Tuesday, February 24, 2009

4% Mandatory Mortgage Rates and 40 Year Terms. Why They Won’t Work.

This post cold easily be title “just how screwed we are.” But know that I have a suggestion that would get us out of this mess. It will have to come in a later posts, but if I can figure it out, the people on the hill are much smarter then me will. Right?

One of my favorite and most quoted cliché’s is, "common sense is often common, but rarely makes sense." This is true when listening to people make wild thoughtless suggestions on how to fix the economy. The phrases that send off my B.S. detectors are things like, "It's economics 101" or "it's about supply and demand" or "you are over complicating". First there are very few "or's" in economics and accounting. Capital generally follows the laws of conservation. For every action there is an equal and opposite reaction.

Two prevailing suggestions I have seen posted in the last week or so to "help the ailing housing market" and help out home owners are about the same. One is to lower everybody who needs it to 4% mortgage rate. The second one is to extend the mortgage out to 40 years? Neither of these things make economical sense, and/ or follows the free capital everybody is treated equally spirit of the country.

First let us address the 4% suggestion that has been going around. It basically says tell "the banks" they can only charge 4%. We will get to who "the banks" actually are at the end of the post. Let us say you got your loan and you agreed to a 7% interest rate, right? (Numbers don’t matter here really. All things are relative.) Your $100,000 loan was worth about $240,000 when the loan goes to fruition. The mortgage broker immediately sells that loan to Fannie or Freddie for about $140,000 leaving the new lender to make $100,000 profit over 30 years. (You probably didn't even send one check to your mortgage broker) Essentially Fan or Fred just paid 28.5% plus administrative cost for the loan. We could call it 3%. Quick basic math tells us the 7%-3% is only 4%. As any lender knows not everybody pays you back, and in the real-estate game for the big banks, I would think that 1% of the money lost to default would be a low norm. With today’s market that has even gotten worse. But even at just 1%. The banks are now down to needing to make 5% interest on those loans just to break even (3% they paid plus covering losses and administrative costs.) Telling them to only charge 4% is the same as telling them to close their doors. (That is a big problem we will get to later.) Also, the first 5 to 10 years of a mortgage is all interest. The amount you owe on that house is not changed much. The value on the other hand, well that has.

This is a good time to move to the problems with the extension of the loan solution that is equally bad. First we know that time equals money. As mentioned before the giant lender banks are in the business of selling time. They make you pay for their part of the investment up front. Fannie and Freddie sit on the loan for 30 years and count on collecting “X” amount every year. They count on that return to in turn buy more loans and make more investments. If you extend the loan, at the end of 30 years instead of the projected capital of $240,000 to use to offer more loans, they now only have $220,000. Would you take that deal? "Well, I know you were panning on retiring when you were 65, but now you will have to wait till you are 75. Hey, we will throw in an extra 10 grand for your trouble."

There are other questions too. Do contracts have to be redrawn up? They can’t just send you a letter saying, “oh we just extended your home loan, from here on out just send us the smaller house payment.” If you let them renegotiate and scrap the contract, there is no way you would buy the house at the price you paid for it 5 years ago, and there is no way they would lend you the money to do so. It does nobody any good to “invest” in a house that is priced 30% below market value. The second you open the contract you would have the legal equivalent to a “Mexican Stand-off”. Not to mention the operating cost and the original amount they paid for the loan ate into their profits from before. This causes other problem equally dysfunctional to the system. The reductions in income would ultimately cause the banks to stall and go belly up. What would you say to somebody who owes you $1000 and says they can pay you $20 a month for 50 months? Exactly. What if you counted on that 1000 bucks to pay your own bills.

One last point on the loan extension solution. A $100,000 loan at 7% is $665 a month without taxes and insurance costs that the bank has no control over. Extending that to 40 years only lowers the payment to $621. Is $44 a month going to save the average home owner? Who is to say that fuel prices and tax increases won’t eat that new savings?

