Retired IB’r on bailing out housing

All this makes a lot more sense to me than the drivel I’m hearing and reading elsewhere. Does this blog have the smartest readers or what?

This is something I just penned to a friend on the topic of house price corrections and the current government approach. It is long so feel free not to publish:

Housing is going to find its clearing price. It is only a question of over what timeframe the correction will happen. The government, with all its misguided policies on housing, WILL NOT stop the ongoing re-pricing of housing stock. All they will do is cause the process of price adjustment to be prolonged. They are hoping wage inflation will bail them out if they can only keep people “dancing” in their houses long enough to generate said wage inflation. I do not think they will get wage inflation in this environment of negative feedback loops (think rising unemployment). Moreover, the process of creating wage inflation has been made more difficult with the globalization of the labor pool. Finally, I believe the housing market is too big and too diverse for the government to succeed in propping up. The only thing they (policy makers) can do is find ways to slow the process, spreading the adjustment over time.

In any case, I do not think you have to take my word as to the likely success of these policy initiatives: you need only look to Japan. Housing prices (and the stock market and pricing levels in general) have fallen for fifteen years (and counting) after their real estate/credit bubble burst despite their mighty efforts to the contrary. And why did they not succeed, because they endeavored to prop up the economy through government intervention to forestall the self-correcting mechanisms of the markets. The very policies we criticized the Japanese for pursuing, we are, at least at this point, following as well.

In my view, which is obviously not shared by the current policy makers, the best approach is to deal with the pain of the current mess by ripping the band aid off quickly (instead of slowly) and then pick up the pieces, which renewed growth (which will only come when the markets reach equilibrium) will help deal with. Bad debts have to be recognized as such and written off. They only question is who takes the pain: do we privatize profits and socialize losses (our current approach) or let the private sector investors take the losses and then reconstitute the banks afterwards.

There is no hiding from the enormous pain the past sins of easy credit are afflicting on the world’s economies. The sooner we flush out the bad debts/unsustainable behaviors (both public and private) the sooner we can get back on track. Everything else is just slowly pulling off the band aid and will lead to more pain in the long run.

6 Comments

Filed under Uncategorized

6 responses to “Retired IB’r on bailing out housing

  1. Anonymous

    Retired IB’r gets in “F”. Half baked analysis. Under the current economic crisis, a laissez-faire response, which prohibits government intervention in the marketplace, would be disastrous to the US and world economy.

    This is the problem that I have with the Austrian free market camp. They argue that we should do nothing: let the free market work, let banks fail, let housing collapse, allow credit to dry up, don’t save the big three auto cos, allow thousands of companies, suppliers, dealers and retailers to go bankrupt in a domino affect, etc.

    Great. Now before we follow you into the abyss how about describing in clear deliberate terms (1) how bad it will get in this country and around the world if we follow this approach and (2) how long would we have to live under these extremely austere conditions? You never hear this part of the equation. There’s never any explanation of the harsh consequences that will be inflicted upon us all if we simply allow the world banking system to collapse. You want to unleash hell upon the entire globe and want us to believe that the hell you will cast us into will actually be good for our long term prospects but you fail to explain to the public what living in hell will entail.

    We are talking about the total collapse of the US banking system if not the world! What will be the consequences of this? What President and government would want to be responsible for worldwide unrest, anarchy, wars, famine and poverty? There will be serious consequences to a “do nothing” policy, one that seriously threatens the very fabric of our society. This is not an academic exercise. Politicians must govern and provide leadership, especially in a time of international crisis.

    How many people are willing to live in a country with (1) deflationary spiral; (2) 25% unemployment; (3) a stock market at 15% of it’s current value; (4) 35% of the US housing stock either being foreclosed upon or abandoned; (5) rapid spread of urban decay, poverty, blight and disease; (6) rampant crime; (7) significant drop in public goods and services; (8) abandonment of social welfare programs; (9) underfunded schools; (10) hedge fund, private equity and venture capital failures by the thousands, (11) generational wealth destroyed and (11) property prices at record lows (in our beloved Greenwich too). Yes, the top 3%, like me, will survive but the other 97% of this country will be screwed.

