The Great Deformation (107 page)

Under the circumstances, Bernanke was the more dangerous, and his stint as monetary commissar made the maestro look good by comparison. Even after Greenspan surrendered his gold standard virginity in the political fleshpots of Washington, he had remained a numbers-crunching monetary experimentalist. Most certainly, he would have paused in September 2008 to ascertain why the financial system was suddenly in apparent meltdown.

By contrast, Professor Ben Bernanke was a doctrinaire academic who “knew” what was happening. Except what he knew was dead wrong. So in becoming yoked to Bernanke's calamitous error the nation was victim of a terrible fluke.

Virtually no one in the nation's capital had initially viewed the sinking stock market averages and collapsing CDOs which greeted officialdom on the morning of September 15, 2008, as a flashback to 1930–1933. Reasonably informed observers understood that the market had closed the previous Friday only 10 percent lower than where it had been in January 2007 before the subprime trouble started, and that by comparison the stock market meltdowns of 1987 and 2000–2001 had been far more severe—three to four times more severe.

Perforce, these two more recent crashes were far more pertinent to the contemporary financial system than that of 1929, and neither had led to a
depression or even a significant recession. The nation's economy, in fact, kept on growing for several years after the 30 percent stock collapse on Black Monday in 1987, and suffered only a minor hiccup during 2001–2002 in the wake of an even larger decline in the stock averages.

So Bernanke's depression mongering was on its face reckless and inexcusable, and leaves no doubt about his culpability for the fear-driven fiscal mania that soon enveloped Washington. Indeed, not one in a thousand of the politicians, policy players, and cronies who inhabited the nation's capital were in mind of the Great Depression on the morning of the Lehman event.

The threat of the Great Depression 2.0, and the madcap doubling of the Fed's balance sheet from $900 billion to $1.8 trillion during the next seven weeks, got interjected into the discourse only because Bernanke claimed to be a scholar of those seminal events. Ironically, Ben Bernanke, the full-fledged Keynesian, invoked the moral authority of Milton Friedman, the implacable anti-Keynesian, to sanction his case.

Within nine months, the empirical data would prove that what was actually happening on September 15 didn't remotely resemble the circumstances after the 1929 crash, and that the idea the nation was threatened by the Great Depression 2.0 was specious nonsense. But by then it was too late. Even if the evidence could have been properly interpreted, the nation's political system had already gone off its rails.

The folk memory of the Great Depression had been in deep hibernation, but Bernanke's invocation of it in the context of tumbling financial markets and the hysteria surrounding the passage of TARP brought it roaring out of the remote caves of financial history. The impact was incendiary; it was a full-throated cry of “Fire” in Washington's crowded theater of special interest plunder and statist projects of economic stimulus and social uplift.

The city's plodding policy machinery was electrified. The urgent project of stopping the Great Depression 2.0 was the legislative equivalent of suspending the fiscal and economic rules. Opening the floodgates to any and all measures of intervention and bailout, Bernanke's depression bugaboo thus installed crony capitalism as the conclusive algorithm of American governance.

The danger to free markets and political democracy was overwhelming. Depression fighting triggered a great doubling down by all of Washington's policy factions: monetarists, Keynesians, and Republican tax cutters alike. They all scrambled to implement more of the same when, in truth, the financial crisis was a repudiation of these very doctrines: monetarism had produced serial bubbles and had ruined capital markets; tax cutting had
generated massive public debt and deep subsidies for leveraged speculation; and Keynesianism had remained an all-purpose excuse for government spending and fiscal profligacy. Now the nation's bedraggled economy would get massive doses of all three of these poisonous medications.

MORE HOUSING BAILOUTS:

THE DISASTER WHICH WON'T QUIT

In truth, the American economy was already booby-trapped with deformations that had resulted from the application of these doctrines. The housing sector was in ruins, for example, because it had been battered by endless ministrations of the state, all of which had the purpose of overriding honest housing prices and free market choices about whether to rent or own, spend, or save, live in big houses or small, and accumulate home equity or cash it out.

