“Faith-based investing” and total economic collapse

By Martin Bosworth

In looking at the various examples of bad economic news over the last few days, I’ve been struck once again by how the supposedly rational, logical, God-forbid-we-regulate-it-because-it-works-fine-on-its-own free market is driven by the very human fears, frailties, and stupidities that govern so much else of human life.

It’s pretty amazing, for instance, to watch Treasury Secretary Hank Paulson saber-rattle China over its trade policies and reiterate the health of the American economy while his own former firm’s hedge funds are getting kicked in the nuts. Or that Federal Reserve Chairman Ben Bernanke could repeatedly state that the failures in the American subprime mortgage lending market could be “contained,” even as the global markets are pumping out new money like blood transfusions while the credit crunch jitters extend across the world.

These are perfect examples of what I like to call “faith-based investing,” the belief that somehow you’ll be able to ignore or overcome decades of economic advice, market indicators from the world over, and your own common sense, and strike it rich in risky investment areas that promise huge profits for little work. That’s how the housing bubble was created–people were encouraged to buy into the market using “creative” mortgage products, lying about their income and assets and clicking their heels together in the hopes of selling their homes before the ARM reset to a much higher rate, or bringing in enough income to pay for it.

And the lenders and brokers were no better, as this column from CreditBloggers succinctly notes:

What happened with the subprime lenders was that they simply threw out the rule books altogether. The executives and other employees became so addicted to the massive amounts of money they were making, – two, three, four times or more than what ethical lenders were earning on comparable loans – that they just didn’t want to quit. They would approve anything!

As long as the money kept coming in, everyone–from borrowers to sellers to lenders to brokers to executives–fooled themselves into thinking the profits would last forever and that the American economy (and the global economy by extension) could enjoy healthy growth and strength based solely on the real estate industry. Now that the markets are tanking, the house of cards is tumbling, and the futures are seeing everything from more cash transfusions to the possibility of the Federal Reserve lowering interest rates to spur more lending and borrowing. Yeah, because that worked so well this last time around.

In the end, this will probably require some kind of government bailout to prevent total economic collapse, which will make me laugh heartily the next time someone yaps about how regulation stifles economic growth or whatever. But as Ian Welsh from the Agonist notes, even if we pull off another miracle bailout this time, the underlying problems won’t go away, and we’ll just be in a set of worse circumstances next time.

That’s what happens in “faith-based investing,” when you forget everything you know (or never learned) about how money and economics works, click your heels, and take incredibly stupid risks with your money (or other people’s money) just to earn fat bonuses, commissions, or capital-gains free home sales profits. Because it always bounces back in the end.


14 replies »

  1. There doesn’t need to be any government intervention. Hedge funds and derivatives are doing what they’re supposed to do.

    The US is the only country that seems to have enjoyed these Ninja bonds (No Income No Job or Assets) and, in any case, the people that will be hurt are the investors – the idiots who thought that unsecured loans were a good idea. So far, while various hedge funds have been hit hard (or bankrupted) the pain hasn’t been nearly as disruptive as, say, when the dotcom bubble burst.

    It’s the regulations you have to watch out for. If the US gets all protectionist against China (or India, for off-shoring) then, not only will jobs be lost in China (and India) but US consumers will be hit even harder by dramatically rising prices as all those savings on imports are undone. Along with regulations chasing out low-wage immigrants, inflation could get very nasty indeed.

    Caveat Emptor … and let the speculators learn their lesson and lick their wounds. But don’t, under any circumstances, intervene to prop up the losers. That will hurt everyone.

  2. Gavin,

    I realize that you have this bubble of purely theoretical libertarianism that blocks out actual economic activity from reaching you at times, but you’re fooling yourself if you think this is that cut-and-dried.

    The job losses from the subprime collapse already number in the thousands–many of these companies have already filed for Chapter 13 bankruptcy to protect themselves and sell off their assets while their employees are out pounding the pavement. Foreclosure numbers in America are at well over 920,000–and that’s just for the first six months of the year. Homebuilders, designers, even auto makers are all being affected by the collapse of this one sector. It is by no means contained.

    There will be a bailout, just like Black Monday in 1987, and regulation, just like the S&L scandals in the late 80s, and the flippers and specuvestors will move on to the next unobserved sector of the economy to print up more fake money and bamboozle more people out of their savings. The real criminals always go unpunished.

  3. Gavin,

    You’re totally arguing something different than what I am. Did you start taking discourse lessons from Threebells? 🙂

    The point isn’t the U.S. saber-rattling. That’s bullshit and we all know it. Paulson’s predecessor, John Snow, went to China with the platform that consisted mostly of “Spend more, save less, and start using credit cards.” They basically laughed him out of the meeting, and he went back to bilking the government out of millions for his train company and running one of those shady hedge funds you love so much.

