Fortune Magazine) -- Sometimes it takes a near-death experience to change bad behavior. Think of your friend who quit Lucky Strikes after a coronary incident. Or look at how banks are reducing their dependency on debt after watching rivals go belly-up.
On Wall Street this process of reducing debt relative to equity is called deleveraging. Main Street should be deleveraging too.
Deleveraging is different for people than it is for companies, however. Big institutions are selling equity to pay down debt, but most individuals can do little if any of that. Their largest asset is probably their home, which they don't want to sell because they need a place to live, and in today's environment it may be worth less than the mortgage balance. So for most people the only way to pay down debt is to cut back on spending, or to use a quaintly antique term for it, be thrifty.
To realize how far we have gotten away from thrift, consider how those in the Greatest Generation financed the big purchases of their lives and how little cash the Facebook generation puts down for homes and cars or how comfortable they are with credit card debt. The present crisis could actually be the ideal moment to make thrift cool again, because debt has rarely been in worse repute.
Debt got us into this mess. Blaming the subprime lenders has become popular, and in some cases they were deceptive, but most borrowers knew perfectly well what they could afford. Millions joined in the debt mania, and now we're paying the price. Maybe American culture is ready to turn a corner.
It's an idea that's gaining momentum. The Thrift Project, a research effort by several think tanks, has produced a recent report ("For a New Thrift: Confronting the Debt Culture"), a book, and a traveling exhibit. Ronald T. Wilcox, a professor at the University of Virginia's Darden Business School, has written a book called Whatever Happened to Thrift?: Why Americans Don't Save and What to Do About It. The common message: America's debt addiction is seriously bad news for the country, and solving the problem requires action on many fronts.
The researchers of the Thrift Project believe we need to change our institutions. Most big banks are no longer very friendly toward small savers or even present in less than affluent neighborhoods. Meanwhile, state lotteries are depressingly effective at getting poor people to put their scarce dollars into essentially negative-interest "investments."
Wilcox believes we can use the findings of behavioral finance to entice people to save more - for example, by changing the default choice in 401(k) plans so that employees have to opt out rather than opt in. From that perspective, Barack Obama's proposal to let citizens break into their 401(k)s is a step in the wrong direction.
But it will take more than white papers and wonkery to change social norms. So what forces in today's society could be harnessed to make economizing admirable? A couple seem promising.
One is environmentalism: The mantra of "reduce, reuse, recycle" is a formula for saving money, while wasting resources not only is personally profligate but also harms everyone by hurting the planet. In Hollywood a Prius is far hipper than a Hummer.
Another force might be retirement anxiety: If you don't save enough to pay all your own bills, then you're forcing your kids and mine to pay them, and that's not right.
It's far from certain that focusing on any of this would work. The famous Harvard sociologist (and former Fortune staffer) Daniel Bell contended in The Cultural Contradictions of Capitalism that something like the current mess was predictable; capitalism depends on diligent hard work but also on the promotion of hedonism and self-gratification to keep people spending, which eventually must corrode the ethic of self-sacrifice. The story, he felt, cannot end happily.
I'm not ready to give up on thrift just yet, because I suspect Americans are finally ready to embrace thrift today for a better tomorrow. If we do, and even if that causes a temporary hit to economic growth, I'm certain that we will be happier, saner, calmer, and ultimately much better off
By Geoff Colvin, senior editor at large
Showing posts with label economy. Show all posts
Showing posts with label economy. Show all posts
Thursday, October 30, 2008
Tuesday, October 14, 2008
How to Survive the next depression
How to survive the next depression
Whether the sky is falling or not, times definitely will be tougher, and you can't count on anyone to bail you out. It's time to be a grown-up.
By Liz Pulliam Weston
Let me make it clear at the start: I don't think we're headed for another Great Depression.
Many of you disagree. More than half the people polled in a recent CNN survey believe an economic depression is either very likely (21%) or somewhat likely (38%).
I do believe that a recession is probable, that it may be severe and that many people will lose their jobs in the coming months.
But I don't think we'll return to a time when:
The official unemployment rate was 25%, with many more people who either gave up looking for work or who involuntarily worked part time.
Bank failures wiped out the life savings of millions of customers.
One-third of the nation was, as President Franklin D. Roosevelt famously put it in his 1937 inaugural address, "ill-housed, ill-clad, ill-nourished."
This 12-year period of economic disruption and widespread poverty was unprecedented in our nation's history. From it sprang many of the safety nets -- including Federal Deposit Insurance Corp. coverage, Social Security, unemployment insurance and food stamps -- that, though overburdened now, will continue to keep our most vulnerable citizens from falling into the destitution that characterized the Great Depression.
Still, I think we're in for a rough ride. And the smart steps to take now are virtually the same whether you think what's coming is a run-of-the-mill downturn or a once-in-a-lifetime cataclysm.
Such as:
Implement your austerity budget Pretend you just lost your job. Whatever expenses you'd cut in that situation, cut them now and use the savings to build up your emergency fund and pay off your toxic debt, such as credit cards.
"If you'd shut off the cable (after losing your job), shut it off now," says Sheryl Garrett, founder of the Garrett Planning Network, which represents fee-only financial planners who charge by the hour. "Only spend money on essentials."
If you need some inspiration, check out "Could you stop spending for a month?" Many people find they can save hundreds of dollars a month just by changing their food purchases: eating at home instead of dining out, cooking more meatless meals, reusing leftovers and shopping with coupons.
Erase that toxic debt You know you should have done it long ago. Credit card debt is expensive and leaves you vulnerable to the ever-changing whims of credit card companies, which have been raising interest rates with abandon.
Now, though, shedding credit card balances may be critical. If you still have a job, Garrett says, use it to pay off this cancerous debt.
"Go ahead and get serious about it. Be a grown-up," Garrett says. "Realize you aren't going to get bailed out by a 0% credit card offer or another mortgage refinance."
If you're seriously behind -- if you can't pay the minimums or if you're getting collection calls -- make appointments with a legitimate credit counselor and a bankruptcy attorney. Between the two, you'll learn your options for dealing with truly difficult debt.
Stock market historyDon't panic. Historical data show that, short of another Great Depression, investors who hold on for 5 years don't lose much money, even in a bear market, says MSN Money's Jim Jubak.
Keep your emergency exits open Once you've paid off the cards, don't close them. Not only can closing accounts hurt your credit scores -- which have become all-important lately for getting loans -- but you may need access to that credit in an emergency.
The same holds true for other lines of credit, including home-equity lines. If you've got access to those, try to keep them open and unused so they're available in case of emergency.
Try to stay employed No kidding, right? But here's exactly what that looks like: Volunteer for extra work, nab high-profile assignments, keep higher-ups apprised of your victories and value to the company.
Don't complain, and steer clear of people who do. And if you're on irredeemably rocky ground, tune up that resume now and start networking.
Pile up cash In bad times, cash is king. Your emergency savings will pay the bills if you lose your job and will generally help you sleep better at night. Set up automatic transfers into a high-yield, FDIC-insured savings account and add any windfalls you get along the way.
If you've been prepaying any low-rate, tax-deductible debt -- such as a mortgage or a federal student loan -- consider suspending those extra payments and putting the money into your savings instead to boost your financial flexibility.
Prepare for inflation The Federal Reserve and other central banks will flood our financial system with cash as they try to encourage lenders to lend. Once the economy starts to turn around, all that cash sloshing around in the system could spark inflation that might be tough to bring under control.
To protect clients, financial-planning firm Evensky & Katz of Coral Gables, Fla., has been adding TIPS (treasury income protected securities) to the fixed-income side of its portfolios, says Taylor Gang, the firm's vice president.
"We feel that the long-term risk is likely to be inflation," Gang said, "and we construct portfolios with this in mind."
But the firm isn't telling clients to abandon stocks. Far from it.
"Through exposure to equities, clients own securities that are likely to appreciate in value," Gang said, "and outpace inflation over time."
To repeat:
Stay invested in stocks This advice is hard for many people to stomach. They feel that if only they'd gotten out of the market weeks or months ago, they'd feel so much better now.
That's probably why so many are raiding their retirement funds, cashing them out or refusing to contribute. A recent AARP survey found that 20% of workers 45 or older had stopped contributing to their retirement funds in the past year and that 13% are tapping their accounts to pay day-to-day expenses.
These are exactly the wrong moves. While the current market turmoil may mean a delayed retirement for many people (see "How to retire in bad times"), failing to fund your retirement accounts could mean no retirement at all.
And the problem with getting out of the market is that you won't know when to get back in. Markets usually turn around well before the actual economy starts improving, and they typically advance so rapidly that people who aren't already invested miss most of the gains.
Besides, it's not like most of us need the money right now. Many of us have decades to go before we'll tap our retirement funds. These losses we're seeing are purely theoretical unless we act to make them real, by selling in a panic.
And if inflation does kick in, it will be even more important to have the inflation-beating returns that only stocks can provide. Furthermore:
Don't ignore your asset allocation It may feel like diversification hasn't worked, since all classes of U.S. and foreign stocks have taken it in the teeth lately. But this synchronized performance is temporary, says financial planner Ross Levin of Accredited Investors in Edina, Minn. Eventually, a rebound will begin, and some of the most-beaten-down sectors will bounce back the strongest.
"Rebalancing is critical during these periods," Levin recently told his clients in a quarterly newsletter. "By systematically rebalancing, you are forcing yourself to buy low."
Stock market historyDon't panic. Historical data show that, short of another Great Depression, investors who hold on for 5 years don't lose much money, even in a bear market, says MSN Money's Jim Jubak.
Learn some old-school skills Plant a garden. Plan your meals. Repair rather than toss. Barter or trade rather than buy. Throw a potluck.
You'll save money, help the planet and combat that feeling that you're the helpless pawn of economic forces greater than you.
Construct your Plan B If the bottom does drop out of our economy, you probably won't wind up on the street. Maybe you'd move in with your in-laws or rent out rooms in your home (as many previously affluent families did during the Depression). Honing your backup plan can be surprisingly therapeutic, particularly for people who tend to get all catastrophic. (For details, read "Is your money making you crazy?")
Instead of fearing the worst, in other words, you plan for it -- then hope to be surprised.
Whether the sky is falling or not, times definitely will be tougher, and you can't count on anyone to bail you out. It's time to be a grown-up.
By Liz Pulliam Weston
Let me make it clear at the start: I don't think we're headed for another Great Depression.
Many of you disagree. More than half the people polled in a recent CNN survey believe an economic depression is either very likely (21%) or somewhat likely (38%).
I do believe that a recession is probable, that it may be severe and that many people will lose their jobs in the coming months.
But I don't think we'll return to a time when:
The official unemployment rate was 25%, with many more people who either gave up looking for work or who involuntarily worked part time.
Bank failures wiped out the life savings of millions of customers.
One-third of the nation was, as President Franklin D. Roosevelt famously put it in his 1937 inaugural address, "ill-housed, ill-clad, ill-nourished."
This 12-year period of economic disruption and widespread poverty was unprecedented in our nation's history. From it sprang many of the safety nets -- including Federal Deposit Insurance Corp. coverage, Social Security, unemployment insurance and food stamps -- that, though overburdened now, will continue to keep our most vulnerable citizens from falling into the destitution that characterized the Great Depression.
Still, I think we're in for a rough ride. And the smart steps to take now are virtually the same whether you think what's coming is a run-of-the-mill downturn or a once-in-a-lifetime cataclysm.
Such as:
Implement your austerity budget Pretend you just lost your job. Whatever expenses you'd cut in that situation, cut them now and use the savings to build up your emergency fund and pay off your toxic debt, such as credit cards.
"If you'd shut off the cable (after losing your job), shut it off now," says Sheryl Garrett, founder of the Garrett Planning Network, which represents fee-only financial planners who charge by the hour. "Only spend money on essentials."
If you need some inspiration, check out "Could you stop spending for a month?" Many people find they can save hundreds of dollars a month just by changing their food purchases: eating at home instead of dining out, cooking more meatless meals, reusing leftovers and shopping with coupons.
Erase that toxic debt You know you should have done it long ago. Credit card debt is expensive and leaves you vulnerable to the ever-changing whims of credit card companies, which have been raising interest rates with abandon.
Now, though, shedding credit card balances may be critical. If you still have a job, Garrett says, use it to pay off this cancerous debt.
"Go ahead and get serious about it. Be a grown-up," Garrett says. "Realize you aren't going to get bailed out by a 0% credit card offer or another mortgage refinance."
If you're seriously behind -- if you can't pay the minimums or if you're getting collection calls -- make appointments with a legitimate credit counselor and a bankruptcy attorney. Between the two, you'll learn your options for dealing with truly difficult debt.