    Relatively small Lehman Bros went bankrupt on Sept 15th and entire system almost came to a screeching halt? Now we are talking about allowing behemoth AIG, Bank of America and Citigroup to fail? That happens and it takes down JP Morgan Chase, Wells Fargo and all the other banks, American Express, MasterCard, Visa, etc. Our entire capital market would come crashing down. And you think that private capital will fill in the gap? Yes, in perhaps 25 years.

    Are you guys simply playing devil’s advocate or just plain stupid?

    IB’r, provide us with details. Don’t just argue, “We should let the banks fail and after a few years we’ll come out stronger.” What will be the consequences of doing nothing? How will the world look during the recovery stage? How long will it take? How will the world look when we come out of it? Will the US remain a super power?

    • christopherfountain

      I suppose if I had any faith that the 1/4 baked plans hatched by the Washingtonians would work I’d be more sanguine. Doing nothing is often better than doing something that will make things worse. But since your approach is what’s going forward, we’ll have a chance to see how it works out. I hope you’re right and I’m wrong.

  2. anonymous

    Not aware of a more constructive, analytic (and public) proposal from any of the many rather astute hedgie billionaires like Paulson, Simons, Druckenmiller, Kovner, Jones, Lampert and others

    Suspect those drawn to public political debates self-select…and others quietly place bets in the markets (and possibly chat w/guys in Wash on occasion)

    What gives me confidence is that, in US (esp in Manhattan, Greenwich and Silicon Valley) we have far more smart hedgies (and engineers) than anywhere in world….and it seems that many equally brilliant and accomplished guys continue to offer divergent, well-informed views toward “solving” this historically complex and troubled economy

    Suspect any resolution will be post a multi-yr structural bloodbath…but needed and inevitable after a 25+yr consumer debt/consumption bubble

    Politicians need to periodically seek re-election, so will inevitably offer moronic, short-term solutions to pacify masses/media who have limited economic literacy….but laws of “economic physics” and unintended consequences are difficult to overcome

  3. Retired IB'er

    My comments are in all caps to anonymous’ post of 9:01 PM:

    Retired IB’r gets in “F”. Half baked analysis. Under the current economic crisis, a laissez-faire response, which prohibits government intervention in the marketplace, would be disastrous to the US and world economy.

    This is the problem that I have with the Austrian free market camp. They argue that we should do nothing: let the free market work, let banks fail, let housing collapse, allow credit to dry up, don’t save the big three auto cos, allow thousands of companies, suppliers, dealers and retailers to go bankrupt in a domino affect, etc.

    I NEVER SUGGESTED THE GOVERNMENT SHOULD SIT BY AND DO NOTHING. WHAT I DID SUGGEST WAS THAT THE GOVERNMENT NEEDS TO ALLOW THE MARKETS TO CLEAR, AND THEN SHOULD USE ITS BALANCE SHEET TO RECONSTITUTE/RECAPITALIZE THE BANKS AFTER INVESTORS HAVE TAKEN THE FIRSTLOSSES.

    Great. Now before we follow you into the abyss how about describing in clear deliberate terms (1) how bad it will get in this country and around the world if we follow this approach and (2) how long would we have to live under these extremely austere conditions? You never hear this part of the equation. There’s never any explanation of the harsh consequences that will be inflicted upon us all if we simply allow the world banking system to collapse. You want to unleash hell upon the entire globe and want us to believe that the hell you will cast us into will actually be good for our long term prospects but you fail to explain to the public what living in hell will entail.

    I HAVE NEWS FOR YOU HELL HAS ALREADY BEEN UNLEASHED. WHAT WE ARE TALKING ABOUT IS HOW TO DEAL WITH THE MESS CREATED BY GREEDY BANKER, GREEDY CITIZENS AND INCOMPETENT REGULATORS.

    We are talking about the total collapse of the US banking system if not the world! What will be the consequences of this? What President and government would want to be responsible for worldwide unrest, anarchy, wars, famine and poverty? There will be serious consequences to a “do nothing” policy, one that seriously threatens the very fabric of our society. This is not an academic exercise. Politicians must govern and provide leadership, especially in a time of international crisis.