Well I also promised to enlighten the reader on “who the banks really are.” I have on occasions heard people say, “So what, let the banks go bankrupt.” I too have been guilty of this naivety myself when this all first hit. Believe it or not, my background is in system design, not economics. I didn’t realize how the whole thing worked. So it took awhile to identify the trouble being cause by banks. So I did some research, some asking, and lots of listening. Then I added 2+2. You can say, “We don’t want to nationalize banks” all you want, but in the end, the US mint is “the bank”. Ask yourself this question. (It is the one that was the epiphany for me.) How does the US mint get money into the system? Well let me tell you. They don’t load up a plane, fly it over a trouble spot like Cleveland, and just open the hatch. I am betting many of you have heard terms like “Prime Interest Rate”, “Federal reserve board”, “Fed Chairman”, and even had “Prime” described to you are “the interest rate at which banks loan each other money”. Now why would banks with their highly educated CEOs worth billions of dollars themselves in a perfectly good free capital system need a government body to tell them what the market price should be for their loans? Because the reality is that “Prime” isn’t the price banks charge each other. It is a good “suggested retail price”. No “the Prime Rate” is the rate at which the US mint lends money to the big “time sitters”. Where do you think these banks got their trillions of dollars to pay for the mortgage that the pizza delivery boy turned mortgage broker got you into and then sold to one of the “big banks”? Right Fannie and Freddie got that money from the US mint. So what happens if somebody owes you money then goes bankrupt? Right again, they pay you only a fraction, if any at all, of the money they owed you. So what happens if Fanny, Freddie, US bank, go belly up. They pay the government only a “fraction, if any” of the money they owed the US mint. (remember how secure t-bonds were as a kid?) Real quick, in the US who runs the US mint? Right, the government. So who is “the government”? Oh yeah, they are “by the people, for the people.” So when these banks don’t pay back their debts, who are they not paying them to? “We the people.”

Friday, February 20, 2009

When You’re Stuck In Quicksand, Kicking Your Feet Only Makes You Sink Faster

When you are sinking in quicksand the natural reaction is to kick your feet and struggle. The problem is that kicking only causes you to sink faster. I know this is going to come as a blow to those who are trying to say, “The government should help us because we can’t pay for our house”, but you are mistaken. I am sorry. The only thing that this home rescue plan is going to do is cause the rest of us to go down with you. Not to mention your attempted salvation will result in the prices remaining artificially high.

Let us say that I wanted to buy a nice midsized bungalow overlooking the water with a dock where I could store my sailboat. However 4 years ago when I was looking for a house, that house was going for $300,000. About $200,000 outside my price range. At the time an autoworker who was making about $80,000 a year with overtime bought the house. At the same rate I got for my house at the time, the payment would be about $1600 a month over 30 years. That would be less then 2 weeks pay per month going to his house payment. His wife had a job as a local bank teller making $20,000. Then the bottom fell out of the auto industry. He gets his hours reduced and laid off. They are now in deep, and house prices in the area have dropped 30%. No houses are moving in the area. He has put lug nuts on the new car tires for 15 years since leaving high school. No chance of him getting another job like that anytime soon. My dream home is already down to $210,000. Why should the government deny me of my dream home? Over the next 2 to 3 years, that house is apt to be worth about $100,000. I can afford that. Not only will I be able to afford that, but I will be able to buy other stuff and still be economically sound.

The problem with the home owner rescue plan is that it will damage the economy faster or at the very least it will have no affect. If you give money to people who are barely surviving and need help, then the money is just going to go to pay off debt that already exist. No new jobs will be created, and the economic problems will continue to drag us down. It would make much more sense to send that money to states and cities to hire police officers, firefighters, teachers, immigration agents, road construction, corrections officers, IRS agents, and other civil servants. It seems that there is a need for more staffing at the Security and Exchange Commission. Offer loans to anybody who can start a manufacturing business that could compete with Chinese version. This will create jobs that will keep capital in this economy. People with jobs will be able to afford to buy the houses at the new deflated price. People who have a place to live that they can barely afford but no job are not going to contribute to the economy.

Let s take a different perspective on this. We will follow money. Let us say a family is struggling to make a $1000 a month house payment. They get a new deal that drops that payment to $800. What happens then? They don’t have $200 a month extra to spend. They were struggling to spend that $200. Hopefully they don’t go out and spend it on other stuff. That would mean they didn’t learn the lesson. They are not going to buy a new car with it. They are not going to hire people to remodel. They will be in a pickle all over again when they have some routine maintenance happens to the house. Cities to make up for their cash flow problems are very apt to raise property taxes. As the economy stabilizes globally, what if gas prices rise again? There will be so many ways that little break could get gobbled up. If prices are let to fall and people are hired who were already making it for the new jobs, the economy will move again. Please not that I said “move” and not grow. This quest for growth is self defeating.

Of course in the end none of this will do anything to help the 800# gorilla in the room. That being the fact that no matter who gets this government stimulus, they are going to take it straight to a department store and buy Chinese goods. With in a few turns of the capital it will all have escaped to a foreign economy. That, or it will end up in the pockets of those so wealthy that they are not going to be spending it in the near future.
So when is the administration going to stop enabling Americas to kick their feet and start figuring out how to pull them out of the quicksand.

Tuesday, February 10, 2009

What Is Good For The Producer Is Good For The Consumer Economies

It seems that the EU and China as well as many other economies both established and “emerging” are complaining about the US only clause in our stimulus package. I know I have been harping on this for awhile now. But, they keep complaining and there are so many lessons and insight to be gleaned from this issue. Many have been touched upon in previous posts. I would like to explore an overall depth of this issue.