Stock market historyDon't panic. Historical data show that, short of another Great Depression, investors who hold on for 5 years don't lose much money, even in a bear market, says MSN Money's Jim Jubak.
Keep your emergency exits open Once you've paid off the cards, don't close them. Not only can closing accounts hurt your credit scores -- which have become all-important lately for getting loans -- but you may need access to that credit in an emergency.
The same holds true for other lines of credit, including home-equity lines. If you've got access to those, try to keep them open and unused so they're available in case of emergency.
Try to stay employed No kidding, right? But here's exactly what that looks like: Volunteer for extra work, nab high-profile assignments, keep higher-ups apprised of your victories and value to the company.
Don't complain, and steer clear of people who do. And if you're on irredeemably rocky ground, tune up that resume now and start networking.
Pile up cash In bad times, cash is king. Your emergency savings will pay the bills if you lose your job and will generally help you sleep better at night. Set up automatic transfers into a high-yield, FDIC-insured savings account and add any windfalls you get along the way.
If you've been prepaying any low-rate, tax-deductible debt -- such as a mortgage or a federal student loan -- consider suspending those extra payments and putting the money into your savings instead to boost your financial flexibility.
Prepare for inflation The Federal Reserve and other central banks will flood our financial system with cash as they try to encourage lenders to lend. Once the economy starts to turn around, all that cash sloshing around in the system could spark inflation that might be tough to bring under control.
To protect clients, financial-planning firm Evensky & Katz of Coral Gables, Fla., has been adding TIPS (treasury income protected securities) to the fixed-income side of its portfolios, says Taylor Gang, the firm's vice president.
"We feel that the long-term risk is likely to be inflation," Gang said, "and we construct portfolios with this in mind."
But the firm isn't telling clients to abandon stocks. Far from it.
"Through exposure to equities, clients own securities that are likely to appreciate in value," Gang said, "and outpace inflation over time."
To repeat:
Stay invested in stocks This advice is hard for many people to stomach. They feel that if only they'd gotten out of the market weeks or months ago, they'd feel so much better now.
That's probably why so many are raiding their retirement funds, cashing them out or refusing to contribute. A recent AARP survey found that 20% of workers 45 or older had stopped contributing to their retirement funds in the past year and that 13% are tapping their accounts to pay day-to-day expenses.
These are exactly the wrong moves. While the current market turmoil may mean a delayed retirement for many people (see "How to retire in bad times"), failing to fund your retirement accounts could mean no retirement at all.
And the problem with getting out of the market is that you won't know when to get back in. Markets usually turn around well before the actual economy starts improving, and they typically advance so rapidly that people who aren't already invested miss most of the gains.
Besides, it's not like most of us need the money right now. Many of us have decades to go before we'll tap our retirement funds. These losses we're seeing are purely theoretical unless we act to make them real, by selling in a panic.
And if inflation does kick in, it will be even more important to have the inflation-beating returns that only stocks can provide. Furthermore:
Don't ignore your asset allocation It may feel like diversification hasn't worked, since all classes of U.S. and foreign stocks have taken it in the teeth lately. But this synchronized performance is temporary, says financial planner Ross Levin of Accredited Investors in Edina, Minn. Eventually, a rebound will begin, and some of the most-beaten-down sectors will bounce back the strongest.
"Rebalancing is critical during these periods," Levin recently told his clients in a quarterly newsletter. "By systematically rebalancing, you are forcing yourself to buy low."
Stock market historyDon't panic. Historical data show that, short of another Great Depression, investors who hold on for 5 years don't lose much money, even in a bear market, says MSN Money's Jim Jubak.
Learn some old-school skills Plant a garden. Plan your meals. Repair rather than toss. Barter or trade rather than buy. Throw a potluck.
You'll save money, help the planet and combat that feeling that you're the helpless pawn of economic forces greater than you.
Construct your Plan B If the bottom does drop out of our economy, you probably won't wind up on the street. Maybe you'd move in with your in-laws or rent out rooms in your home (as many previously affluent families did during the Depression). Honing your backup plan can be surprisingly therapeutic, particularly for people who tend to get all catastrophic. (For details, read "Is your money making you crazy?")
Instead of fearing the worst, in other words, you plan for it -- then hope to be surprised.
Thursday, October 9, 2008
The Economy
By Stephen Gandel and Paul J. Lim
If you're watching the news and scratching your head wondering what bomb hit the economy, you're certainly not alone. It's rough out there. People are losing their jobs, retirement dreams are going up in smoke and personal wealth is plummeting. Here's why it's happening and what it all means.
How did we get here?
By now you likely know that the crisis in the financial markets is the culmination of years of reckless mortgage lending and Wall Street dealmaking. It's the final gasp of the burst housing bubble. But how exactly did this happen?
To find the root cause of Wall Street's woes, you have to go back to the collapse of a different bubble - tech. In 2001, after the dotcom craze ended and the bear market began, the Federal Reserve started aggressively slashing short-term interest rates to stave off recession. By eventually reducing rates to a historically low 1%, the Fed reinflated the economy. But this cheap money sparked a new wave of risk taking.
Homeowners, armed with easy credit, snapped up properties as if they were playing Monopoly. As prices soared, buyers were able to afford ever-larger properties only by taking out risky mortgages that lenders were happily approving with little documentation or money down.
At the same time, Wall Street investment banks got a brilliant idea: bundle the riskiest of these mortgages, then slice and dice these portfolios into tradable bonds to be sold to other banks and investors. Amazingly, bond-rating agencies slapped their highest ratings on the "best" of this debt.
This house of cards came down when subprime borrowers began defaulting on their mortgages. That sent housing prices tumbling, unleashing a domino effect on mortgage-backed securities. Banks and brokerages that had borrowed money to boost the impact of those investments had to race to raise capital.
Some, like Merrill Lynch, were forced to sell. Others, like Lehman Brothers, weren't so lucky. "What we always tell investors is beware of too much leverage in a company," says Brian Rogers, chairman and portfolio manager for T. Rowe Price. "Leverage is the enemy of the investor."
Sure, everyone from former Fed chairman Alan Greenspan to your friends and neighbors played a role in stoking this casino culture. But troubled banks and brokerages can't pass the blame. "These firms closed their eyes and made very bad bets on risky securities that they didn't truly understand," says Jeremy Siegel, finance professor at the University of Pennsylvania's Wharton business school. "Investments that they did not have to make led to their demise."
How bad could the economy get?
Before the meltdown, economists fell into two camps: those who thought the economy had already slipped into recession and those who thought a recession could still be avoided.
While forecasters still differ on the timing and severity of a downturn, "the consensus view is that we're headed for recession and will be in one until next year," says Mark Zandi, chief economist for Moody's Economy.com.
Corporate profits are already on the verge of falling for a fifth straight quarter, according to Thomson Financial. The next shoe to drop will be consumer spending. "Two years ago, people were using their homes as ATMs, pumping out cash," says Robert Arnott, chairman of the investment consulting firm Research Affiliates in Pasadena. "As banks continue to tighten their lending, that spending is disappearing."
But softer profits and slower spending haven't translated into widespread layoffs yet. "This is the strongest recessionary job market in 40 years," says James Paulsen, chief investment strategist of Wells Capital Management. A jump in unemployment could still be coming, especially given bank and brokerage failures and mergers. But outside of finance and housing, much of the rest of the economy is strong, he says.
The weak dollar is boosting demand for our goods abroad, and lower gas prices are making Americans feel more flush. Add in the cash that the Fed has been hosing into the banking system and we are bound to see growth in 2009. "If all this stimulus has no effect on the economy, that would be a rarity indeed," says Paulsen.
Standard & Poor's chief economist David Wyss expects a mild recession that ends next spring. "Gradually we will regain confidence in the market. Lower oil prices and a falling trade deficit will help," he says. "This is a financial panic, not an economic one."
Of course, that could change if the financial panic doesn't abate soon. If banks remain too scared or broke to lend, would-be home buyers will be frozen out of the market. If that happens, home values could fall even more, crimping confidence and putting the brakes on the economy's greatest engine: the consumer.
Does all this mean I'll pay higher taxes?
Yes. "Taxes will rise regardless of who wins the Presidency," predicts Greg Valliere, chief political strategist for Stanford Group Co.
It's impossible to say what the final bill for rescuing Wall Street will be. Even before the bill to buy $700 billion of unwanted mortgage-backed debt, the government had already signed on for nearly $365 billion in loan guarantees and other costs.
The eventual price tag will depend in part on the housing market. If it recovers by 2010, the value of mortgage-backed securities could rise, minimizing the tab for taxpayers, says Brian Bethune, chief U.S. financial economist for Global Insight.
"On the other hand," Bethune adds, "if the economy continues to tank into a deeper recession, dragging the housing market along with it, then the costs to the taxpayers easily could escalate to several hundred billions of dollars."
Under Treasury Secretary Henry Paulson's original debt-buyback proposal, some economists predicted the federal deficit could soar to $900 billion in 2009. Even without a bailout, the federal budget was expected to hit $482 billion next year. If government aid pads that figure by $200 billion, the deficit will be back to where it stood in the 1980s - around 5% of GDP. At the very least, that will make it hard for a future President to keep tax-cut promises.
If you're watching the news and scratching your head wondering what bomb hit the economy, you're certainly not alone. It's rough out there. People are losing their jobs, retirement dreams are going up in smoke and personal wealth is plummeting. Here's why it's happening and what it all means.
How did we get here?
By now you likely know that the crisis in the financial markets is the culmination of years of reckless mortgage lending and Wall Street dealmaking. It's the final gasp of the burst housing bubble. But how exactly did this happen?
To find the root cause of Wall Street's woes, you have to go back to the collapse of a different bubble - tech. In 2001, after the dotcom craze ended and the bear market began, the Federal Reserve started aggressively slashing short-term interest rates to stave off recession. By eventually reducing rates to a historically low 1%, the Fed reinflated the economy. But this cheap money sparked a new wave of risk taking.
Homeowners, armed with easy credit, snapped up properties as if they were playing Monopoly. As prices soared, buyers were able to afford ever-larger properties only by taking out risky mortgages that lenders were happily approving with little documentation or money down.
At the same time, Wall Street investment banks got a brilliant idea: bundle the riskiest of these mortgages, then slice and dice these portfolios into tradable bonds to be sold to other banks and investors. Amazingly, bond-rating agencies slapped their highest ratings on the "best" of this debt.
This house of cards came down when subprime borrowers began defaulting on their mortgages. That sent housing prices tumbling, unleashing a domino effect on mortgage-backed securities. Banks and brokerages that had borrowed money to boost the impact of those investments had to race to raise capital.
Some, like Merrill Lynch, were forced to sell. Others, like Lehman Brothers, weren't so lucky. "What we always tell investors is beware of too much leverage in a company," says Brian Rogers, chairman and portfolio manager for T. Rowe Price. "Leverage is the enemy of the investor."
Sure, everyone from former Fed chairman Alan Greenspan to your friends and neighbors played a role in stoking this casino culture. But troubled banks and brokerages can't pass the blame. "These firms closed their eyes and made very bad bets on risky securities that they didn't truly understand," says Jeremy Siegel, finance professor at the University of Pennsylvania's Wharton business school. "Investments that they did not have to make led to their demise."
How bad could the economy get?
Before the meltdown, economists fell into two camps: those who thought the economy had already slipped into recession and those who thought a recession could still be avoided.
While forecasters still differ on the timing and severity of a downturn, "the consensus view is that we're headed for recession and will be in one until next year," says Mark Zandi, chief economist for Moody's Economy.com.
Corporate profits are already on the verge of falling for a fifth straight quarter, according to Thomson Financial. The next shoe to drop will be consumer spending. "Two years ago, people were using their homes as ATMs, pumping out cash," says Robert Arnott, chairman of the investment consulting firm Research Affiliates in Pasadena. "As banks continue to tighten their lending, that spending is disappearing."
But softer profits and slower spending haven't translated into widespread layoffs yet. "This is the strongest recessionary job market in 40 years," says James Paulsen, chief investment strategist of Wells Capital Management. A jump in unemployment could still be coming, especially given bank and brokerage failures and mergers. But outside of finance and housing, much of the rest of the economy is strong, he says.
The weak dollar is boosting demand for our goods abroad, and lower gas prices are making Americans feel more flush. Add in the cash that the Fed has been hosing into the banking system and we are bound to see growth in 2009. "If all this stimulus has no effect on the economy, that would be a rarity indeed," says Paulsen.
Standard & Poor's chief economist David Wyss expects a mild recession that ends next spring. "Gradually we will regain confidence in the market. Lower oil prices and a falling trade deficit will help," he says. "This is a financial panic, not an economic one."