    NONSENSE! SCARE TACTICS TO MOVE THE DISCUSION AWAY FROM SUBSTANCE AND INTO THE REALM OF HYSTERIA/HYPERPOLE.

    How many people are willing to live in a country with (1) deflationary spiral; (2) 25% unemployment; (3) a stock market at 15% of it’s current value; (4) 35% of the US housing stock either being foreclosed upon or abandoned; (5) rapid spread of urban decay, poverty, blight and disease; (6) rampant crime; (7) significant drop in public goods and services; (8) abandonment of social welfare programs; (9) underfunded schools; (10) hedge fund, private equity and venture capital failures by the thousands, (11) generational wealth destroyed and (11) property prices at record lows (in our beloved Greenwich too). Yes, the top 3%, like me, will survive but the other 97% of this country will be screwed.

    MORE OF THE SAME HYPERBOLE. THE MAJORITY OF THE POINTS YOU MAKE HAVE NOTHING TO DO WITH THE DISCUSSION. NO ONE IS ADVOCATING ABANDONING SOCIAL PROGRAMS, UNDER FUNDING SCHOOLS, ETC. THIS IS A DISCUSSION OF WHAT TO DO ABOUT HOUSING AND THE RECOGNITION OF LOSSES AND WHO TAKES THEM. I CAN ONLY ASSUME BY YOUR POSITION YOU MUST BE ONE OF THE GREEDY WHO WANT TO KEEP HIS PROFITS AND SOCIALIZE HIS LOSSES TO HIS FELLOW TAXPAYERS.

    Relatively small Lehman Bros went bankrupt on Sept 15th and entire system almost came to a screeching halt? Now we are talking about allowing behemoth AIG, Bank of America and Citigroup to fail? That happens and it takes down JP Morgan Chase, Wells Fargo and all the other banks, American Express, MasterCard, Visa, etc. Our entire capital market would come crashing down. And you think that private capital will fill in the gap? Yes, in perhaps 25 years.

    LEH WAS THE TRIGGER. YOU ARE LIVING IN A DREAM WORLD IF YOU THINK SAVING LEH WOULD HAVE AVOIDED THE CURRENT PROBLEMS WE ARE FACING. I WILL GRANT YOU, HOWEVER, THAT LEH’S FAILURE ACCELERATED THE CRISIS.

    Are you guys simply playing devil’s advocate or just plain stupid?

    AND NOW I WILL BE SNARKY, IF IN FACT YOU ARE IN THE TOP 3% AS YOU CLAIM, I CAN ONLY ASSUME IT IS BY VIRTUE OF MEMBERSHIP IN THE LUCKY SPERM CLUB, AS YOUR COMMENTS ARE LONG ON HYSTERIA AND COMPLETELY VOID OF SERIOUS THOUGHT.

    IB’r, provide us with details. Don’t just argue, “We should let the banks fail and after a few years we’ll come out stronger.” What will be the consequences of doing nothing? How will the world look during the recovery stage? How long will it take? How will the world look when we come out of it? Will the US remain a super power?

  4. Anonymous

    Gentlemen, please don’t pull untested economic theories out of your ass. We are talking about the potential collapse of the global economic system! I don’t think you have any empirical evidence or historical data that contemplates or can even model a global occurrence of this size and magnitude? It’s the Black Swan that every government, central bank and monetary body thought and prayed would never happen. Well, the financial tsunami is here and we must act or the sheer size of this disaster will devour us all.

    Again, tell me how bad it will get if we do nothing and for how long? What do you project would happen to unemployment, the capital markets, corporate credit, bankruptcies, housing, education, health care, crime and the poverty rate?

    Let the banks fail and chances are that most of you will be living in the streets and standing on soup lines.

  5. SizeBuyer

    Anonymous:

    This is where you can send your check if you live in CT:

    Internal Revenue Service
    P.O. Box 970011
    St. Louis, MO 63197-0011