If you have been with me all along, you know that I put much more merit in labor hours then actual currency. If you haven’t been with me a quick but necessary synopsis goes like this. We should not judge how much somebody is paid by the dollar figure as much as we assess how many of hours they have to put in at work to pay for needs and wants. If a man could live on bread alone, the man who only makes $1 a day but pays only a penny for bread is richer then the man who makes $100 a day but pays $3 for the exact same loaf of bread.

So with this concept of the importance of the "labor hour" fresh in our minds, we have to consider what our employers have to offer as compensation to attract good candidates, and what kind of expenses our employees have to cover with their salaries. Our employers often offer, and are required to offer some kind of health care program. The employee is most often required to pay a growing large portion of that health care cost themselves. I have what is considered good health care, but still i pay close to $200 a month for the premium and I still have to pay deductibles and co-pays when I go to the doctor. So right off the bat I have to pay $200 a month or around $1.70 and hour just for health insurance. Now if the Chinese really make 40 cents a month, how do they pay for their health insurance? Oh wait, their government subsidies their work force by giving them free health insurance. Then again, it is also acceptable to just let them die. It is kind of one of those negative effects of being Communist. You can't use the need to pay for health insurance to demand more from the employer.

What other cost might an employer in the good ole US of A be either asked or required to pay that people in say China, India, or the E.U. might not have to? All employers have to pay into a retirement fund called "Social Security". This is a tax, and could arguably be said to be covered by the tax leveled against foreign companies. But for the most part it is another unfair advantage. First of all our skyrocketing daily costs is not being paced with an increase in the benefit. Also, one could easily counter that if you had a national health care plan, that SS, Medicare, and Medicaid would become unnecessary. one of the biggest costs for the elderly is medical expenses. Many have their houses paid off and some kind of savings from they employment years. Or they could go greet people at Wal-Mart for enough to suit other needs. But, aside from all of that, it is a staple of our society that some kind of "retirement savings" plan should be offered. In many of our older and larger industrial models, these plans came in the form of "pensions". That meant that the company keeps paying the employer for sometimes 20, 30, even 40 years after they are no longer contributing to the production of the company. In countries where the government, work force, or a combination of both do not require retirement savings plans, they are at an advantage. lack of such future expectations in the culture can cause and "intangible advantage". In the US we all expect to live to at least 75 or 80. ten to 15 years after we retire. if you live in a society where mortality is never expected beyond 70, there is a huge advantage to your expected cost over the economies with more longevity.

That said, it should be noted that other economies subsidies their labor force in ways that are not immediately recognizable. Ideas such as national health care, free higher education, housing, and energy support are benefits to its labor force that advantages them financially over the US labor force. Intangibles such as a road system that has allowed us to "sprawl" in a way that requires an automobile to live. Insurance, public transportation systems, and other related cost associated with that "infrastructure" that was developed to get us out of the great depression. So unless these countries are willing to end their unfair subsidies and/ or send us the money to pay each for the advantage to each of our laborers, I do not think they have a case for "protectionism".

One last quick thought to demonstrate the uniqueness of this mess we are in. A "durable good" is defined as a product with a lifespan of less then 3 years. The "no prize" this week goes to anybody who can name me 5 durable goods from the Great Depression era. 5 products that were expected to last more then 3 years.

Wednesday, February 4, 2009

5 Myths About Globalization, Free Trade, And Protectionism

There has been a lot of hub-bub about the stipulation that Obama has put on the stimulus money being used only by those who buy American steel for related constructions projects. While this idea merits a bonus factor because he is using taxpayers dollars to pay for these project, there is really nothing wrong with policies that cater to your own economy. Many opponents like to label it “protectionism” or “isolationism”, but their arguments are not based in another “ism” “realism”.

1) “Protectionism” or “isolationism” limits consumers to inferior products.

The statement I often hear uttered goes something like this. “It promotes bad products and drives up the price.” This is a false notion usually derive from good economics’ worst enemy “common sense”. What really happens is a country like the US develops things like autos, electronics, and other durable goods inside an economy that requires wage, environmental, and safety standards. These are things that are part of the moral fabric that make up our nationality. Then economies without such standards duplicate the process with out all that overhead. The more restricted economy must then attempt to produce at a disadvantage. In the end a product requires a certain amount of labor hours to produce. That is a constant. So are the costs to be safe and environmentally sound. R&D and quality assurance are not constants and can be re-budgeted to compete. So in order to keep up with the “unleveled” playing field, a producer has only a few choices. Cut the cost of R&D, quality assurance, or both. They could also buy most of their parts from the less regulated economies. We have seen plenty of this. Left alone internal competition would have yield the required quality from the markets. Probably even better products. In reality, external competition often drags down quality advancements.

