase homeownership.
And a lot of it was supposed to come at the people who were going to be entering the homeownership market were going to be poor and minority.
And it was successful.
They increased homeownership starting in 1995, and it went up for 10 years in a row.
And that was after 25 years of essentially having no growth in homeownership.
So they achieved what they intended to achieve.
But their main method of doing that was to weaken the underwriting standards on mortgages.
And they kept repeating over and over again, you don't need those old underwriting standards.
The new easy ones will work just as well.
And there were two problems that arose.
One was that if you wanted to see, okay, are they correct?
Are the new standards okay?
If you actually looked at the defaults, it seemed like they were right, that the defaults were holding up.
The problem was that they weren't getting a good measurement of the defaults because they had started a housing bubble.
Now, the simplest economics is supply and demand, which is what you learn in your first course.
And supply and demand basically says if you increase demand for a product, you wind up increasing the price.
When you have a lot more people who can qualify for mortgages than you did in the previous regime of underwriting, you have an increase in demand for housing, and that raises the price of housing.
So in 95 is when you start having this increased ownership rate.
And it's a big increase.
It doesn't sound that big.
They went from 64% to 69% ownership of houses by household.
But households normally increase about 1% growth a year.
We get about a million new households every year.
There's about 100 million households.
During this period of time where all of a sudden you had this increase in homeownership, you had an extra 500,000 people every year who were able to qualify for a home.
So that was like a 50% increase in the number of new people entering the market to buy a home.
So you have to understand in the context, that's a very big increase.
And so people who were creating new homes found that there was a big sudden demand for more new homes.
And so that winds up increasing the price.
And that's the beginning of the housing bubble, which starts in about 1997, just a year or so after the increase in homeownership starts.
And it continues through to 2006.
And then like you say, for the people who are going bankrupt all this time, rather than defaulting on their mortgages all this time, because of the bubble, pretty much anybody, no matter how far behind they get, they can still turn around and sell their house for a profit and get out and go rent somewhere or something.
So the numbers of defaults were way down this whole time.
That's right.
Which was giving false signals.
Even at record low numbers in many cases during this period, even when they were weakening the lending standard.
And the reason was pretty simple.
Now, it wasn't true everywhere.
We're in Texas.
We didn't have a big housing price increase here.
So that in some parts of the country, they didn't have that benefit and defaults didn't go down.
But the places which had the lowest default rates were like Las Vegas and California, the places that were having the biggest house appreciation.
Right.
And they had such low default rates because nobody ever needed to default.
If you couldn't pay your mortgage, and I'm sure there were plenty of people there who really couldn't pay their mortgage because they had all these weak lending standards, you just go refinance it.
Or you sell it and you take the profit.
But you never have to get foreclosed because the house keeps going up in price, and it's a moneymaker for you.
So the places that had the really big increase in housing prices have low defaults.
And the people, then in the late 90s, they started to sell it in the secondary market, the private secondary market.
And the sales pitches, which I give in the paper.
I give you one of the sales pitches from Bear Stearns, one of the companies that's no longer with us.
They talked about why people should invest in these mortgages, which had these weak reduced lending standards.
And they basically repeated what the Boston Fed said, that you don't need strong lending standards.
The old ones were obsolete, and these were perfectly safe.
And they convinced both the rating agencies, which is the really sad part.
The rating agency should have been smart enough to know that you can't get a good reading during a housing bubble on what the impact is going to be of changing lending standards.
And they had no real history.
Until 1998, there was no private market, no big private market for these types of mortgages with reduced lending standards.
So they should have said, we can't rate them, we don't have any experience.
But instead they said, well, they seem to be holding up okay after the first couple years, so they gave them a good rating.
But now people buy them like crazy in terms of holding these mortgage-backed securities.
And the market just sort of keeps going and gets bigger and bigger until it stops.
In the second quarter of 2006, the housing prices stopped going up.
And now you say in the article that basically the foreclosures are happening not just to the variable rate mortgages, but also to the fixed rate mortgages.