Of course, that could change if the financial panic doesn't abate soon. If banks remain too scared or broke to lend, would-be home buyers will be frozen out of the market. If that happens, home values could fall even more, crimping confidence and putting the brakes on the economy's greatest engine: the consumer.
Does all this mean I'll pay higher taxes?
Yes. "Taxes will rise regardless of who wins the Presidency," predicts Greg Valliere, chief political strategist for Stanford Group Co.
It's impossible to say what the final bill for rescuing Wall Street will be. Even before the bill to buy $700 billion of unwanted mortgage-backed debt, the government had already signed on for nearly $365 billion in loan guarantees and other costs.
The eventual price tag will depend in part on the housing market. If it recovers by 2010, the value of mortgage-backed securities could rise, minimizing the tab for taxpayers, says Brian Bethune, chief U.S. financial economist for Global Insight.
"On the other hand," Bethune adds, "if the economy continues to tank into a deeper recession, dragging the housing market along with it, then the costs to the taxpayers easily could escalate to several hundred billions of dollars."
Under Treasury Secretary Henry Paulson's original debt-buyback proposal, some economists predicted the federal deficit could soar to $900 billion in 2009. Even without a bailout, the federal budget was expected to hit $482 billion next year. If government aid pads that figure by $200 billion, the deficit will be back to where it stood in the 1980s - around 5% of GDP. At the very least, that will make it hard for a future President to keep tax-cut promises.
Wednesday, October 8, 2008
The Decline of Men
(Fortune Magazine) -- The mood in the ballroom at Cipriani Wall Street was exultant as several hundred influential New Yorkers gathered last year at the Women Who Make a Difference gala to benefit the National Council for Research on Women. Dina Dublon, a PepsiCo board member and former CFO of J.P. Morgan Chase, introduced one of the evening's honorees, PepsiCo chairman Steve Reinemund, who was about to hand over his post to his chosen successor, Indra Nooyi.
In her remarks, Dublon noted that Reinemund was the first man ever to receive an award from the group, adding that he was "part of our No Man Left Behind program." The mostly female audience laughed appreciatively, but the truth behind the jest stirred conversation. The suddenly pensive diners traded stories about men they knew who had lost their jobs or their marriages or both, and were now basically idle, taking up golf or the piano, writing that novel, doing nothing. The women spoke about brothers, sons, nephews, and husbands. "It's weird how everyone has a story like this," remarked a woman officer from a Fortune 1,000 company. "There's definitely something going on."
What's going on is a conundrum with economic and cultural ramifications for both men and women. From the classroom to the boardroom, American men are losing ground. It affects affluent white men in the heartland and young immigrants in the Southwest, computer nerds and family guys. To some extent it's the inevitable result of greater competition from women - as barriers have fallen, women have achieved according to their potential.
But it raises a critical question: If the playing field is level, why are so many men tripping up and dropping out? Why have they failed to keep up not only with women but with the higher competitive standards of the global marketplace? That failure is not just eroding the ability of men to earn a living and become contributing members of society but also undermining the very definition of what it means to be a man. No wonder that cable reality shows like Ice Road Truckers and Deadliest Catch, which glorify men who do dangerous, physically demanding jobs, have struck a nostalgic chord in the zeitgeist.
America's gender divide starts in elementary school and progresses through college, where women now earn 60% of all degrees (51% of the total U.S. population is female). On American college campuses, women now outnumber men by more than two million.
"Women have been making educational progress, and men are stuck," Tom Mortenson, senior scholar for the Pell Institute for the Study of Opportunity in Higher Education, told the Associated Press. "They haven't just fallen behind women. They have fallen behind changes in the job market."
Those changes tend to favor women, whose innate networking and social skills often give them an edge in the service industry, now the fastest-growing sector of the U.S. economy. In corporate America the cycle has accelerated because women tend to know their customers: other women. The ability of women consumers to make or break a brand is being felt in industries from publishing to health care. Women, armed with advanced degrees and expanding spending power, are increasingly seen as the decision-makers in housing, autos, and technology.
And that power is showing up in paychecks. While women on average still earn less than men, the gap in some areas has reversed itself. A study by the Citizens Union Foundation calculated that females between the ages of 21 and 30 earned 117% of male wages in the same age group; U.S. Census figures confirm that women in their 20s already make more than their male counterparts in major cities like New York, Los Angeles, Chicago, Boston, Minneapolis, and Dallas.
As many women's earnings have soared, incomes for men, including those with college degrees, have stalled or declined. Ronald Mincy, a professor of social policy at Columbia University, has spent a decade tracking what he considers a very ominous number. "We've seen no growth in the average hourly earnings of men in 25 years - and that is the biggest, most glaring statistic because as the earnings of men go, so go the fortunes of men," he observes.
One consequence could be a painful impact on family life. A pillar of male identity is the ability to work - to earn money and social status to help support a wife and family. "If you're a man," says Mincy, "you can't play house if you're not making enough money at your job."
Most disturbing of all, perhaps, is the drift of able-bodied unemployed men of all ages who are dropping out of the workforce altogether. Among American men in their prime working years - between the ages of 30 and 55 - 13% are not working, up from 5% during the 1960s, according to the New York Times. Most of those men, who number about four million, are former blue-collar workers who have been displaced. But a growing number are college-educated professionals in their 30s and 40s who have been out of a job for years.
While it's been widely noted that women have innate skills that help them thrive in an organization - communication, multitasking, collaboration - what's less well-known is how this extends to global competition. Geert Hofstede, a Dutch psychologist who worked at IBM and now consults at major corporations, has profiled national cultures according to key values, including masculinity. On that index the U.S. scores relatively high at 62, compared with countries like Sweden (5) and Norway (8), but lower than Japan, which has the highest masculinity index in the world at 95. For Christopher Liechty, a design and marketing executive based in Salt Lake City, "Masculine is primarily competitive and prestige-oriented; feminine is primarily nurturing, caring, but that means egalitarianism. Women are more consensus-building."
Liechty notes that when national gender values are overlaid onto corporations, many of those with the most "feminine" traits, including Scandinavian companies like Nokia (NOK), IKEA, Lego, and Volvo, have an inclusive brand identity that often gives them an edge in today's global - and increasingly feminine - markets. The world, it turns out, may be curved after all.
Help for struggling U.S. males will have to take many forms, starting with school. But one way for men to help themselves is to take a few pages from the female playbook: less hierarchy, more networking; less aggression, more consensus.
Not all men are swimming against the tide. "Women are playing a bigger role, but I think it's a good thing," says an affable, 34-year-old software designer in the Washington, D.C., area, who says he has no problems working for a woman (but didn't want his name used). "Change is difficult, though, and some guys will have an identity crisis." To put it in bluntly male terms, those who fail to adapt may find their next position is at the end of an unemployment line.
Adapted from The Decline of Men by Guy Garcia, to be published in October by Harper. Copyright © 2008 by Guy Garcia.
In her remarks, Dublon noted that Reinemund was the first man ever to receive an award from the group, adding that he was "part of our No Man Left Behind program." The mostly female audience laughed appreciatively, but the truth behind the jest stirred conversation. The suddenly pensive diners traded stories about men they knew who had lost their jobs or their marriages or both, and were now basically idle, taking up golf or the piano, writing that novel, doing nothing. The women spoke about brothers, sons, nephews, and husbands. "It's weird how everyone has a story like this," remarked a woman officer from a Fortune 1,000 company. "There's definitely something going on."
What's going on is a conundrum with economic and cultural ramifications for both men and women. From the classroom to the boardroom, American men are losing ground. It affects affluent white men in the heartland and young immigrants in the Southwest, computer nerds and family guys. To some extent it's the inevitable result of greater competition from women - as barriers have fallen, women have achieved according to their potential.
But it raises a critical question: If the playing field is level, why are so many men tripping up and dropping out? Why have they failed to keep up not only with women but with the higher competitive standards of the global marketplace? That failure is not just eroding the ability of men to earn a living and become contributing members of society but also undermining the very definition of what it means to be a man. No wonder that cable reality shows like Ice Road Truckers and Deadliest Catch, which glorify men who do dangerous, physically demanding jobs, have struck a nostalgic chord in the zeitgeist.
America's gender divide starts in elementary school and progresses through college, where women now earn 60% of all degrees (51% of the total U.S. population is female). On American college campuses, women now outnumber men by more than two million.
"Women have been making educational progress, and men are stuck," Tom Mortenson, senior scholar for the Pell Institute for the Study of Opportunity in Higher Education, told the Associated Press. "They haven't just fallen behind women. They have fallen behind changes in the job market."
Those changes tend to favor women, whose innate networking and social skills often give them an edge in the service industry, now the fastest-growing sector of the U.S. economy. In corporate America the cycle has accelerated because women tend to know their customers: other women. The ability of women consumers to make or break a brand is being felt in industries from publishing to health care. Women, armed with advanced degrees and expanding spending power, are increasingly seen as the decision-makers in housing, autos, and technology.
And that power is showing up in paychecks. While women on average still earn less than men, the gap in some areas has reversed itself. A study by the Citizens Union Foundation calculated that females between the ages of 21 and 30 earned 117% of male wages in the same age group; U.S. Census figures confirm that women in their 20s already make more than their male counterparts in major cities like New York, Los Angeles, Chicago, Boston, Minneapolis, and Dallas.
As many women's earnings have soared, incomes for men, including those with college degrees, have stalled or declined. Ronald Mincy, a professor of social policy at Columbia University, has spent a decade tracking what he considers a very ominous number. "We've seen no growth in the average hourly earnings of men in 25 years - and that is the biggest, most glaring statistic because as the earnings of men go, so go the fortunes of men," he observes.
One consequence could be a painful impact on family life. A pillar of male identity is the ability to work - to earn money and social status to help support a wife and family. "If you're a man," says Mincy, "you can't play house if you're not making enough money at your job."
Most disturbing of all, perhaps, is the drift of able-bodied unemployed men of all ages who are dropping out of the workforce altogether. Among American men in their prime working years - between the ages of 30 and 55 - 13% are not working, up from 5% during the 1960s, according to the New York Times. Most of those men, who number about four million, are former blue-collar workers who have been displaced. But a growing number are college-educated professionals in their 30s and 40s who have been out of a job for years.
While it's been widely noted that women have innate skills that help them thrive in an organization - communication, multitasking, collaboration - what's less well-known is how this extends to global competition. Geert Hofstede, a Dutch psychologist who worked at IBM and now consults at major corporations, has profiled national cultures according to key values, including masculinity. On that index the U.S. scores relatively high at 62, compared with countries like Sweden (5) and Norway (8), but lower than Japan, which has the highest masculinity index in the world at 95. For Christopher Liechty, a design and marketing executive based in Salt Lake City, "Masculine is primarily competitive and prestige-oriented; feminine is primarily nurturing, caring, but that means egalitarianism. Women are more consensus-building."
Liechty notes that when national gender values are overlaid onto corporations, many of those with the most "feminine" traits, including Scandinavian companies like Nokia (NOK), IKEA, Lego, and Volvo, have an inclusive brand identity that often gives them an edge in today's global - and increasingly feminine - markets. The world, it turns out, may be curved after all.
Help for struggling U.S. males will have to take many forms, starting with school. But one way for men to help themselves is to take a few pages from the female playbook: less hierarchy, more networking; less aggression, more consensus.
Not all men are swimming against the tide. "Women are playing a bigger role, but I think it's a good thing," says an affable, 34-year-old software designer in the Washington, D.C., area, who says he has no problems working for a woman (but didn't want his name used). "Change is difficult, though, and some guys will have an identity crisis." To put it in bluntly male terms, those who fail to adapt may find their next position is at the end of an unemployment line.
Adapted from The Decline of Men by Guy Garcia, to be published in October by Harper. Copyright © 2008 by Guy Garcia.
Tuesday, October 7, 2008
We'll Pay for it later
Editor's note: Canadian writer Margaret Atwood is the author of more than 35 books of poetry, fiction and nonfiction. Her novels include "The Handmaid's Tale" and "The Blind Assassin," which won the Booker Prize in 2000. Her new book, published this week by House of Anansi Press, is "Payback: Debt and the Shadow Side of Wealth." Atwood says the book "is not a practical guide about how to get out of debt. Instead it examines the underpinnings of the whole structure -- why we human beings have such a thing as a debt-credit system in the first place."
Margaret Atwood says we've come to feel that debt is essential to our lives.
(CNN) -- Unless we value fairness, reciprocity, and honest dealing, and the concept of balances -- for debt and credit depend on them -- and unless we are able to trust our systems, we would not be able to have debt and credit -- no one would lend, because there would be no expectation of ever getting paid back.