As previously reviewed, Fannie and Freddie, the Federal Reserve, the tax code, and Wall Street had all conspired to preternaturally jack up housing prices by 180 percent between 1994 and 2007, thereby paving the way for a thundering crash that since then has wiped out upward of four-fifths of the bubble-era gain in many leading markets. Yet, in stubborn denial that any lesson had been learned and spurred on by Bernanke's depression bugaboo, post-crisis policy has degenerated into a mindless scramble to prop up the remnants.

Lack of homeowner skin in the game was the indelible lesson of the subprime fiasco, but the Federal Housing Administration (FHA) was soon wheeled onto the battlefield with a massively ramped-up mortgage insurance program based on up to 97 percent loan-to-value ratios (LTV). Consequently, FHA insurance exploded from $300 billion to more than $1 trillion during the four years ending in June 2011, dragging the nation's taxpayers once again directly into harm's way.

With virtually no down payment cushion, FHA insured mortgages quickly lapsed into “negative equity” as housing prices continued to fall throughout the period. An American Enterprise Institute (AEI) study recently estimated that more than half of FHA mortgages are “underwater,” meaning that as the American economy continues to flounder, borrowers will send back the keys and default rates will soar.

In fact, already nearly 17 percent of FHA's 7.6 million borrowers are delinquent, and this rate will continue to rise as the giant recent tranches of new mortgages go sour. Accordingly, the AEI study projects that the FHA fund will require a $50 billion taxpayer infusion—a prospect that is not only appalling, but also demonstrates the unrelenting hold of crony capitalism on public policy.

It is now blindingly evident that big down payments are essential to a healthy mortgage market. Even the boneheads who control congressional housing policy would not willingly embrace FHA's 97 percent LTV policy if they were not indentured to the National Association of Realtors, the mortgage bankers, the home builders, the Appraisal Institute, and the rest of the housing lobby.

Similarly, the shock stemming from the failure of Fannie and Freddie in September 2008 and the quarter-trillion-dollar price tag for its nationalization have not slowed down the government-sponsored enterprise (GSE) racket at all. In a desperate gambit to prop up housing prices, Washington nearly doubled the lending limit for qualified mortgages to $730,000. So, instead of winding down the GSEs, Washington insinuated them even more deeply into home finance. They accounted for 70 percent of all mortgages by 2011, a figure which rises to 97 percent when all government programs including FHA and Veterans Administration are considered.

There was also the home-buyers' tax credit scam, another brainchild of the Bush administration and a noisy anti–Big Government Republican senator from Georgia, Johnny Isakson. This boondoggle was utterly stupid as a policy matter, but in that benighted state it perfectly illustrates the end game of crony capitalism: it is a place where eventually there is no plausible public purpose at all. Special interest lobbies simply conduct naked raids on the treasury. In this case, the real estate brokers and home builders secured an $8,000 per household tax credit for so-called “first-time” buyers in a desperate attempt to stimulate churn in a housing market that was otherwise dead as a doornail.

In the end, $30 billion was spent during 2009 and 2010, at a time when the federal deficit was soaring above $1 trillion, while the ranks of the poor mushroomed due to the Great Recession. Still, there was no effort to target inherently scarce federal dollars by a means test. Instead, the policy was “come one and all” for taxpayers with family incomes up to $250,000.

It is hard to think of a more capricious use of public money than to gift $8,000 to a $150,000 household, for example, that had been a serial house flipper but had wisely stayed out of the market for thirty-six months, thereby qualifying as a “first time” buyer. Beyond that, 90 percent of the 4 million taxpayers who claimed the tax credit bought existing homes, meaning that the credit directly stimulated only a tiny amount of new construction and jobs.

In fact, the program amounted to a giant, random reshuffle of the capital gains being scalped from the existing US housing stock. The evidence clearly shows that the expiration of the tax credit on a date certain caused housing transactions to be pulled forward and crest as the deadline approached.
For instance, the monthly sales rate for existing homes soared from a rock-bottom recession level of 4.3 million (annualized rate) before the tax credit incepted to a peak of nearly 7 million prior to the original November 2009 deadline, and then fell back to the recession bottom after the tax credit's final expiration.