No, not just to the subprime, but to the prime.
Oh, yeah, okay.
I'm sorry.
I got it backwards there.
Setting it straight on what I'm talking about.
Both of them went up at the same time to the same extent.
In fact, there was a slightly bigger increase in default percentage increase among the prime mortgages than the subprime.
And what you do find is starting in the next quarter after the housing prices stopped going up, in the third quarter of 2006, that's when foreclosures start going up.
And it's both primes and subprimes together.
But if you take a look carefully at the primes and the subprimes, both of them have both adjustable and fixed rate mortgages.
And for both of those markets, the adjustable rate mortgages are the ones where the foreclosures go up.
And the fixed rate mortgages, whether they're prime or subprime, have very low, comparatively low increases in foreclosures.
Okay.
Well, yeah, I was conflating all those terms together then.
So what is a subprime loan if it's not a variable rate one?
A subprime loan is just a loan that goes to somebody who doesn't have very good qualifications.
Okay.
But they could still get a fixed rate.
And higher interest rate.
Okay.
But it doesn't mean that it has to be adjustable.
It can be fixed or adjustable.
Right.
And the same thing with prime.
You could have sterling credit history and sterling other economic characteristics, in which case you get a low interest rate, and it's a prime.
And then you have a choice of whether you want the adjustable or the fixed.
And the reason people will pick adjustable is that adjustables always have lower rates than the fixed.
And so for any moment in time when you get a mortgage, if you want to pay the lowest rate right now, you get an adjustable.
The risk of an adjustable is that maybe it will go up sometime in the future.
And the person who gets the fixed rate loan knows that they won't have to pay any more than they're currently paying because that rate is fixed.
But the person with the adjustable, when it adjusts, which might be one or two or three or five or seven years out, it might go higher.
Now, of course, it might also go lower, but it might go higher, and that's the risk you take.
And so when people buy a house, they have to decide which type of mortgage they want.
Now, you say during all this boom time that up to a quarter of houses were just speculators buying and selling flipping houses like on TV?
Yeah, when they asked people why they were buying the house.
Now, this was not a mortgage question, but they would ask people, they would do surveys separately.
Not the bank, but other people.
Mortgage Banking Association did these surveys of homebuyers and said how many of these are speculative, and 25 percent of the homes that were being bought in the last few years were speculative.
Now, how out of whack is that to the regular free market, all things being equal, you think?
Well, it's hard to get good statistics going backwards, but it's certainly higher than it used to be.
I can't tell you exactly how much higher, but I'm quite sure it's considerably higher than it used to be.
Because it was a bubble, and the thing about bubbles is that they're always being pushed by speculators at the end.
That's sort of what makes them a bubble.
So part of the increase in prices of houses came from the increase in demand from the new people entering the market, but part of it also came after the prices started going up for a while from people who were speculating because they found out they could make money on houses and didn't have to put anything down.
So it turned out to be a terrific investment for people who would buy a house with almost no money down, and then flip it a few months later, and it's called leverage when you don't put much down and you get a lot out.
It turns out to be a terrific investment.
There is a measure.
There's two measures of speculation.
One was the survey that they do.
The other one doesn't give you numbers that are quite as high, but it's the number of people buying houses who don't plan to live there.
Because if you don't plan to live there, it's either a vacation home, and there's some small number of those, or it's a speculative home.
And it turns out most of the homes that people were buying that they weren't planning to live in were actually in poorer neighborhoods, so they were unlikely to be vacation homes.
And so in the poor neighborhoods, you ran about 20% of the homes that didn't have the owner living in them.
In the wealthier neighborhoods, you had about 10% of the homes.
So you had considerable difference between the poor neighborhoods and the wealthy neighborhoods in terms of how many of those homes looked like they were speculative on that basis.
So there are people who are speculating who would claim to be living in a house even though they weren't going to, because you can often get a slightly lower interest rate if you do that.