What caused the massive financial mess we are in comes back ultimately to these concepts. The rules were too loose, fairness and honest dealing were violated, the balance was upset. We must now restore trust so people will take their pennies out of the sock under the mattress where they are now inclined to store them.
In my part of the world we have a ritual interchange that goes like this:
First person: "Lovely weather we're having."
Second person: "We'll pay for it later."
My part of the world being Canada, where there is a great deal of weather, we always do pay for it later. One person has commented, "That's not Canadian, it's just Presbyterian." Nevertheless, it's a widespread saying among us.
What this ritual interchange reveals is a larger habit of thinking about the more enjoyable things in life: They're only on loan or acquired on credit, and sooner or later the date when they must be paid for will roll around. It's pay-up time. Or payback time, supposing that you haven't paid up.
In any case, the time when whatever is on one side of the balance is weighed against whatever is on the other side -- whether it's your heart, your soul or your debts -- and the final reckoning is made.
The financial world has recently been shaken as a result of the collapse of a debt pyramid involving something called "subprime mortgages" -- a pyramid scheme that most people don't grasp very well, but that boils down to the fact that some large financial institutions peddled mortgages to people who could not possibly pay the monthly rates and then put this snake-oil debt into cardboard boxes with impressive labels on them and sold them to institutions and hedge funds that thought they were worth something.
A friend of mine from the United States writes: "I used to have three banks and a mortgage company. Bank number one bought the other two and is now trying hard to buy the mortgage company, which is bankrupt, only it was revealed this morning that the last bank standing is also in serious trouble.
"Now they are trying to renegotiate with the mortgage company. Question One: If your company is going broke, why would you want to buy a company whose insolvency is front-page news? Question Two: If all the lenders go broke, will the borrowers get off the hook?
"You can't imagine the chagrin of the credit-loving American. I gather that whole neighborhoods in the Midwest look like neighborhoods in my hometown, empty houses with knee-high grass and vines growing over them and no one willing to admit they actually own the place. Down we go, about to reap what we sow."
Which has a nice biblical ring to it, but still we scratch our heads. How and why did this happen? The answer I hear quite often -- "greed" -- may be accurate enough, but it doesn't go very far toward unveiling the deeper mysteries of the process.
What is this "debt" by which we're so bedeviled? Like air, it's all around us, but we never think about it unless something goes wrong with the supply. Certainly it's a thing we've come to feel is indispensable to our collective buoyancy.
In good times we float around on it as if on a helium-filled balloon; we rise higher and higher, and the balloon gets bigger and bigger, until -- poof! -- some killjoy sticks a pin into it and we sink. But what is the nature of that pin?
Another friend of mine used to maintain that airplanes stayed up in the air only because people believed -- against reason -- that they could fly: Without that collective delusion sustaining them, they would instantly plummet to earth. Is "debt" similar? In other words, perhaps debt exists because we imagine it.
Another part of the human imaginative debt/credit structure has to do with payback time -- the time when you have to pay the debt back, or else suffer the consequences.
All major religions have extended this structure to the afterlife, where, if you haven't righted the moral balances on earth, you must do so after death.
There are no clocks in heaven. Nor are there any in hell. In both, everything is always now. Or so goes the rumor.
In heaven, there are no debts -- all have been paid, one way or another -- but in hell there's nothing but debts, and a great deal of payment is exacted, though you can't ever get all paid up. You have to pay, and pay, and keep on paying. Hell is like an infernal maxed-out credit card that multiplies the charges endlessly.
Margaret Atwood says we've come to feel that debt is essential to our lives.
(CNN) -- Unless we value fairness, reciprocity, and honest dealing, and the concept of balances -- for debt and credit depend on them -- and unless we are able to trust our systems, we would not be able to have debt and credit -- no one would lend, because there would be no expectation of ever getting paid back.
What caused the massive financial mess we are in comes back ultimately to these concepts. The rules were too loose, fairness and honest dealing were violated, the balance was upset. We must now restore trust so people will take their pennies out of the sock under the mattress where they are now inclined to store them.
In my part of the world we have a ritual interchange that goes like this:
First person: "Lovely weather we're having."
Second person: "We'll pay for it later."
My part of the world being Canada, where there is a great deal of weather, we always do pay for it later. One person has commented, "That's not Canadian, it's just Presbyterian." Nevertheless, it's a widespread saying among us.
What this ritual interchange reveals is a larger habit of thinking about the more enjoyable things in life: They're only on loan or acquired on credit, and sooner or later the date when they must be paid for will roll around. It's pay-up time. Or payback time, supposing that you haven't paid up.
In any case, the time when whatever is on one side of the balance is weighed against whatever is on the other side -- whether it's your heart, your soul or your debts -- and the final reckoning is made.
The financial world has recently been shaken as a result of the collapse of a debt pyramid involving something called "subprime mortgages" -- a pyramid scheme that most people don't grasp very well, but that boils down to the fact that some large financial institutions peddled mortgages to people who could not possibly pay the monthly rates and then put this snake-oil debt into cardboard boxes with impressive labels on them and sold them to institutions and hedge funds that thought they were worth something.
A friend of mine from the United States writes: "I used to have three banks and a mortgage company. Bank number one bought the other two and is now trying hard to buy the mortgage company, which is bankrupt, only it was revealed this morning that the last bank standing is also in serious trouble.
"Now they are trying to renegotiate with the mortgage company. Question One: If your company is going broke, why would you want to buy a company whose insolvency is front-page news? Question Two: If all the lenders go broke, will the borrowers get off the hook?
"You can't imagine the chagrin of the credit-loving American. I gather that whole neighborhoods in the Midwest look like neighborhoods in my hometown, empty houses with knee-high grass and vines growing over them and no one willing to admit they actually own the place. Down we go, about to reap what we sow."
Which has a nice biblical ring to it, but still we scratch our heads. How and why did this happen? The answer I hear quite often -- "greed" -- may be accurate enough, but it doesn't go very far toward unveiling the deeper mysteries of the process.
What is this "debt" by which we're so bedeviled? Like air, it's all around us, but we never think about it unless something goes wrong with the supply. Certainly it's a thing we've come to feel is indispensable to our collective buoyancy.
In good times we float around on it as if on a helium-filled balloon; we rise higher and higher, and the balloon gets bigger and bigger, until -- poof! -- some killjoy sticks a pin into it and we sink. But what is the nature of that pin?
Another friend of mine used to maintain that airplanes stayed up in the air only because people believed -- against reason -- that they could fly: Without that collective delusion sustaining them, they would instantly plummet to earth. Is "debt" similar? In other words, perhaps debt exists because we imagine it.
Another part of the human imaginative debt/credit structure has to do with payback time -- the time when you have to pay the debt back, or else suffer the consequences.
All major religions have extended this structure to the afterlife, where, if you haven't righted the moral balances on earth, you must do so after death.
There are no clocks in heaven. Nor are there any in hell. In both, everything is always now. Or so goes the rumor.
In heaven, there are no debts -- all have been paid, one way or another -- but in hell there's nothing but debts, and a great deal of payment is exacted, though you can't ever get all paid up. You have to pay, and pay, and keep on paying. Hell is like an infernal maxed-out credit card that multiplies the charges endlessly.
Tuesday, September 30, 2008
The Credit Crunch
While Congress bickers over how to fix the financial meltdown, there's a decent chance you haven't even felt it. Why, you may be asking yourself, does everyone think there's such a big a problem when you're still being offered credit cards in the mail and zero-percent financing at the car dealership? Maybe you used to bank with Washington Mutual or Wachovia and overnight you've become a Chase or Citi customer, but if your money's still there, why does the rest matter?
The tumult at the top of financial markets has not filtered down evenly, but that doesn't mean it's not seeping. There are cracks on Main Street, but whether or not you see them largely depends on where you stand. Just ask anyone who wants to buy a house with a subprime mortgage — they're not all evil, but these days they are exceedingly rare — or with a jumbo loan, which now carries an average rate 1.2 percentage points above a regular mortgage. (In normal times, the spread is closer to a quarter of a percentage point.) "Some people are saying, 'Credit crunch, what credit crunch?' and others are ready to cry uncle," says Greg McBride, senior financial analyst at Bankrate.com. "It shows it really matters where you fall on the risk spectrum."
Now about those credit card offers. You may not feel it, but there are fewer of them going out — 1.1 million during the second quarter, down 17% from the same time last year, according to the Synovate, a research firm that tracks direct mail. Who's being ignored? Well, subprime borrowers (no surprise there), but also anyone who doesn't make a lot of money: 52% of households with annual income under $50,000 received at least one offer in the second quarter, compared with 66% of such households during the same period last year.
Already got all the credit cards you need? You're still not immune from higher delinquency fees or lower limits. American Express typically cuts the credit limit on about 4% of its members in any given year. That figure now stands closer to 10%, as the card company takes a hard look at customers' credit profiles — including data on who lives in the areas with the most house-price deterioration.
For car loans, the division between those who feel the crunch and those who don't often comes down to credit score. The average 60-month new car loan is priced at 7.10%, not much different than in the spring, according to HSH Associates, Financial Publishers — and the average rate on a 60-month used car loan, 7.54%, has actually been drifting downward. (Those zero-percent financing deals still exist, too, from struggling car companies desperate to move inventory.) The difference is, you're probably not going to get that rate (or any at all) unless your FICO score is north of 700, whereas six months or a year ago, a score as low as 620 would have gotten you behind the wheel. "Some of this just represents moving back to standards that were in place five or six years ago," says Paul Taylor, chief economist at the National Automobile Dealers Association. "But if you're a customer, not getting credit you could've gotten a year before looks like a credit crunch to you."
The situation in student loans doesn't break down quite as neatly. Since the summer of 2007, 137 lenders have stopped funding federal loans, and 33 have suspended private programs, according to Mark Kantrowitz, publisher of FinAid.org and other financial aid web sites. Part of that had to do with a cut in federal subsidies, but part was directly related to the credit crunch — issuers that pulled out tended to be those that packaged and resold loans, a market that has evaporated.
Students at community and technical colleges, especially institutions that are for-profit, are having the toughest time of it. The reason: those students are more likely to use private loans (where credit standards have tightened), and lenders under profit pressure are less willing to write loans for shorter, one- and two-year programs — especially at schools with historically high default rates.
Federal loans aren't completely unaffected. While Stafford loans, which are made directly to students and don't take into account credit history, were up in the second quarter compared to a year ago, loans made to parents through the Parent PLUS program have plummeted — down 29% in dollar volume year-over-year, according to Department of Education data analyzed by Kantorwitz.
The mood at banks more generally is cautious. The most recent Federal Reserve survey of loan officers showed a plurality of banks tightening credit standards across the board. Add in anecdotal evidence — like Bank of America declining to increase lending to McDonald's franchisees even though the two companies have a long-standing partnership — and things do seem to be cascading down to Main Street, or whatever road is home to your local fast food joint. In August, 67% of small-business owners said they'd been affected by the credit crunch, compared with 55% in February, according to surveys by the National Small Business Association.
It's not hard to find anecdotes of business booming at credit unions and community banks, which rely on deposits rather than financing in the capital markets. But even there's nuance even there. The amount you can expect from a top-yielding certificate of deposit has fallen from about 5.5% to 4.25% over the past year, according to Bankrate.com. On the surface that seems to indicate banks aren't that worried — if they really needed cash, wouldn't they up their rates to attract more money? Well, over the same period of time, the federal funds rate has been cut from 5.25% to 2% — a much wider margin. "Banks are hungry for deposits, and that's why yields haven't fallen all that much," says Bankrate's McBride. And CD yields are now on the rise.
Does that mean you're feeling the credit crunch? Maybe not. But it might be an indication that the cracks on Main Street are spreading.
By Barbara Kiviat
The tumult at the top of financial markets has not filtered down evenly, but that doesn't mean it's not seeping. There are cracks on Main Street, but whether or not you see them largely depends on where you stand. Just ask anyone who wants to buy a house with a subprime mortgage — they're not all evil, but these days they are exceedingly rare — or with a jumbo loan, which now carries an average rate 1.2 percentage points above a regular mortgage. (In normal times, the spread is closer to a quarter of a percentage point.) "Some people are saying, 'Credit crunch, what credit crunch?' and others are ready to cry uncle," says Greg McBride, senior financial analyst at Bankrate.com. "It shows it really matters where you fall on the risk spectrum."
Now about those credit card offers. You may not feel it, but there are fewer of them going out — 1.1 million during the second quarter, down 17% from the same time last year, according to the Synovate, a research firm that tracks direct mail. Who's being ignored? Well, subprime borrowers (no surprise there), but also anyone who doesn't make a lot of money: 52% of households with annual income under $50,000 received at least one offer in the second quarter, compared with 66% of such households during the same period last year.