So it might be fairly asked why $30 billion was wasted fiddling the existing housing stock turnover rate by a few months. But that would be the easy question. This artificial acceleration of housing demand also caused a temporary pause in the downward housing price correction. So when the tax credit expired the plunge resumed, meaning that last wave of proud new home buyers it had “incentivized” was instantly underwater.

This whack-a-mole effect was especially pronounced in the lower tier of the housing market. Between mid-2010 (when the final extension expired) and December 2011, housing prices in the bottom one-third of the market dropped by 20 percent in Minneapolis, 30 percent in Chicago, and 50 percent in Atlanta. Lower-end households who got lured into home ownership via the tax credit thus ended up taking it in the chops yet again.

In the boundary case of Atlanta, the decline could have amounted to $40,000 for a lower-end home purchased during the last month of the tax credit. In short, attempting to levitate the housing market in the midst of an unprecedented and unavoidably deep price correction, government intervention only arbitrarily reshuffled the deck chairs, and probably ended up luring the least financially capable households into harm's way.

Worse still, the housing lobby once again found it could bully through the Congress a raid on the treasury that on its face was implausible, but which generated as much GOP support as Democratic. Debt-free home owners and renters once more saw their less prudent neighbors get a big Washington handout.

Not least, the legions of hustlers who prowl for federal goodies were also strikingly emboldened. The subsequent fraud investigations show that the credit was claimed by 75,000 taxpayers who weren't eligible, 19,000 who didn't actually even buy a house, 1,200 that already had a home as guests of the US prison system, 500 who were minor children, 3 who were dogs, and 1 who was a four-year-old.

HOW THE FED MANGLED HOUSING EVEN MORE

The Bernanke Fed made all of these affronts to fairness and consistency seem trivial. In its money-printing madness after Lehman, the Fed has not only purchased $1 trillion in outright Treasury Department debt, but has also accumulated nearly $1 trillion of GSE mortgaged-backed securities and agency debt, or nearly 20 percent of the total outstanding. The purpose
has been straightforward; namely, to drive down the yield on mortgages and thereby levitate the moribund housing market.

Yet this blunderbuss maneuver to fix housing prices has backfired miserably. On the one hand, housing prices have remained marooned 30 percent below the peak achieved five years ago, proving that the Fed has levitated nothing. At the same time, it has forced down the yield on thirty-year GSE-guaranteed mortgages from 5.3 percent on the eve of the crisis to 3.3 percent at present, meaning that a select subset of US home owners have been afforded the opportunity to realize massive windfalls by refinancing their mortgages.

These windfalls, which have a present value of $600 billion, reflect the interest-rate rigging of the state's central banking branch, not an outcome on the free market. The proof of that lies in the nonexistent mortgage yield when taxes and inflation are taken into account. Savers in an honest market would never lend thirty-year mortgage money at 0.7 percent, yet that is the implied real after-tax mortgage yield, given that the consumer price index has increased 2.3 percent annually since the crisis.

Accordingly, the entire 2 percentage point reduction of the nominal mortgage rates engineered by the Fed since September 2008 represents a gift of the state; that is, a noxious and arbitrary transfer from saver-depositors to mortgage debtors. Given the fact that about $5 trillion of mortgages have been refinanced since the crisis, the Fed is essentially conducting a fiscal transfer of $100 billion per year from savers to households that have refinanced, often multiple times. At the same time, the giant survivors in the home mortgage market—JPMorgan Chase, Wells Fargo and Bank of America—have also captured a slice of this windfall via lucrative refinancing fees.

This refinancing binge is non-economic; it would not have happened on the free market. The Fed's money-printing policies therefore, have generated a reallocation of wealth that is mind-boggling in its pure caprice. There are about 50 million households with mortgages, but currently upward of 25 million can't refinance because they are “underwater,” or do not have enough positive equity in their homes to cover a down payment and refinancing fees. Accordingly, the serial refinancers have been drawn from the remaining pool of 25 million households which are generally more affluent or still have a decent chunk of embedded equity. Beyond that, the 35 million households which are renters and 25 million who own their homes free and clear have gotten none of the refinancing windfall, but undoubtedly have chipped into the Fed's fiscal transfer pot in their role as deposit account holders.