And that's why it's probably an underestimate of the actual amount of speculation to take a look at the mortgage application and the people who admit that they're not planning to live in that house.
So there was plenty of speculation going on.
The reason why that becomes so important is that you have to ask yourself, we know that the foreclosures are occurring at a much higher rate for the adjustable-rate mortgages, that the fixed-rate mortgages are not being foreclosed, but the adjustables are.
And so what could explain that?
There are two possible explanations.
Because it's an adjustable-rate mortgage, it's possible that interest rates went up, and they went up so much that when they refinanced the house, when it came up again for the adjustment, it was much higher and they couldn't afford that higher amount, and that was the reason for the foreclosures.
And some of the foreclosures may be due to that.
But when I looked at the numbers, it appeared that it was likely to be only a relatively small percentage for two reasons.
One is that there was an increase in interest rates over the last few years, but there had been another increase in interest rates from 1999 to 2001 that wasn't quite as big as the one we have now, but was, you know, a half or two-thirds of the size.
And so I went and took a look to see what happened to foreclosures after that increase in interest rates, and the answers were they hardly really increased at all, even if you look just at the adjustable-rate mortgages.
So therefore, based on that past experience, it's unlikely that we would have the type of increase in foreclosures that we've had.
We have some, but not anything severe from the interest rate increase that's occurred over the last few years.
But probably the more important element, again, is the timing.
You can pinpoint exactly when the foreclosures started increasing, because they're sort of sitting there, and they're going up and down a little bit, and then they just start shooting up like a rocket.
And they start shooting up like a rocket in the third quarter of 2006.
Well, there's nothing that happens with interest rates right around there that would suddenly cause mortgages to just suddenly start foreclosing like crazy because of some change in interest rates.
So that just doesn't seem like it's going to be able to explain it.
But there is something else that goes on that would explain why these foreclosures start jumping so rapidly in the third quarter of 2006, and that is the speculators are going to buy adjustable-rate mortgages.
It's not the mortgage itself, it's the people who are attracted to the mortgages.
If you're planning to own a home for a relatively short period of time, one year or two years or six months, and turn around to make a profit, you're going to want an adjustable-rate mortgage because they always have lower interest rates.
And you want to pay as low a rate as possible, and you don't care if it's going to go up.
Let's say you get a lot of these are three-year resets.
So it stays constant for three years, and then after three years, it resets to a higher rate.
Well, you can buy one of those.
You get one of those mortgages.
You pay the lowest rate you're going to get for those three years, and you're going to be out of that house by three years.
That's your expectation.
So those people, the people who don't plan to be in a house very long, are going to always get the adjustable if they're planning to speculate and not get the fixed.
And so the speculators should basically be drawn to the adjustables, and that's where you should see the speculators being mainly focused.
And they should prefer the prime adjustables to the subprime because those interest rates are even lower.
But if they don't qualify for a prime adjustable, then they'll go to the subprime adjustable.
So that's where the speculators are going to be housed.
The second quarter of 2006 is when housing prices stop going up.
And then in the third quarter of 2006 is when you see this spike, this sudden spike in foreclosures.
The story that fits that the best is the speculators realize there's no money to be made.
Housing prices aren't going up anymore.
And then in successive quarters, the price keeps dropping further and further, and they start running for the door because they don't want to stay in those houses.
They don't want to keep owning those houses, even if they're renting them out.
They want to get out because there's no money.
There's no future there.
And they're the ones who probably are causing, this is my hypothesis at least, the big increase in foreclosures.
That fits the timing, not the interest rate.
Okay, well, now this whole thing sort of sounds like the Congress is somewhat responsible for this, and at the root of that are community activist types on behalf of the poor.
But, of course, we're talking about home builders, giant home builder corporations, giant banks who also have political influence.
And what role does the Fed's set interest rate play in this?
And the reserve ratio was actually heard not too long ago.
And this is one that seems like this would be the headline, but I've never heard anybody talk about this except my one source, which is mostly just hearsay.