Already got all the credit cards you need? You're still not immune from higher delinquency fees or lower limits. American Express typically cuts the credit limit on about 4% of its members in any given year. That figure now stands closer to 10%, as the card company takes a hard look at customers' credit profiles — including data on who lives in the areas with the most house-price deterioration.
For car loans, the division between those who feel the crunch and those who don't often comes down to credit score. The average 60-month new car loan is priced at 7.10%, not much different than in the spring, according to HSH Associates, Financial Publishers — and the average rate on a 60-month used car loan, 7.54%, has actually been drifting downward. (Those zero-percent financing deals still exist, too, from struggling car companies desperate to move inventory.) The difference is, you're probably not going to get that rate (or any at all) unless your FICO score is north of 700, whereas six months or a year ago, a score as low as 620 would have gotten you behind the wheel. "Some of this just represents moving back to standards that were in place five or six years ago," says Paul Taylor, chief economist at the National Automobile Dealers Association. "But if you're a customer, not getting credit you could've gotten a year before looks like a credit crunch to you."
The situation in student loans doesn't break down quite as neatly. Since the summer of 2007, 137 lenders have stopped funding federal loans, and 33 have suspended private programs, according to Mark Kantrowitz, publisher of FinAid.org and other financial aid web sites. Part of that had to do with a cut in federal subsidies, but part was directly related to the credit crunch — issuers that pulled out tended to be those that packaged and resold loans, a market that has evaporated.
Students at community and technical colleges, especially institutions that are for-profit, are having the toughest time of it. The reason: those students are more likely to use private loans (where credit standards have tightened), and lenders under profit pressure are less willing to write loans for shorter, one- and two-year programs — especially at schools with historically high default rates.
Federal loans aren't completely unaffected. While Stafford loans, which are made directly to students and don't take into account credit history, were up in the second quarter compared to a year ago, loans made to parents through the Parent PLUS program have plummeted — down 29% in dollar volume year-over-year, according to Department of Education data analyzed by Kantorwitz.
The mood at banks more generally is cautious. The most recent Federal Reserve survey of loan officers showed a plurality of banks tightening credit standards across the board. Add in anecdotal evidence — like Bank of America declining to increase lending to McDonald's franchisees even though the two companies have a long-standing partnership — and things do seem to be cascading down to Main Street, or whatever road is home to your local fast food joint. In August, 67% of small-business owners said they'd been affected by the credit crunch, compared with 55% in February, according to surveys by the National Small Business Association.
It's not hard to find anecdotes of business booming at credit unions and community banks, which rely on deposits rather than financing in the capital markets. But even there's nuance even there. The amount you can expect from a top-yielding certificate of deposit has fallen from about 5.5% to 4.25% over the past year, according to Bankrate.com. On the surface that seems to indicate banks aren't that worried — if they really needed cash, wouldn't they up their rates to attract more money? Well, over the same period of time, the federal funds rate has been cut from 5.25% to 2% — a much wider margin. "Banks are hungry for deposits, and that's why yields haven't fallen all that much," says Bankrate's McBride. And CD yields are now on the rise.
Does that mean you're feeling the credit crunch? Maybe not. But it might be an indication that the cracks on Main Street are spreading.
By Barbara Kiviat
America Can't go Cold Turkey
(CNN) -- My family doesn't use credit much. We pay off our charge cards every month. We drive used cars. We paid off our house mortgage early and have not refinanced. We carefully live well within our means. In fact, until very recently, my "apartment" in Washington has been my office.I'm pretty well-known as a cheapskate.
So when I said recently that I would be willing to give up my seat in Congress in order to pass the financial rescue package, it turned some heads.
It's because I understand what's at stake and because I hope to be a part of reforming our financial system so that we don't have these problems again.
I have spent my career as a business, finance and bankruptcy law professor and lawyer. I have helped individuals and institutions get out of financial trouble. More important, I have studied ways to make sure they don't get into trouble in the first place -- and drag all of us down with them.
Some politicians -- and a few economists -- would say that America is drunk on credit and just needs to go cold turkey. But it's more accurate to say we're addicted to credit. Too much credit. Good credit, bad credit, anything that lets us live the high life. We have mistaken growth in the value of financial paper for real economic growth.
Getting clean will not be so easy. When credit is quickly withdrawn, everyone in the business of lending panics. Credit becomes scarce and is not available at a reasonable interest rate. Institutions that need to use credit daily start to fall like dominoes. The financial fallout -- bank failures, risking a stock market crash, worthless retirement and pension funds -- could kill us. We need to reduce our dependence on credit gradually but steadily and with no excuses.
Deep down, we all know that a financial rescue is necessary. I voted for the plan that was defeated today because, to paraphrase Rep. Spencer Bachus, I'm unwilling to play Russian roulette with the financial lives of my children and grandchildren. Although the bill was imperfect and wildly unpopular, I believed that those of us in Congress needed to suck it up, vote for it and let the chips fall where they may.
But the plan has failed. I hope the economists who have warned of an imminent collapse are wrong. To paraphrase Franklin Roosevelt, what we have to fear is fear itself. If people can take a deep breath and avoid an immediate panic, it is my hope that we can improve this plan and still act in time to save our financial future.
My own strong preference is that it focus less on acquiring mortgage-backed securities and be more of a tightly focused effort to minimize foreclosures and home vacancies that drive down property values for all of us. For these non-prime mortgage notes, I would give bankruptcy courts the power to modify mortgage payments to make them more realistic. I would limit the pay of not only top Wall Street executives but the traders who made millions by making this problem worse.
I hope we can get a plan that includes at least some of those elements. But most important, we need a bill that can attract enough support to pass.
Then the hard work begins, and that is the work I want to be a part of in the months ahead: Making sure this doesn't happen again. That's why you run for office, or at least why I did. If I have not, in fact, given up my seat because of my vote, I'll be back to work on that myself.
U.S. Rep. Jim Marshall, a Democrat serving his third term in Congress, represents Georgia's 8th Congressional District. He serves on the House Armed Services and Agriculture Committees.
So when I said recently that I would be willing to give up my seat in Congress in order to pass the financial rescue package, it turned some heads.
It's because I understand what's at stake and because I hope to be a part of reforming our financial system so that we don't have these problems again.
I have spent my career as a business, finance and bankruptcy law professor and lawyer. I have helped individuals and institutions get out of financial trouble. More important, I have studied ways to make sure they don't get into trouble in the first place -- and drag all of us down with them.
Some politicians -- and a few economists -- would say that America is drunk on credit and just needs to go cold turkey. But it's more accurate to say we're addicted to credit. Too much credit. Good credit, bad credit, anything that lets us live the high life. We have mistaken growth in the value of financial paper for real economic growth.
Getting clean will not be so easy. When credit is quickly withdrawn, everyone in the business of lending panics. Credit becomes scarce and is not available at a reasonable interest rate. Institutions that need to use credit daily start to fall like dominoes. The financial fallout -- bank failures, risking a stock market crash, worthless retirement and pension funds -- could kill us. We need to reduce our dependence on credit gradually but steadily and with no excuses.
Deep down, we all know that a financial rescue is necessary. I voted for the plan that was defeated today because, to paraphrase Rep. Spencer Bachus, I'm unwilling to play Russian roulette with the financial lives of my children and grandchildren. Although the bill was imperfect and wildly unpopular, I believed that those of us in Congress needed to suck it up, vote for it and let the chips fall where they may.
But the plan has failed. I hope the economists who have warned of an imminent collapse are wrong. To paraphrase Franklin Roosevelt, what we have to fear is fear itself. If people can take a deep breath and avoid an immediate panic, it is my hope that we can improve this plan and still act in time to save our financial future.
My own strong preference is that it focus less on acquiring mortgage-backed securities and be more of a tightly focused effort to minimize foreclosures and home vacancies that drive down property values for all of us. For these non-prime mortgage notes, I would give bankruptcy courts the power to modify mortgage payments to make them more realistic. I would limit the pay of not only top Wall Street executives but the traders who made millions by making this problem worse.
I hope we can get a plan that includes at least some of those elements. But most important, we need a bill that can attract enough support to pass.
Then the hard work begins, and that is the work I want to be a part of in the months ahead: Making sure this doesn't happen again. That's why you run for office, or at least why I did. If I have not, in fact, given up my seat because of my vote, I'll be back to work on that myself.
U.S. Rep. Jim Marshall, a Democrat serving his third term in Congress, represents Georgia's 8th Congressional District. He serves on the House Armed Services and Agriculture Committees.
Monday, September 22, 2008
Is this fixing the problem?
Reports are showing that they government could spend around 1.5 trillion or about $15,000 per family on their bailout plan, but it is not fixing the problem only the effects of the problem. The problem is that we have a huge surplus of houses and no one is buying them . The reason people are not buying them is concern about the hosuing market and lack of credit or change in requirements for credit (i.e 20% down). Years ago you used to have 20% down to buy a house. Lenders felt that they could get more people into houses and in turn make more money if they let people put less money down. You used to have to save for years to be able to purchase a house and it was then an accomplishment to have a house. People were less willing to walk away from the house and giving up without a fight if they had worked so hard to get it in the first place. Fast forward to about 5 -10 years ago and you could buy a house with little or no money down. So everyone was buying houses, the prices rose dramatically because so many more people could purchase one, now that you didn't need as large of down payments. They didn't have as much invested and had very little equity so it was eaiser to walk away and harder to sell because of little to no wingle room on price. The housing crises we are currently and the change in lending requirements now requiring 10-20% down again in addition to great credit this limits the amount of people who can purchase a house. This also comes when the national savings is $0 if not negative (in some reports). When you currently save zero it sure takes a long time to save 20% on a down payment of a house. This limits the amount of people who can purchase a house at a time where there is too many houses on the market for the demand. We are in a time period were we have the most houses for sale with the smallest amount of people who can purchase them. This is will take years to adjust and correct it self. Some have questioned that if the government gave each family $15,000 they are spending on the bailout that people would have money to pay for down payments on houses (which would help with the hosuing surplus) and spend on other things to help stimulate the economy that this would have a greater impact on the economy than the bailout. Of course this will never happen but it makes you wonder if the money could have been spent in a better way to help the economy. The bailout might be more of a symbolic event showing we are going to do everything in our means to fix the problem. The stock market seemed to react to this idea and you might not be able to put a number of the piece of mind idea.
Are we going to become like the french?
This is the state of our great republic: We've nationalized the financial system, taking control from Wall Street bankers we no longer trust. We're about to quasi-nationalize the Detroit auto companies via massive loans because they're a source of American pride, and too many jobs — and votes — are at stake. Our Social Security system is going broke as we head for a future where too many retirees will be supported by too few workers. How long before we have national healthcare? Put it all together, and the America that emerges is a cartoonish version of the country most despised by red-meat red-state patriots: France. Only with worse food.
Admit it, mes amis, the rugged individualism and cutthroat capitalism that made America the land of unlimited opportunity has been shrink-wrapped by a half dozen short sellers in Greenwich, Conn. and FedExed to Washington D.C. to be spoon-fed back to life by Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson. We're now no different from any of those Western European semi-socialist welfare states that we love to deride. Italy? Sure, it's had four governments since last Thursday, but none of them would have allowed this to go on; the Italians know how to rig an economy.
You just know the Frogs have only increased their disdain for us, if that is indeed possible. And why shouldn't they? The average American is working two and half jobs, gets two weeks off, and has all the employment security of a one-armed trapeze artist. The Bush Administration has preached the "ownership society" to America: own your house, own your retirement account; you don't need the government in your way. So Americans mortgaged themselves to the hilt to buy overpriced houses they can no longer afford and signed up for 401k programs that put money where, exactly? In the stock market! Where rich Republicans fleeced them.
Now our laissez-faire (hey, a French word) regulation-averse Administration has made France's only Socialist president, Francois Mitterand, look like Adam Smith by comparison. All Mitterand did was nationalize France's big banks and insurance companies in 1982; he didn't have to deal with bankers who didn't want to lend money, as Paulson does. When the state runs the banks, they are merely cows to be milked in the service of la patrie. France doesn't have the mortgage crisis that we do, either. In bailing out mortgage lenders Fannie Mae and Freddie Mac, our government has basically turned America into the largest subsidized housing project in the world. Sure, France has its banlieus, where it likes to warehouse people who aren't French enough (meaning, immigrants orAlgerians) in huge apartment blocks. But the bulk of French homeowners are curiously free of subprime mortgages foisted on them by fellow citizens, and they aren't over their heads in personal debt.
