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Essays, Opinion, & Commentary |
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April 13, 2008
by Gary North, Ph.D.
By now, the term "liar loans" is common. Prospective house buyers provided false information to representatives of loan-initiating firms. The loan-initiating firms knew that there were people who did this, but they winked at the practice. Their well-compensated job was to pass on the paperwork to a government-created agency, either Fannie Mae or Freddie Mac, who then sold scientifically diversified packages of statistically safe mortgages to investors. Some of these investors were hedge funds. They in turn borrowed money from investment banks at up to 32-to-1 leverage (Carlyle Capital) to buy even more packages of statistically safe mortgages. Everyone was happy until reality caught up with the lying borrowers, whose meager incomes did not allow them to keep paying their monthly mortgages. The dominoes started to topple in August, 2007. The experts were caught flat-footed. The mortgage interest rate re-sets will continue through 2009. This process is barely half over. Meanwhile, a recession has appeared. From start to finish, from top to bottom, the entire structure was based on lies. It began with this one: "I'm from the government, and I'm here to help you." This is the third most widely believed lie in history, right after this:
And this:
THE GREAT AMERICAN DREAM We all remember the 1946 movie, It's a Wonderful Life. It centers around one family's funding of the great American dream: home ownership. We love the movie because it's about a man who is shown by an angel that his life really mattered. So, our lives really matter, too. We all like to believe that we also have a guardian angel, though perhaps not so incompetent as Clarence. Jimmy Stewart's nemesis was the town's banker, Mr. Potter. He was a liar and a thief, preying on sin-loving local citizens (as we see in the sequence about Pottersville) and the likes of the kindly but imbecilic Uncle Billy. Potter used the fractional reserve banking system to borrow short and lend medium. The Bedford Falls Building and Loan borrowed short and lent long. Potter was able to survive the bank run because his bank had liquid reserves and assets it could sell. The Building and Loan survived because George Bailey had liquid reserves -- his honeymoon money -- and a script writer who ended the bank run at 6 p.m. and did not let it extend to the next day, which it obviously would have done when word got out that Jimmy's honeymoon money was gone. Potter was a liar: he was lent medium. George Bailey was a much bigger liar: he was lent long. The Federal Deposit Insurance Corporation was created in 1933 by the Roosevelt Administration as part of the Glass-Steagall Act. This bailed out the mini-liars: bankers. The Savings and Loan oligopoly then pressured Congress to provide something similar, which Congress delivered: the Federal Savings & Loan Corporation was created by the National Housing Act of 1934. This bailed out the bigger liars. The American dream was extended to the masses by means of government insurance against runs by investors -- who mistakenly thought they were depositors -- in Savings & Loans. This did more to establish the economics of the carry trade -- borrowing short to lend long -- than anything in history. The investment world saw the profit potential. The carry trade has increased ever since. But who will insure the middlemen who profit from the carry trade? Who has sufficient resources to bail out the profit-seeking, loss-avoiding hedge fund entrepreneurs who decided that the interest rate spread between short-term money paid to investment banks and long-term money paid by borrowers was just too tempting. In short, who will come to the rescue of our generation of George Baileys? Congress? It did in 1986 during the S&L collapse. But the on-budget Federal deficit is running at an estimated $410 billion this year. This deficit is accelerating. Then how about the Federal Reserve System? It can swap Treasury debt for not-statistically-safe-after-all mortgages, but only until it runs out of Treasury debt, about $800 billion to go. Then it will have to create money. Lots and lots of money. LIAR, LIAR, PANTS ON FIRE We live in the FIRE economy: finance, insurance, and real estate. The crucial insurance today is Federal insurance -- explicit, implicit, and widely assumed even when legally absent. Big institutions are considered too big to fail, meaning too big for the government to allow to fail. Think Bear Stearns. So, promises made by the government serve as the ultimate back-up for the promises made by the largest carry traders. The extent of the participation of the Federal government in the residential real estate markets can be seen in the law governing liar loans. You need to read the following law. I realize that no one except lawyers reads a document like this one. It has two sentences. One of them is 291 words long. Only lawyers write sentences that are 291 words long. Nevertheless, I am asking you to read it. Here is what you should understand after you have read it. There is hardly a nook or cranny left in the residential real estate market that is not covered by this law. The extent of government control, which derives from government insurance of real estate lending, is enormous. How enormous? Read for yourself.