Maybe you can confirm this for me, that they slashed the reserve ratio from 12 to 1 to 40 to 1.
The SEC did.
The Securities and Exchange Commission said you can loan out $40 for everyone in reserve.
No, no, that's not.
I think that I understand what they may have been trying to say to you.
But, no, the Fed didn't change the reserve ratio like that.
What has happened is that we've had a growth in certain sectors of the financial world that are less heavily regulated.
So the difference between a commercial bank and an investment bank is that the investment bank, of which there really aren't any more, but, you know, they've all sort of got under or converted to commercial banks in the last few months, the commercial banks are more heavily regulated.
The government does have this regulation that they can't lend out at a certain, there's only a certain limit, usually 10 to 1, on how much they can lend given their reserves.
However, investment banks were allowed to borrow at a higher ratio than that.
And then there are these businesses that are even less regulated than that, hedge funds and whatnot.
And they can basically go at virtually any level they want.
And it turns out a lot of these non-commercial banks, the investment banks and the hedge funds, are levered 30 to 1 or so.
And that magnifies the loss if any of their assets go down in value.
And so you have to remember the mortgage market is like the biggest market out there.
Homes are a giant percentage of people's total assets.
It's a $10 billion market overall, the housing market.
And the mortgage market.
And so a lot of them are sold in the secondary market, so there's a lot of secondary market securities out there.
And everyone's holding them.
And they're rated AAA, a lot of them.
And so they were considered to be very safe.
And then you have some of these financial organizations that are leveraged 30 to 1.
Well, it doesn't take a very big percentage decline in those assets if they have enough of them.
If you're leveraged 30 to 1, they'll sort of bankrupt you.
And so the leverage has magnified this for certain of the financial institutions.
But with or without leverage, the foreclosures are three times, they're running right now, three times their old rate.
And that's a big increase.
And it is a big market.
So big losses were going to be showing up for somebody.
And it just happened to be magnified with these companies that were highly leveraged.
Well, now, what role does Freddie Mac or did Freddie Mac and Fannie Mae play in all this?
Because I guess the way I understand it is that the Congress mandates that these government-created banks lower their qualifications.
And then that sort of forces everybody else.
I remember hearing a guy on NPR or something talking about he was in selling mortgages and how every day almost it seemed like they had to lower their standards more and more and more just to keep up with everybody else, lowering their standards more and more and more or else they'd be out of business by the end of the day.
The competition was so fierce that that's where you get all these ninja loans and all this stuff where people just walk in and walk out of the house.
Yeah, well, I mean, the bigger problem of Fannie Mae, in my opinion, was in the 90s, because that's when they really started destroying the old standards.
And Fannie Mae was basically a pretty big supporter of weakening the lending standards.
And so it was writing these reports.
You've got to remember, information, what people think they know, is very important.
And so this story that these reduced lending standards were just as good as the old ones, if enough people believed it, you were going to get in trouble.
And Fannie Mae and Freddie Mac, particularly Fannie Mae, though, was a big pusher of that storyline, and kept claiming that it was true and that they did lower their standards.
But sometime in the late 90s or early 2000s, their standards were surpassed, if you will, by the private sector, which was buying mortgages at that point, and was willing to accept standards as low or lower than Fannie Mae.
But there was competition between them to see who could lower standards faster.
And the government agencies actually had some restrictions that hindered them, that they were trying to get rid of.
There are FHA loans, which are government loans that used to go largely to poor people.
And they were better loans for poor people in many ways, because they didn't have interest rates that were as high, and they had other conditions in the mortgage that was better.
But there was this limitation in the books for a long time, that they couldn't lend more than 97% of the value of the house, which meant that the homeowner had to come up with 3% down payment.
Now, remember, 20% is what the old number used to be for a lot of people making loans.
And so this was 3%, which in the early 90s would have been unbelievably lenient.
But that wasn't lenient enough.
And so the FHA was complaining that they were losing business.
And they were losing business, because the subprimes were taking zero, and they wanted to go down to zero too.