We've always dismissed the French as exquisitely fed wards of their welfare state. They work, what, 27 hours in a good week, have 19 holidays a month, go on strike for two days and enjoy a glass of wine every day with lunch — except for the 25% of the population that works for the government, who have an even sweeter deal. They retire before their kids finish high school, and they don't have to save for a $45,000-a-year college tuition because college is free. For this, they pay a tax rate of about 103%, and their labor laws are so restrictive that they haven't had a net gain in jobs since Napoleon. There is no way that the French government can pay for this lifestyle forever, except that it somehow does.
Mitterand tried to create both job-growth and wage-growth by nationalizing huge swaths of the economy, including some big industries, including automaker Renault, for instance. You haven't driven a Renault lately because Renault couldn't sell them here. Imagine that. An auto company that couldn't compete with a Dodge Colt. But the Renault takeover ultimately proved successful and Renault became a private company again in 1996, although the government retains about 15% of the shares.
Now the U.S. is faced with the same prospect in the auto industry. GM and Ford need money to develop greener cars that can compete with Toyota and Honda. And they're looking to Uncle Sam for investment — an investment that could have been avoided had Washington imposed more stringent mileage standards years earlier. But we don't want to interfere with market forces like the French do — until we do.
Mitterand's nationalization program and other economic reforms failed, as the development of the European Market made a centrally planned economy obsolete. The Rothschilds got their bank back, a little worse for wear. These days, France sashays around the issue of protectionism in a supposedly unfettered EU by proclaiming some industries to be national champions worthy of extra consideration — you know, special needs kids. And we're not talking about pastry chefs, but the likes of GDF Suez, a major utility. I never thought of the stocks and junk securities sold by Goldman Sachs and Morgan Stanley as unique, but clearly Washington does. Morgan's John Mack calls SEC boss Chris Cox to whine about short sellers and bingo, the government obliges. The elite serve the elite. How French is that?
Even in the strongest sectors in the U.S., there's no getting away from the French influence. Nothing is more sacred to France than its farmers. They get whatever they demand, and they demand a lot. And if there are any issues about price supports, or feed costs being too high, or actual competition from other countries, French farmers simply shut down the country by marching their livestock up the Champs Elysee and piling up wheat on the highways. U.S. farmers would never resort to such behavior. They don't have to: they're the most coddled special interest group in U.S. history, lavished with $180 billion in subsidies by both parties, even when their products are fetching record prices. One consequence: U.S. consumers pay twice what the French pay for sugar, because of price guarantees. We're more French than France.
So yes, while we're still willing to work ourselves to death for the privilege of paying off our usurious credit cards, we can no longer look contemptuously at the land of 246 cheeses. Kraft Foods has replaced American International Group in the Dow Jones Industrial Average, the insurance company having been added to Paulson's nationalized portfolio. Macaroni and cheese has supplanted credit default swaps at the fulcrum of capitalism. And one more thing: the food snob French love McDonalds, which does a fantastic business there. They know a good freedom fry when they taste one.
By Bill Saporito
Admit it, mes amis, the rugged individualism and cutthroat capitalism that made America the land of unlimited opportunity has been shrink-wrapped by a half dozen short sellers in Greenwich, Conn. and FedExed to Washington D.C. to be spoon-fed back to life by Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson. We're now no different from any of those Western European semi-socialist welfare states that we love to deride. Italy? Sure, it's had four governments since last Thursday, but none of them would have allowed this to go on; the Italians know how to rig an economy.
You just know the Frogs have only increased their disdain for us, if that is indeed possible. And why shouldn't they? The average American is working two and half jobs, gets two weeks off, and has all the employment security of a one-armed trapeze artist. The Bush Administration has preached the "ownership society" to America: own your house, own your retirement account; you don't need the government in your way. So Americans mortgaged themselves to the hilt to buy overpriced houses they can no longer afford and signed up for 401k programs that put money where, exactly? In the stock market! Where rich Republicans fleeced them.
Now our laissez-faire (hey, a French word) regulation-averse Administration has made France's only Socialist president, Francois Mitterand, look like Adam Smith by comparison. All Mitterand did was nationalize France's big banks and insurance companies in 1982; he didn't have to deal with bankers who didn't want to lend money, as Paulson does. When the state runs the banks, they are merely cows to be milked in the service of la patrie. France doesn't have the mortgage crisis that we do, either. In bailing out mortgage lenders Fannie Mae and Freddie Mac, our government has basically turned America into the largest subsidized housing project in the world. Sure, France has its banlieus, where it likes to warehouse people who aren't French enough (meaning, immigrants orAlgerians) in huge apartment blocks. But the bulk of French homeowners are curiously free of subprime mortgages foisted on them by fellow citizens, and they aren't over their heads in personal debt.
We've always dismissed the French as exquisitely fed wards of their welfare state. They work, what, 27 hours in a good week, have 19 holidays a month, go on strike for two days and enjoy a glass of wine every day with lunch — except for the 25% of the population that works for the government, who have an even sweeter deal. They retire before their kids finish high school, and they don't have to save for a $45,000-a-year college tuition because college is free. For this, they pay a tax rate of about 103%, and their labor laws are so restrictive that they haven't had a net gain in jobs since Napoleon. There is no way that the French government can pay for this lifestyle forever, except that it somehow does.
Mitterand tried to create both job-growth and wage-growth by nationalizing huge swaths of the economy, including some big industries, including automaker Renault, for instance. You haven't driven a Renault lately because Renault couldn't sell them here. Imagine that. An auto company that couldn't compete with a Dodge Colt. But the Renault takeover ultimately proved successful and Renault became a private company again in 1996, although the government retains about 15% of the shares.
Now the U.S. is faced with the same prospect in the auto industry. GM and Ford need money to develop greener cars that can compete with Toyota and Honda. And they're looking to Uncle Sam for investment — an investment that could have been avoided had Washington imposed more stringent mileage standards years earlier. But we don't want to interfere with market forces like the French do — until we do.
Mitterand's nationalization program and other economic reforms failed, as the development of the European Market made a centrally planned economy obsolete. The Rothschilds got their bank back, a little worse for wear. These days, France sashays around the issue of protectionism in a supposedly unfettered EU by proclaiming some industries to be national champions worthy of extra consideration — you know, special needs kids. And we're not talking about pastry chefs, but the likes of GDF Suez, a major utility. I never thought of the stocks and junk securities sold by Goldman Sachs and Morgan Stanley as unique, but clearly Washington does. Morgan's John Mack calls SEC boss Chris Cox to whine about short sellers and bingo, the government obliges. The elite serve the elite. How French is that?
Even in the strongest sectors in the U.S., there's no getting away from the French influence. Nothing is more sacred to France than its farmers. They get whatever they demand, and they demand a lot. And if there are any issues about price supports, or feed costs being too high, or actual competition from other countries, French farmers simply shut down the country by marching their livestock up the Champs Elysee and piling up wheat on the highways. U.S. farmers would never resort to such behavior. They don't have to: they're the most coddled special interest group in U.S. history, lavished with $180 billion in subsidies by both parties, even when their products are fetching record prices. One consequence: U.S. consumers pay twice what the French pay for sugar, because of price guarantees. We're more French than France.
So yes, while we're still willing to work ourselves to death for the privilege of paying off our usurious credit cards, we can no longer look contemptuously at the land of 246 cheeses. Kraft Foods has replaced American International Group in the Dow Jones Industrial Average, the insurance company having been added to Paulson's nationalized portfolio. Macaroni and cheese has supplanted credit default swaps at the fulcrum of capitalism. And one more thing: the food snob French love McDonalds, which does a fantastic business there. They know a good freedom fry when they taste one.
By Bill Saporito
Thursday, September 18, 2008
Are Banks Next?
When you read reports coming out about the economic crises that we are currenlty in one of the questions is who is next to fall. A lot of people are pointing to Washington Mutal and other banks. Most people think this is one in the same but they are different. Washington Mutal is a savings and loan. Which means they historically hold on to their loans for a longer period of time especailly mortgages. While most banks originate the mortgage and sell them off in a package to Freddie Mac, Fannie Mae or a mortgage servicing agent. So the bad mortgages that is causing alot of these companies to fail are off the books on most banks. Not so with Washington Mutal they kept most of the mortgages they originated. Since a lot of their branches are located in California and Florida, two of the hardest hit places, they currently have a very high number of bad mortgages. This is not to say that all banks are free from the mortgage fall out. Banks could have bought mortgage backed bonds to help manage liquidity or they could have also made loans to commercial contractors that build houses and with the surplus of new and forclosed houses this has led to a very high number of bankruptcies for this type of compnay if they didn't set aside a reserve to ride the slow times. For years housign contrators were making tons of money and didn't have houses sitting without being sold for an extended period of time but with the economy in the shape that it currently is in houses are setting for a much longer period of time. Also the value in the houses has dropped so this means a cut into profits for theses companies. This will effect banks that loaned heavily into these companies. So some banks could fail but not as many as most people think and only banks that were located in areas that were the hardest hit by the mortgage bubble bursting. Banks are so heavily regulated and audited by FDIC and Federal Reserve each year that they know which ones are in trouble and have programs to help them out. If you want an extra piece of mind that your money will be safe make sure you have less than $100,000 at each bank. If you want to piece of mind and ease of working with one bank, ask your bank if they offer CDARS. To make this short and sweet CDARS program allows you to have all your money FDIC insured. Let me give you an example, if you have $500,000 and you want it fully FDIC insured. You can put into the CDARS program which will send it to 6 banks (your bank plus 5 others) breaking the money up evenly all each under the FDIC $100,000 insurance limit. You money is sent out to other banks and in return your bank get the same amount of money back from someone else doing the same thing. So you will get a statement from your home banks saying you have $500,000 at their bank but in reality you have $500,000 FDIC insured at 6 different banks. Don't worry this is perfectly legal and could help you out if you are one of the fortuate people that have over $100,000 in you checking and saving accounts.
How we got into this mess
NEW YORK (CNNMoney.com) -- The nation's financial system is in the midst of a massive shakeup and many on Wall Street and in Washington are pointing fingers and looking for someone to blame.
But in the end, it all comes back to one issue - housing.
Earlier this decade, it was much easier to get a mortgage. Home prices soared about 85% from 1996 through 2006 in inflation-adjusted dollars, creating a bubble.
Then the bubble popped. And the fallout isn't over yet, experts say.
In the past two weeks, the government took over Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), Lehman Brothers (LEH, Fortune 500) filed for bankruptcy and Merrill Lynch (MER, Fortune 500) sold itself to Bank of America (BAC, Fortune 500).
If all that weren't enough, the Federal Reserve announced late Tuesday night that it was loaning $85 billion to insurer American International Group (AIG, Fortune 500).
None of this would have happened if the housing market had not imploded, leaving all these firms with staggering losses from their investments tied to mortgages.
"These institutions, which weathered all kinds of calamities before, including depressions, are being knocked out," said Lakshman Achuthan, the managing director of the Economic Cycle Research Institute. "It's a testament to the significance of the problem we have here."
Thus, experts agree that there are likely to be future shocks to the financial system until the housing market finally hits bottom.
Even Treasury Secretary Henry Paulson, the administration's point man in the many rescue discussions of the past month, admits this.
"The housing correction poses the biggest risk to our economy," Paulson said the day he announced the Fannie and Freddie seizure. "Our economy and our markets will not recover until the bulk of this housing correction is behind us."
The problem of falling home prices
But because of the depth of the housing problems, it may take a long time before real estate prices head higher again. Here's why.
Home prices, while sharply off from the 2006 peaks, are still high in comparison to long-term gains in income, rents or overall prices, suggesting that they still have a way to fall, according to experts.
The reason housing is wreaking havoc even on insurers like AIG and big investment banks, who do not make mortgage loans, is that during the boom, trillions of dollars of mortgages were packaged together into securities that promised to pay investors with the proceeds of those loan payments.
Those securities paid better rates than other types of assets during the boom years. So many investors from around the globe poured as much money as they could into those securities.
Faced with this demand, lenders starting making more loans to riskier borrowers, including people who might not be able to afford their mortgage payments in the future and even many with no proof of income.
When prices were rising, this wasn't a problem. The risk of loan foreclosure or default was limited because many homeowners were able to sell their house for more than they owed and make a profit.
But once prices topped out and began falling, loan defaults and foreclosures started shooting higher as homeowners found it more difficult to sell their house. This created problems not just for subprime borrowers but even for those with good credit and income.
When foreclosures rose, the value of the various types of securities tied to mortgages started to fall, causing huge losses up and down Wall Street. It also made banks less eager to extend credit because of the risks involved.