Did you read it? If so, I hope you noticed this passage: ". . . shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both." Here is the inescapable reality: the Federal government let the subprime disaster build up for many years. This law was never enforced. No one in the entire government-insured scam worried about it. The bureaucrats were in on the deal from day one. All of the posturing by politicians about the exploited borrowers who lost their homes -- liars -- and the need for new laws to be passed by Congress to prevent unscrupulous mortgage brokers -- liars -- from ever exploiting the poor again, and also preventing them from endangering the solvency of the nation's financial institutions -- liars -- is nothing but election-year politicking by the biggest liars of all: politicians. Do we need more laws? Hardly. A law that imposes a million-dollar fine and 30 years in jail is more than sufficient. This law's stiff penalties were supposed to make people take it seriously. But it was not taken seriously. No one ever intended to enforce the law. No one ever did. It was all posturing by the politicians. The biggest housing bubble in American history, 1995-2005, took place under the watchful eyes of the entire Federal real estate bureaucracy, the bureaucracy listed by name in the law. No one in government issued a warning. No one in government saw the bubble coming. No one in government identified it as a bubble. The appraisals were made, the loans were made, the mortgages were bought and re-packaged and sold again. The carry trade did its work. And now there is a line in front of the banks. No, scratch that. There are no lines. There are instead collapsing prices in the scientifically packaged mortgage sector because investors now see that those mortgages, rated AAA by independent firms (it says here), are in fact packages of promises to pay made by liars. Everyone knew. This is the famous bottom line. Everyone knew. Nobody cared. We live in an economy built on lies. Everyone knows. Almost nobody cares. Do you care? If so, what have you done to protect yourself? WHO INSURES THE INSURERS? The Federal Deposit Insurance Corporation insures bank accounts up to $100,000. It holds about a penny in reserve (in T-bills) for every dollar worth of insured deposits. Who insures the T-bills? The Federal Reserve System. Who insures the Federal Reserve System? No one. It doesn't need insurance. It can create money. Then who insures the purchasing power of the dollar? The central banks of the world, which hold dollars as legal reserves for their own currencies. What happens if they decide not to add to their holdings of dollars? That is the ultimate default today. If the liars known as central bankers decide that our central bank's liars are no longer to be trusted, there will be a great dumping of Treasury debt. There will be no lines in front of American banks. There will instead be rising prices for imported goods. There will be rising domestic interest rates because foreign central banks are not buying Treasury debt any longer. There will be unemployment. There will be bankruptcies. There will be defaults. Above all, there will be defaults. The lies will be exposed as lies. The promises will not be kept. When the checks from Washington no longer buy much of anything, the great political transformation will begin. The promises will not be fulfilled. I assume that you know this. The economy built on lies will fall. So will the political order. When will this take place? I don't know. But we have seen it happen in our lifetime. The Soviet Union fell in three days: August 19-21, 1991. No one predicted this. The best and the brightest in the West did not see it coming. One man suspected it and did what he could to accelerate it: John Paul II. But the politicians were universally caught flat-footed. The USSR was $140 billion in debt to the West in 1991. The West is now in debt to Russia by $500 billion. No one predicted that, either. CHOOSE YOUR LIARS CAREFULLY The modern economy is built on debt. It is therefore built on promises to pay. It is therefore built on lies. As investors, we must look at the dominoes and try to get out from under the next one to topple. If all of them topple, the division of labor will collapse. Then most of us will die. Think of a world without digital money. The trains would stop rolling. The trucks would stop rolling. The government would intervene and force some deliveries, such as coal to power plants in large cities. But the government would also have a problem: how to pay the bureaucrats and troops. So, most of us cannot plan for a complete collapse of banking. That would bring down Western civilization. We have to assume that some lies will still be accepted, that some promises will be kept. But which ones? I think it is wise to have reserves that are not digital. You can't eat digits. But if your neighbors are starving, reserves won't help much. This is why you should not try to prepare for complete collapse today. You can't afford it. I hope you have the familiar six months' of expenses in reserve. You could lose your job. If you don't, what about your spouse? Today, most American families have about 19 days' worth of expenses. The chart on this decline since the year 2000 is shocking. You must not follow the herd on this one. CONCLUSION The tissue of lies that held together the subprime market was believed by the best and the brightest. They were blind to what was coming. It has wiped out over $200 billion in assets. We are assured that the worst is over. But who assures us of this? Salaried reporters in a dying field: newspapers and network TV. The ill-informed tout the liars. We are assured that the liars know what went wrong and will not let it happen again. Re-read the liars' law. That will give you some indication of how serious the liars were. They are no more serious today. When they tell you the worst is over, batten down the hatches. Dr. Gary North earned a Ph.D. in history and is one of America's keenest economic analysts and commentators. He supports the Austrian school of economics and is a previous assistant to libertarian congressman Dr. Ron Paul. Visit his website at http://garynorth.com. To subscribe to Gary North's Reality Check go to http://www.dailyreckoning.com/sub/GetReality.cfm If you enjoyed this essay and would like to read more of Gary's writing please visit his website at http://www.garynorth.com or http://www.freebooks.com
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Enrich your life with a book about politics and current events...
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In
this report, I am going to present an astounding
document. You have not heard of it. It is at the
heart of the current residential real estate
crisis. It has to do with liar loans.
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