But they had to try to get their regulations altered to allow them to go to zero.
So they're fighting to see who could get to the bottom faster.
Most of the increase in subprime wound up coming from FHA loans.
They had a fairly big decline in their loans, and the people went to subprime, because the subprime would allow them to get them with zero down, and the FHA was requiring three.
But even three is pretty low.
Plus, one of the other changes that had been brought about is, it used to be back in the good old days, in the early 90s, that when you had a down payment of, let's say, 3%, which used to be higher than that in those days, you had to come up with it yourself, basically.
There were certain types of money that you couldn't count as a down payment.
Well, that was one of the things that they changed when they relaxed the lending rules.
And so it then became acceptable to take a charitable contribution from the builder and use that as a down payment.
And so what builders would routinely do is raise up the price of the house by 3% and give you 3% down as a down payment, which you could then go if you were getting a loan with a 3% down payment.
And that was basically, I don't know if you've ever seen The Soprano, but they had several episodes that were talking about stuff that were not that different to this.
Oh, right, where Carmela's doing her spec house and leaning on it.
No, not Carmela.
It's when Tony's buying these houses in Newark.
Oh, right, right.
And they get no special deal.
Yeah, yeah, that's right, FHA loans.
There's some government official, some black community activist who sort of sold out, who's sort of a friend of the local politician from Newark.
And they're buying these houses, which are pieces of garbage, and then they're getting them appraised at this high price, and it's all through some government agency.
And that's the type of thing that was being allowed.
It's not quite the same, obviously.
But when they sort of let the builder give the money to a If the builder wouldn't just give it to you, it had to be a charitable contribution.
So the builder would give it to the community organization, and the community organization would then give the 3% gift to the home buyer, who would then give it back to the builder as a down payment.
Right.
What a scam.
All right, now, well, I want to ask you a couple of things here, and we've got, let's see, I guess about eight minutes left, and I'm sure these will both require quite a bit of explanation.
But first of all, I want you to please address, if you could, the idea of the moral hazard and the confidence of people like, say, I don't know, the board of directors over at Lehman Brothers, that no matter how bad they screw up, the government will come and save them.
Of course, it didn't work out so well for them, but it has worked out for Goldman Sachs by way of the AIG bailout.
And then also I was wondering if you could get into what precipitated that AIG bailout and the credit default swaps and all the bundling of these mortgages.
But I can give you the basics of some of it.
Okay, this idea of moral hazard is the way our economy works, the way it's supposed to work, is that the people who make good products do well, companies, and consumers get to pick what they want, and the people who make bad products wind up going out of business, and that's what weeds out the good from the bad.
And that works in most markets.
What you don't want is people who make bad products or consumers who do sort of a crummy job getting access to more assets and being allowed to do that more in the future.
The problem that you have is we're talking about bailout of some sort or another.
We were at least a few weeks ago.
We're doing a little better now.
We're talking about injections, which are temporary, which are not quite the same as a bailout.
But if they bail out the people that did the investing, then investors in the future, and these are the people who bought the mortgages, won't have any incentive to be any more careful than those previous investors were, and you want them to be careful.
And the way to give the investors an incentive to be careful is to say, hey, you don't do a careful job, you're going to lose your money, and now you've been taught a good lesson, and so you'll be more careful next time.
Same thing with the homeowners.
If they lose money because they're foreclosed and they wind up having to rent or something, it's so to say, well, don't get a mortgage that you know you can't afford and where you're making up all these stories about what your income is, and there's a penalty in doing that.
If you say to someone whose house has gone down 15% and they can't afford to keep it up, we're going to bail you out, then they say, great, I'll just keep buying these houses and I don't need to tell you what my real income is if you're going to let me get away with it, and I don't have to worry about whether I can really make the payments or not because you're going to keep bailing us out.
So you want people who are involved in the market to suffer the penalty of their bad decisions to help induce them not to make bad decisions in the future.
Now, that's the way it's sort of supposed to be.