A downward spiral
This credit crunch in of itself slowed the economy, leading to job losses and more defaults, feeding a downward spiral that has been difficult to stop.
"A really bad situation -- a home price bubble bursting -- was made significantly worse when the recession began," said Achuthan. "Now we have to let this thing play out."
Some experts even argue that the steps being taken to rescue firms like AIG could make a recovery in housing and the broader economy more difficult, as financial firms and investors become more reluctant to lend money.
"We are certainly taking credit and squeezing it tighter and tighter," said Kevin Giddis, managing director of investment bank Morgan Keegan. "Housing needs buyers. Buyers need credit."
Achuthan said that even though rates for mortgages and other types of loans have fallen in the last two weeks, those loans are becoming more difficult for many consumers and businesses to get because banks are severely tightening their lending standards.
And if housing prices do fall further, that will only cause more losses in the financial sector and perhaps more failures of banks, insurers and securities firms.
"I would hesitate to say the worst is behind us," Achuthan said.
So even with perhaps hundreds of billions of tax dollars going to AIG, Fannie and Freddie, one expert said the only real solution to the housing problem is for the correction in housing to finish running its course.
"We want home prices to return to normal," said Barry Ritholtz, CEO of Fusion IQ and author of the upcoming book "Bailout Nation."
"Until that happens, you can throw as much money at the market as you want at the situation....and it ain't going to make any difference," Ritholtz said.
But in the end, it all comes back to one issue - housing.
Earlier this decade, it was much easier to get a mortgage. Home prices soared about 85% from 1996 through 2006 in inflation-adjusted dollars, creating a bubble.
Then the bubble popped. And the fallout isn't over yet, experts say.
In the past two weeks, the government took over Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), Lehman Brothers (LEH, Fortune 500) filed for bankruptcy and Merrill Lynch (MER, Fortune 500) sold itself to Bank of America (BAC, Fortune 500).
If all that weren't enough, the Federal Reserve announced late Tuesday night that it was loaning $85 billion to insurer American International Group (AIG, Fortune 500).
None of this would have happened if the housing market had not imploded, leaving all these firms with staggering losses from their investments tied to mortgages.
"These institutions, which weathered all kinds of calamities before, including depressions, are being knocked out," said Lakshman Achuthan, the managing director of the Economic Cycle Research Institute. "It's a testament to the significance of the problem we have here."
Thus, experts agree that there are likely to be future shocks to the financial system until the housing market finally hits bottom.
Even Treasury Secretary Henry Paulson, the administration's point man in the many rescue discussions of the past month, admits this.
"The housing correction poses the biggest risk to our economy," Paulson said the day he announced the Fannie and Freddie seizure. "Our economy and our markets will not recover until the bulk of this housing correction is behind us."
The problem of falling home prices
But because of the depth of the housing problems, it may take a long time before real estate prices head higher again. Here's why.
Home prices, while sharply off from the 2006 peaks, are still high in comparison to long-term gains in income, rents or overall prices, suggesting that they still have a way to fall, according to experts.
The reason housing is wreaking havoc even on insurers like AIG and big investment banks, who do not make mortgage loans, is that during the boom, trillions of dollars of mortgages were packaged together into securities that promised to pay investors with the proceeds of those loan payments.
Those securities paid better rates than other types of assets during the boom years. So many investors from around the globe poured as much money as they could into those securities.
Faced with this demand, lenders starting making more loans to riskier borrowers, including people who might not be able to afford their mortgage payments in the future and even many with no proof of income.
When prices were rising, this wasn't a problem. The risk of loan foreclosure or default was limited because many homeowners were able to sell their house for more than they owed and make a profit.
But once prices topped out and began falling, loan defaults and foreclosures started shooting higher as homeowners found it more difficult to sell their house. This created problems not just for subprime borrowers but even for those with good credit and income.
When foreclosures rose, the value of the various types of securities tied to mortgages started to fall, causing huge losses up and down Wall Street. It also made banks less eager to extend credit because of the risks involved.
A downward spiral
This credit crunch in of itself slowed the economy, leading to job losses and more defaults, feeding a downward spiral that has been difficult to stop.
"A really bad situation -- a home price bubble bursting -- was made significantly worse when the recession began," said Achuthan. "Now we have to let this thing play out."
Some experts even argue that the steps being taken to rescue firms like AIG could make a recovery in housing and the broader economy more difficult, as financial firms and investors become more reluctant to lend money.
"We are certainly taking credit and squeezing it tighter and tighter," said Kevin Giddis, managing director of investment bank Morgan Keegan. "Housing needs buyers. Buyers need credit."
Achuthan said that even though rates for mortgages and other types of loans have fallen in the last two weeks, those loans are becoming more difficult for many consumers and businesses to get because banks are severely tightening their lending standards.
And if housing prices do fall further, that will only cause more losses in the financial sector and perhaps more failures of banks, insurers and securities firms.
"I would hesitate to say the worst is behind us," Achuthan said.
So even with perhaps hundreds of billions of tax dollars going to AIG, Fannie and Freddie, one expert said the only real solution to the housing problem is for the correction in housing to finish running its course.
"We want home prices to return to normal," said Barry Ritholtz, CEO of Fusion IQ and author of the upcoming book "Bailout Nation."
"Until that happens, you can throw as much money at the market as you want at the situation....and it ain't going to make any difference," Ritholtz said.
Wednesday, September 17, 2008
Nobel Prize winner's ideas on how to fix the economy
NEW YORK (CNN) -- Many seem taken aback by the depth and severity of the current financial turmoil. I was among several economists who saw it coming and warned about the risks.
There is ample blame to be shared; but the purpose of parsing out blame is to figure out how to make a recurrence less likely.
President Bush famously said, a little while ago, that the problem is simple: Too many houses were built. Yes, but the answer is too simplistic: Why did that happen?
One can say the Fed failed twice, both as a regulator and in the conduct of monetary policy. Its flood of liquidity (money made available to borrow at low interest rates) and lax regulations led to a housing bubble. When the bubble broke, the excessively leveraged loans made on the basis of overvalued assets went sour.
For all the new-fangled financial instruments, this was just another one of those financial crises based on excess leverage, or borrowing, and a pyramid scheme.
The new "innovations" simply hid the extent of systemic leverage and made the risks less transparent; it is these innovations that have made this collapse so much more dramatic than earlier financial crises. But one needs to push further: Why did the Fed fail?
First, key regulators like Alan Greenspan didn't really believe in regulation; when the excesses of the financial system were noted, they called for self-regulation -- an oxymoron.
Second, the macro-economy was in bad shape with the collapse of the tech bubble. The tax cut of 2001 was not designed to stimulate the economy but to give a largesse to the wealthy -- the group that had been doing so well over the last quarter-century.
The coup d'grace was the Iraq War, which contributed to soaring oil prices. Money that used to be spent on American goods now got diverted abroad. The Fed took seriously its responsibility to keep the economy going.
It did this by replacing the tech bubble with a new bubble, a housing bubble. Household savings plummeted to zero, to the lowest level since the Great Depression. It managed to sustain the economy, but the way it did it was shortsighted: America was living on borrowed money and borrowed time.
Finally, at the center of blame must be the financial institutions themselves. They -- and even more their executives -- had incentives that were not well aligned with the needs of our economy and our society.
They were amply rewarded, presumably for managing risk and allocating capital, which was supposed to improve the efficiency of the economy so much that it justified their generous compensation. But they misallocated capital; they mismanaged risk -- they created risk.
They did what their incentive structures were designed to do: focusing on short-term profits and encouraging excessive risk-taking.
This is not the first crisis in our financial system, not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs. There is a pattern here, one that suggests deep systemic problems -- and a variety of solutions:
1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. We should mitigate the incentives for excessive risk-taking and the short-term focus that has so long prevailed, for instance, by requiring bonuses to be paid on the basis of, say, five-year returns, rather than annual returns.
2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for "human consumption." Consenting adults should be given great freedom to do whatever they want, but that does not mean they should gamble with other people's money. Some may worry that this may stifle innovation. But that may be a good thing considering the kind of innovation we had -- attempting to subvert accounting and regulations. What we need is more innovation addressing the needs of ordinary Americans, so they can stay in their homes when economic conditions change.
3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.
4. We need to impose other regulations to improve the safety and soundness of our financial system, such as "speed bumps" to limit borrowing. Historically, rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception.
5. We need better consumer protection laws, including laws that prevent predatory lending.
6. We need better competition laws. The financial institutions have been able to prey on consumers through credit cards partly because of the absence of competition. But even more importantly, we should not be in situations where a firm is "too big to fail." If it is that big, it should be broken up.
These reforms will not guarantee that we will not have another crisis. The ingenuity of those in the financial markets is impressive. Eventually, they will figure out how to circumvent whatever regulations are imposed. But these reforms will make another crisis of this kind less likely, and, should it occur, make it less severe than it otherwise would be.
The opinions expressed in this commentary are solely those of the writer.
Editor's note: Joseph E. Stiglitz, professor at Columbia University, was awarded the Nobel Prize in Economics in 2001 for his work on the economics of information and was on the climate change panel that shared the Nobel Peace Prize in 2008. Stiglitz, a supporter of Barack Obama, was a member and later chairman of the Council of Economic Advisers during the Clinton administration before joining the World Bank as chief economist and senior vice president. He is the co-author with Linda Bilmes of the "Three Trillion Dollar War: The True Costs of the Iraq Conflict."
There is ample blame to be shared; but the purpose of parsing out blame is to figure out how to make a recurrence less likely.
President Bush famously said, a little while ago, that the problem is simple: Too many houses were built. Yes, but the answer is too simplistic: Why did that happen?
One can say the Fed failed twice, both as a regulator and in the conduct of monetary policy. Its flood of liquidity (money made available to borrow at low interest rates) and lax regulations led to a housing bubble. When the bubble broke, the excessively leveraged loans made on the basis of overvalued assets went sour.
For all the new-fangled financial instruments, this was just another one of those financial crises based on excess leverage, or borrowing, and a pyramid scheme.
The new "innovations" simply hid the extent of systemic leverage and made the risks less transparent; it is these innovations that have made this collapse so much more dramatic than earlier financial crises. But one needs to push further: Why did the Fed fail?
First, key regulators like Alan Greenspan didn't really believe in regulation; when the excesses of the financial system were noted, they called for self-regulation -- an oxymoron.
Second, the macro-economy was in bad shape with the collapse of the tech bubble. The tax cut of 2001 was not designed to stimulate the economy but to give a largesse to the wealthy -- the group that had been doing so well over the last quarter-century.
The coup d'grace was the Iraq War, which contributed to soaring oil prices. Money that used to be spent on American goods now got diverted abroad. The Fed took seriously its responsibility to keep the economy going.
It did this by replacing the tech bubble with a new bubble, a housing bubble. Household savings plummeted to zero, to the lowest level since the Great Depression. It managed to sustain the economy, but the way it did it was shortsighted: America was living on borrowed money and borrowed time.
Finally, at the center of blame must be the financial institutions themselves. They -- and even more their executives -- had incentives that were not well aligned with the needs of our economy and our society.
They were amply rewarded, presumably for managing risk and allocating capital, which was supposed to improve the efficiency of the economy so much that it justified their generous compensation. But they misallocated capital; they mismanaged risk -- they created risk.
They did what their incentive structures were designed to do: focusing on short-term profits and encouraging excessive risk-taking.
This is not the first crisis in our financial system, not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs. There is a pattern here, one that suggests deep systemic problems -- and a variety of solutions:
1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. We should mitigate the incentives for excessive risk-taking and the short-term focus that has so long prevailed, for instance, by requiring bonuses to be paid on the basis of, say, five-year returns, rather than annual returns.
2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for "human consumption." Consenting adults should be given great freedom to do whatever they want, but that does not mean they should gamble with other people's money. Some may worry that this may stifle innovation. But that may be a good thing considering the kind of innovation we had -- attempting to subvert accounting and regulations. What we need is more innovation addressing the needs of ordinary Americans, so they can stay in their homes when economic conditions change.
3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.
4. We need to impose other regulations to improve the safety and soundness of our financial system, such as "speed bumps" to limit borrowing. Historically, rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception.
5. We need better consumer protection laws, including laws that prevent predatory lending.
6. We need better competition laws. The financial institutions have been able to prey on consumers through credit cards partly because of the absence of competition. But even more importantly, we should not be in situations where a firm is "too big to fail." If it is that big, it should be broken up.
These reforms will not guarantee that we will not have another crisis. The ingenuity of those in the financial markets is impressive. Eventually, they will figure out how to circumvent whatever regulations are imposed. But these reforms will make another crisis of this kind less likely, and, should it occur, make it less severe than it otherwise would be.