    The posturing isn’t what matters. What matters are the real foreclosures and investment losses, happening to real people, right now, as we speak.

  4. Pingback:
  5. Martin, I agree – it is about the real foreclosures happening to people right now. But let’s contextualise this.

    A person who buys a house on credit does not own that house; the bank does. If the person bought the house without considering their own ability to afford that house then one can certainly question the bank’s lending policies but what? The person who took out the loan has no culpability at all?

    They do not own the house. If they cannot afford their payments they have not lost the house, it was never theirs. That they are still liable for interest payments and any shortfall in the sale of the house is the consequence of their own poor investment decision.

    If I, an entrepreneur, borrow money to start a new business and it fails who should bear the cost of that failure? Society? Or me, for making a questionable investment?

    The only way “some kind of government bailout” can take place is to raise taxes (i.e. penalise people who didn’t make bad investments) or to demand that other countries continue to extend cheap credit to Americans (i.e. take on your debts to minimise your pain).

    It seems to me that the people who took out loans – no matter how misguided the thinking was of the people who lent it to them – have the primary responsibility here. No-one forces you to take credit.

    Credit is not free money. Anyone who takes it, just because it’s easy to get, without thinking of the need to pay it back has only themselves to blame when it all goes wrong.

    That is harsh, but it is a necessary lesson. Who should be punished for your mistakes? Other people?

    The real “faith-based investing” was by the borrower who thought a miracle would happen to separate the money they borrowed from their own lack of capacity to pay it back.

  6. Gavin,

    That libertarian lens of yours is causing you to misread what I’m saying again. I’m not advocating a bailout, necessarily–like you, I don’t have much sympathy for people who knowingly refinanced into risky loans with the expectation that home prices would rise enough that they could sell and avoid the consequences. As Sam and I discussed in an earlier thread, the mass rise of foreclosures around the country will give many people the opportunity to buy distressed homes more cheaply than they would’ve otherwise,

    But people (like markets) are not rational and often make dumb decisions because they simply don’t know enough. Not everyone is a credit or financial genius–hell, I can probably out-argue half of these idiots claiming they couldn’t have predicted this collapse–and these mortgage agreements are often written in incredibly complex, indecipherable language. Put more simply, a lot of people got conned, and that is not something we should just look away from.

    And again, any economic collapse of this nature won’t just affect one sector of one market–it affects EVERYTHING in a global economy. When pension or retirement fund managers put their investors’ money into risky hedge funds that are propped up by crappy loans, and those loans go bad, what happens then? Should we blame the investors, who probably didn’t even know it was happening–or the managers who caused it? I know who I pick.

    Here’re two articles taking a point/counterpoint to this issue, as we are. Max Sawicky, for instance, feels much as you do:

    Jared Bernstein explains how these collapses can absolutely effect larger portions of the economy:

  7. As far as effecting the global economy is concerned, well there we’re in accord. The Johannesburg Stock Exchange has dropped about 5 – 10% in the last week.

    I’ve said before, though, where there is outright fraud it must be investigated and the people concerned punished accordingly. However, most of this cheap debt thing was done with the best of intentions. And we know how good intentions sometimes work out.

    I think that steps are already being taken. I’m sure – as here – it is much harder to get home-loans right now. I’m sure that easy credit rules have been tightened by banks already contemplating over-extended balance sheets.

    Your Fed will watch carefully and adjust interest rates if things start overcooking too badly. As will the EU Central Bank, and others. Our own Reserve Bank is likely to raise interest rates next week to further put a damper on cheap credit.

    In other words, where we differ is that I think that markets already have the tools to react to something like this. I also think that the cavalier attitude to hedge funds and other marketed securities is going to be met with a bit more scepticism.

    These were all slick new financial instruments. They do work well (many economists have remarked that they have significantly limited the extent of the damage) however, they are also capable of abuse – hence some spectacular collapses.

    Now we know. Like the collapse of Bearings Bank (more than a decade ago) investors put systems in place following these messes to counteract and ensure that they don’t happen again.

    I doubt severely that investment banks chose to lose their investors money deliberately. And, where some have been criminally negligent, there are sufficient laws to investigate and punish without having to rush through any new ones. Last I heard the US wasn’t suffering from any critical shortage of big-trial lawyers wanting to take on corporate interests.

    Enron this isn’t.

    Will easy credit dry up in the US? Yes, it will. Will this effect your economy (and the rest of the world)? Yes.