We're in a financial position now as a country because banks are afraid to basically lend money to one another and that they're sort of keeping it in their mattress, so to speak.
That could cause very serious problems for the whole economy, so we need to fix that.
If it turned out that the only way to keep the whole economy from going off the track was to bail out somebody who you would rather not, but that that's the only way to do it, well, then you better bail them out, even if it creates a moral hazard because you don't want the economy to go completely off the track.
But if the economy won't go completely off the track, it will just be some sort of normal recession.
Then take the recession and don't bail the people out because you'll cause bigger problems in the future when people keep expecting the government to bail them out.
So, for example, no one's talking about bailing out the stock owners who've lost $4, $5, $6 trillion in the last nine months in the stock market.
And we don't talk about it because we all know that they took those risks and they knew what they were doing.
And we don't want them to think that they can buy stock and not potentially take a loss.
And there's no reason to think people who buy houses should be treated any different than that.
It's a big investment, and just the fact that the price goes down for the house is no reason that you can't continue to pay that house mortgage off if you have the financial resources to do that.
But, sir, you think that it's necessary to provide all this liquidity to prevent a total breakdown?
I do.
I actually do think that there was a possibility of a total breakdown, and therefore it probably is necessary to provide this liquidity, and it may even create some moral hazard.
Providing direct liquidity, particularly if it's temporary, and particularly if you hurt the equity holders.
So some of the bailouts they had, quote-unquote, weren't really much in the way of bailouts.
So they helped engineer Countrywide being bought out by Bank of America, and they sort of engineered Bear Stearns being bought out.
But the owners of those companies got virtually zero.
So they were taught a lesson as owners of those companies, and hopefully the people running those companies were taught a lesson.
So that's the type of bailout that's not really a bailout.
You're not making the equity holders fall.
If they went into some of these companies and said, okay, we're taking care of all your bad assets.
They're not really suggesting doing this, but we're taking care of all your bad assets and buying them at book value.
Okay, then it would just be completely helping them out and taking all their losses off their hands, and that gives them a terrible incentive in the future.
We really don't want to do that if we don't have to.
And if you give the homeowners 100 percent value of their home, that's essentially doing the same thing.
The people who owe those mortgages are now made whole, and the homeowners are made whole, and neither one of them deserves to be made whole.
That's the John McCain proposal there.
Yes, and that was not a good idea, I don't think.
Well, and I guess it's way too late to get any kind of real detailed description about all these credit default swaps and things, but I guess is there truth to the rumors that there's trillions of dollars in these bogus investments that are still come due?
Well, no, no.
I mean, you've got to confuse them, but don't confuse the two.
There are trillions of dollars in credit default swaps, and the number I've heard is something like $40 trillion, which is way greater than the value of the assets that are underlying all of this, and that's because they're double and triple counting and stuff, and that's all got to do with the leverage and everything else.
The problem there mainly is that these credit default swaps are like little insurance policies, and you go to a company like AIG, which was fairly heavily involved in this swap, and you basically buy some insurance that says, I want to buy some insurance in case Bank of America goes bankrupt, and so I pay you some money, and they agree that if Bank of America goes bankrupt that AIG will pay you some money.
We've got 45 seconds.
The problem is it's not clear that the people selling that insurance have the resources to be able to cover, and that's why AIG has its financial problems.
It's promised to make good if companies go bankrupt.
Well, now they're going bankrupt, and they don't have enough money to pay off.
Regular insurance companies are regulated, and they have to have very careful and stringent conditions to try to make sure that they have the money to pay off, but these credit default swaps weren't required to have such stringent conditions, and they're not going to pay off on a lot of their insurance policies.
We've got to leave it there.
Thank you very much.
Okay.
Everybody, Stan J. Leibowitz from the University of Texas at Dallas and the Independent Institute Anatomy of a Train Wreck, Causes of the Mortgage Meltdown.
We'll be back here at 11 to 1 Texas time for Antiwar Radio.
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