The opinions expressed in this commentary are solely those of the writer.
Editor's note: Joseph E. Stiglitz, professor at Columbia University, was awarded the Nobel Prize in Economics in 2001 for his work on the economics of information and was on the climate change panel that shared the Nobel Peace Prize in 2008. Stiglitz, a supporter of Barack Obama, was a member and later chairman of the Council of Economic Advisers during the Clinton administration before joining the World Bank as chief economist and senior vice president. He is the co-author with Linda Bilmes of the "Three Trillion Dollar War: The True Costs of the Iraq Conflict."
Friday, September 5, 2008
Grim Economy for new Grads
It's a grim economy for new grads
Not only are choices fewer for this year's business grads, some studies suggest those launching careers during 2008's downturn may face years -- or a lifetime -- of lower earnings.
By early February, when Casey Quinn interviewed at Morgan Stanley for an internship, the handwriting was on the wall.
Global stocks had lost $5 trillion in the first few weeks of the year, and the U.S. economy appeared to be on the verge of a recession. So when Morgan told Quinn "no thanks," the 25-year-old MBA student at Washington University in St. Louis went to plan B.
Quinn shelved his dreams of working on Wall Street and took an internship at Mattel, which he hopes will lead to a permanent job after graduation. Says the aspiring chief financial officer: "There's more than one way to skin a cat."
Gone are the days when B-schoolers had the luxury of choosing from among a half-dozen internships or job offers. As the class of 2008 prepares to graduate, an uncertain business climate is forcing students to make difficult career choices that could have long-term economic consequences.
A lifetime of lower earnings? A growing body of research on MBAs and undergraduates suggests that graduating into an economic downturn will substantially reduce lifetime earnings -- in some cases by millions of dollars.
So far the recruiting environment isn't nearly as bad as it was during the 2001 downturn, when MBA grads accepted offers only to have them rescinded. Still, for students at the University of Rochester's business school, salary offers are trending modestly downward.
And big financial-services firms are taking on fewer newly minted MBAs. At Citigroup, such job offers are down 10% to 15% overall, according to Caitlin McLaughlin, the global head of campus recruiting. "We'll err on the side of caution," she says.
For many new college grads, though, the real problems will come later than this summer -- much later. One 2006 study said Canadian college students graduating in a downturn earned about 6% less for the first decade of their careers.
Another study, examining the impact of the 1982 recession on U.S. undergrads, revealed that every percentage-point increase in the unemployment rate at graduation translates into a 7% to 8% initial wage loss. The gap closes over time but lasts at least 13 years. Lisa Kahn, a Harvard University doctoral candidate who authored the study, said recessionary grads had difficulty switching to better jobs after the economy picked up.
High stakes for students Billy Tilson knows what it's like to wander in the wilderness. He took a job with PricewaterhouseCoopers after graduating from the University of Virginia in 2000 but was laid off after eight months. For three years he got by on unemployment and $20-an-hour contract jobs before landing a position with a consulting firm in Richmond, Va.
Looking back, Tilson, 30, says, "I felt like I was doing something wrong."
For MBA students, the stakes are even higher. Paul Oyer, an associate professor at Stanford, combed the job histories of Stanford University MBAs who graduated from 1960 to 1995 and said those attending business school during a bull market were more likely to pursue careers in investment banking. As a result, they earned far more over the course of their careers -- $1.5 million to $5 million more -- than they would have in other professions.
"If you graduate in a recession, you're likely to work in a different (industry)," Oyer says. "That will take you down a different track for the rest of your life."
As fatalistic as that sounds, there is a way for students to escape the boom-and-bust cycle: Stay in school till the economy picks up. It will cost you in the short run, but in the long run, Kahn and Oyer say, graduating in a bull market will more than make up for it.
This article was reported and written by Louis Lavelle for BusinessWeek.
Not only are choices fewer for this year's business grads, some studies suggest those launching careers during 2008's downturn may face years -- or a lifetime -- of lower earnings.
By early February, when Casey Quinn interviewed at Morgan Stanley for an internship, the handwriting was on the wall.
Global stocks had lost $5 trillion in the first few weeks of the year, and the U.S. economy appeared to be on the verge of a recession. So when Morgan told Quinn "no thanks," the 25-year-old MBA student at Washington University in St. Louis went to plan B.
Quinn shelved his dreams of working on Wall Street and took an internship at Mattel, which he hopes will lead to a permanent job after graduation. Says the aspiring chief financial officer: "There's more than one way to skin a cat."
Gone are the days when B-schoolers had the luxury of choosing from among a half-dozen internships or job offers. As the class of 2008 prepares to graduate, an uncertain business climate is forcing students to make difficult career choices that could have long-term economic consequences.
A lifetime of lower earnings? A growing body of research on MBAs and undergraduates suggests that graduating into an economic downturn will substantially reduce lifetime earnings -- in some cases by millions of dollars.
So far the recruiting environment isn't nearly as bad as it was during the 2001 downturn, when MBA grads accepted offers only to have them rescinded. Still, for students at the University of Rochester's business school, salary offers are trending modestly downward.
And big financial-services firms are taking on fewer newly minted MBAs. At Citigroup, such job offers are down 10% to 15% overall, according to Caitlin McLaughlin, the global head of campus recruiting. "We'll err on the side of caution," she says.
For many new college grads, though, the real problems will come later than this summer -- much later. One 2006 study said Canadian college students graduating in a downturn earned about 6% less for the first decade of their careers.
Another study, examining the impact of the 1982 recession on U.S. undergrads, revealed that every percentage-point increase in the unemployment rate at graduation translates into a 7% to 8% initial wage loss. The gap closes over time but lasts at least 13 years. Lisa Kahn, a Harvard University doctoral candidate who authored the study, said recessionary grads had difficulty switching to better jobs after the economy picked up.
High stakes for students Billy Tilson knows what it's like to wander in the wilderness. He took a job with PricewaterhouseCoopers after graduating from the University of Virginia in 2000 but was laid off after eight months. For three years he got by on unemployment and $20-an-hour contract jobs before landing a position with a consulting firm in Richmond, Va.
Looking back, Tilson, 30, says, "I felt like I was doing something wrong."
For MBA students, the stakes are even higher. Paul Oyer, an associate professor at Stanford, combed the job histories of Stanford University MBAs who graduated from 1960 to 1995 and said those attending business school during a bull market were more likely to pursue careers in investment banking. As a result, they earned far more over the course of their careers -- $1.5 million to $5 million more -- than they would have in other professions.
"If you graduate in a recession, you're likely to work in a different (industry)," Oyer says. "That will take you down a different track for the rest of your life."
As fatalistic as that sounds, there is a way for students to escape the boom-and-bust cycle: Stay in school till the economy picks up. It will cost you in the short run, but in the long run, Kahn and Oyer say, graduating in a bull market will more than make up for it.
This article was reported and written by Louis Lavelle for BusinessWeek.
Thursday, September 4, 2008
Option Arm Loans
NEW YORK (CNNMoney.com) -- They're known as "pick-a-payment" mortgages or option ARMs, but their detractors call them pure poison. Now their default rates, which are already high, are about to explode, according to a Fitch Ratings report issued Tuesday.
Option ARMs are loans that allow borrowers to make very low minimum payments that don't even cover the interest for the loans. The difference is then added to the mortgage balance, which grows every month.
There are about one million option ARMs outstanding, according to Fitch, and somewhere between 10% and 24% of these are seriously delinquent - 90 days or more past due.
But payments are slated to jump for large numbers of option ARM borrowers in the next two years, which Fitch predicts will double that delinquency rate.
"These things have their own private hell," said Keith Gumbinger of HSH Associates, a publisher of mortgage information. "The reset trigger is absolutely coming."
Borrowers who take out option ARM loans have four payment options. They can make the minimum payment, which doesn't cover all of the interest; an interest-only payment; a payment that pays off the loans in 30 years; or one that would pay it off in 15 years.
The problem is most borrowers pay just the minimum. According to First American LoanPerformance, which tracks the mortgage market, more than 65% of option ARM borrowers make only minimum payments every month. They can continue to do that for up to five years, or until their loan balance reaches 110% to 125% of the original principal.
After that, borrowers have to start paying at a higher rate that will pay down their principal, which can mean skyrocketing monthly payments. Fitch estimates that the average borrower's bill will increase 63% from $1,672 to $2,735.
As a result, Fitch predicts defaults on these loans will double, adding to the nation's already soaring foreclosure rates.
Scale of the problem
During the boom, option ARMs were often the only way that borrowers could buy wildly appreciating real estate. Indeed, lenders actually approved these loans based only on whether borrowers could afford to make the minimum payments.
Homeowners were counting on the fact that the value of their property would continue to soar, so that they could either refinance or sell when the minimum payment option expired.
Fitch reported that of the $200 billion in option ARMs outstanding, $29 billion worth will convert to what are called "fully amortizing loans," with payments that will reduce the loan balances, by the end of 2009. Another $67 billion will convert to fully amortizing loans through the end of 2010. That represents nearly half a million borrowers.
And, although option ARMs make up only a little more than 2% of all mortgages outstanding, they were concentrated in some of the most over-heated housing markets, which are now suffering heavy price losses.
With property values dropping 20% or 30%, many of these homeowners will be severely "upside-down" on their mortgages, owing much more than their homes are worth. Borrowers could find themselves owing $500,000 on houses worth only $300,000.
Refinancing such option ARM loans into fixed rate mortgages would be very difficult. Lenders won't issue a mortgage for more than the appraised value of a property, so someone with a $500,000 loan on a $300,000 house would have to pony up more than $200,000. If they can't they could lose their homes.
Even homeowners who could afford to continue to make the increased payments may decide that continuing to do so makes little financial sense, and just walk away from their mortgages.
"Your payment is going to go up exponentially," said Gumbinger, "and your ability to pay will not. You just might chuck your keys in an envelope and mail it to your bank."
Option ARMs are loans that allow borrowers to make very low minimum payments that don't even cover the interest for the loans. The difference is then added to the mortgage balance, which grows every month.
There are about one million option ARMs outstanding, according to Fitch, and somewhere between 10% and 24% of these are seriously delinquent - 90 days or more past due.
But payments are slated to jump for large numbers of option ARM borrowers in the next two years, which Fitch predicts will double that delinquency rate.
"These things have their own private hell," said Keith Gumbinger of HSH Associates, a publisher of mortgage information. "The reset trigger is absolutely coming."
Borrowers who take out option ARM loans have four payment options. They can make the minimum payment, which doesn't cover all of the interest; an interest-only payment; a payment that pays off the loans in 30 years; or one that would pay it off in 15 years.
The problem is most borrowers pay just the minimum. According to First American LoanPerformance, which tracks the mortgage market, more than 65% of option ARM borrowers make only minimum payments every month. They can continue to do that for up to five years, or until their loan balance reaches 110% to 125% of the original principal.
After that, borrowers have to start paying at a higher rate that will pay down their principal, which can mean skyrocketing monthly payments. Fitch estimates that the average borrower's bill will increase 63% from $1,672 to $2,735.
As a result, Fitch predicts defaults on these loans will double, adding to the nation's already soaring foreclosure rates.
Scale of the problem
During the boom, option ARMs were often the only way that borrowers could buy wildly appreciating real estate. Indeed, lenders actually approved these loans based only on whether borrowers could afford to make the minimum payments.
Homeowners were counting on the fact that the value of their property would continue to soar, so that they could either refinance or sell when the minimum payment option expired.
Fitch reported that of the $200 billion in option ARMs outstanding, $29 billion worth will convert to what are called "fully amortizing loans," with payments that will reduce the loan balances, by the end of 2009. Another $67 billion will convert to fully amortizing loans through the end of 2010. That represents nearly half a million borrowers.
And, although option ARMs make up only a little more than 2% of all mortgages outstanding, they were concentrated in some of the most over-heated housing markets, which are now suffering heavy price losses.
With property values dropping 20% or 30%, many of these homeowners will be severely "upside-down" on their mortgages, owing much more than their homes are worth. Borrowers could find themselves owing $500,000 on houses worth only $300,000.
Refinancing such option ARM loans into fixed rate mortgages would be very difficult. Lenders won't issue a mortgage for more than the appraised value of a property, so someone with a $500,000 loan on a $300,000 house would have to pony up more than $200,000. If they can't they could lose their homes.
Even homeowners who could afford to continue to make the increased payments may decide that continuing to do so makes little financial sense, and just walk away from their mortgages.
"Your payment is going to go up exponentially," said Gumbinger, "and your ability to pay will not. You just might chuck your keys in an envelope and mail it to your bank."
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