    But the US has some serious debt issues to work out. China is sitting on $1.3 trillion of US paper. And that’s without blaming low-cost mortgages. Time to pay this all back before it gets really ugly.

  8. I agree with you here as well–but why should we wait until *after* market failures occur to create new systems to protect those who should not be harmed? Why is the nature of the action always reactive, rather than proactive?

    And I do agree on one other point–the fact that the U.S. keeps raising its debt ceiling just to stay afloat points to a serious reckoning down the line. We could pay huge chunks of that debt down if we weren’t stuck in Iraq.

  9. Well, the reason it’s reactive is simply because you don’t know the future … unless you’re an Economist reader 😉

    It comes down to the limited tools that governments have for intervention. Central banks can control exchange rates or inflation.

    Countries usually choose to control interest rates and intervene rarely to salvage their currencies. Raise interest rates too high and you kill investment. Drop ’em too low and you get inflation. So it’s a balancing act.

    Now, you may ask, so how can we allow these weird debt instruments if we don’t know what their impact is going to be? For the same reason we allow new flavours of ice-cream and new designs of motor-car. Because they may be good. If they’re not they’ll sink.

    Think of the iPhone. People responded to it like it was religious. I mean, seriously? Queuing up to buy a consumer product? What, Apple is only going to produce a limited number? It’s not a return-from-the-dead concert joint billing The Beatles, The Doors, Elvis Presley, Jimi Henrix and Marvin Gaye for one night only.

    How exactly does a free-market state intervene to stop Apple creating this type of hype and frenzy?

    And how does a government stop people taking out home-loans because they’re too cheap and have too easy terms for acceptance?

    I can’t see that going down while it all seems to be going well, but after it’s fallen apart everyone saw it coming and wants it stopped.

    Technically it’s Bernanke’s problem. Let’s see how he deals with it.

  10. The true problem here is the pump and dump tactic used by the Fed to create permanent debtors. They (the Fed) loosened up lending standards until a bubble developed in real estate. They knew that the ARMs would pop the bubble by causing a retraction in lending once they began to default. The foreclosures and speculators dumping properties to avoid property taxes will cause massive devaluation. This all results in people not being able to sell their homes for what they bought them for therefore creating massive debt for each person stuck in their home. Combine this with high interest credit cards, the doubling of minimum payments, and new bankruptcy laws and you have a perfect storm that was engineered by the Federal Reserve to destroy the average American. THIS WAS ENGINEERED. While our country will be destroyed financially, the other target will be China. Without us, they will not have enough time to replace the US consumer which will cause massive turmoil and revolt. China is already bordering on collapse from their one billion poor citizens being raped for the benefit of the other 200 million citizens. Within 12 to 24 months, the world may be one we do not recognize.

  11. This is the first article I have read here. And, I most certainly haven’t had the time to follow all the links in just this story. I am wondering if folks here have looked at what has been happening to the once vaunted American middle class over the last three decades? If so, please point me in the direction of such articles.

    I speak to the continuous movement of American manufacturing both to China and many other ‘developing’ countries. A process that has been rapidly accelerating over the last eight years. Without those old core industries, one’s that always had some bread and butter products to see them through economic declines, where is the purchasing power to even begin to stop the slide of the US economy, and the resultant drag on the rest of the world? Are we to believe the much vaunted ‘freedom’ of unrestrained capitalism believes we must eventually accept the 25 to 50 cents an hour wage of the Chinese worker to be competitive, without taxing wealth at a ninety percent rate to pay for housing and health care to maintain a cheap labor force?

    Some how in this grab for wealth, it seems to me there has been an assumption American consumers were always going to be able to afford the next best thing. From what I’ve read, that purchasing power, which encompassed sixty to seventy percent of the US population forty years ago, is now down to forty percent and continuing to decline. It seems to me that business here has forgotten that labor costs also represent the ability of consumers to consume the products you would choose to sell them. Let alone, does it leave consumers with the ability to repay loans on property. Though, anyone that bet on property values going up to cover their lack of liqidity…. (no comment)

    As it now stands, our economy has been standing on it’s military contractors, the remains of our auto industry, and an artificially supported boom in the housing industry. With perhaps the largest such contractor involved in the military industry fleeing the country for the Middle East, our auto industry hanging on by its eye teeth, and now the inevitable crash in the housing industry, where are the old bread and butter industries that we have fallen back upon in hard times? In short, I don’t believe we have a depression proof business left in this country. Even if the US can stabilize it’s economy, which I have considerable doubts of that feasibility, I don’t see the physical production base by which to rebuild our economy.

    From Garry…
    Just one old high school graduate setting out here between the bean and corn fields of Mid Missouri.