2) Globalization helps emerging economies.

This is a common and self righteous and pompous assertion that usually comes from people who think that they have the best way of life and everybody else should be like them. The truth of the matter is that globalization gets a lot of wealth in the hands of very few. It hurts the people in the consumer economy by reducing their ability to maintain a previously enjoyed standard of living. (Study: Men in Their 30s Make Less Than Their Dads. http://www.npr.org/templates/story/story.php?storyId=10438943) Moreover, it reduces local ability to demand fair compensation by forcing them to compete for jobs un an unfair playing field. Their cost of living and level of comfort was promoted by their collective innovation.

It is equally damaging to the economy where the new factory or industry is established unnaturally. It hurts the economies that the new industry invades by raising the cost of living for people who hadn’t developed it themselves. It does this by giving a small percentage of people in the developing countries jobs that pay better then the sustainable environment that had existed previous to industry. Anybody who is not fortunate enough to get one of these jobs becomes disadvantaged through no fault of their own. A better description of this can be found on the post, Economics from the CEO perspective (http://logicandpolitics.blogspot.com/2008/12/economics-from-ceo-perspective.html)

You will find that people often have to work for the companies and their culture will have been changed because of it. “You will be assimilated. Resistance is futile”. If I have lost you on this, it is quite simple, higher paying jobs and lower environmental and safety practices do not help the “emerging economy”. Often those people would be quite happy to live out their lives as they had for thousands of years. To say, “they are not like us and they should be.” is a rather selfish and damaging cultural view.

3) The advanced economies need the consumers of the 3 rd world economies they are competing with.

People often say things like, “look what the world buys from the US. What if the world stopped buying soda, fast food, and Microsoft products from the US.” Generally these are low cost items that are A) not durable goods and B) have a better profitability at the distribution point. Meaning that even though they are “American Products” their real source of wealth goes to the people who sell them. I can not think of too many durable goods that are coveted overseas. If everybody pulled back and didn’t allow trade, there would be winners and losers. With in the economy there would be a labor shuffle. But the US would be a definite winner. Want proof? Look at the trade deficit. That simply means we are consuming more then we produce. You can not do that in a completely isolated economy. It is a matter of the US consumer only need so many cars and they have plenty of internal producers to supply them.

4) Globalization helps by supplying low cost products to the poorer members of the advanced economies.

This forsakes a really obvious logical flaw. PEOPLE WITHOUT JOBS CAN’T BUY ANYTHING, NO MATTER HOW CHEAP IT IS. The reason some of the people are poor in this country is because they can’t find decent paying jobs. Wal-Mart loves this logic. “We supply inexpensive goods to people who otherwise couldn’t afford them.” They can’t afford them because you are buying goods from the people who took their jobs!! Here is another reality dope slap for you. People with jobs will pay more for products if they have to. They might grumble, they might even start email chains telling everybody to not buy the product for one day. However, they will still buy it because they can. People who are unemployed and have no income can’t buy even the less expensive product. In order to purchase the things they really need, they will have to rely on the government to give them resources to do it. Look US citizens will dam and chastise people who employ illegal immigrants, children slaves, and unsafe environmentally hazardous productions techniques. They will even sue the hell out of companies if they find them in their neighborhood. But they will run, not walk, down to their nearest Wal-Mart to buy products made under these exact same conditions if not morally more reprehensible. That choice shouldn’t exist. We are addicted to low cost like crack. Like crack it feels good when we do it, but is destroying us in the end.

5) The great depression was caused by isolationism.

There are lost of people who make this claim, yet it is one that has never been backed up by any notable (by that I mean one with a track record of being right) economist. The idea that the reason we didn’t have jobs was because the US restricted industries from selling their products around the world to people who didn’t have money to buy them is ludicrous. We are talking about the 1920’s. The world was way less developed and much larger, logistically speaking, then it is today. The cost to move stuff back then would have been enormous and not worth doing. Who was going to buy the American automobile, and on what roads were they going to drive them? There was no China or India with billions on population wanting to buy our junk. What does happen when the US opens is trade barriers is an initial surge in new economy buying product they never knew existed. That is followed by a feverish period of the new consumers reverse engineering, and then start producing their own version much cheaper.

What we needed to get out of the Great Depression was to create jobs. Then along came the great job creator, war. Workers willing to work for low wages, in unsafe conditions, with very few benefits is the ideal situation created by war. You cut the unemployment rate at both ends. You create jobs and reduce employable population. Goodbye depression. Then again, every economic policy has its equal and opposite reaction, but that is for another post.

In the 1920’s we were isolationist because population and technology limited us to it. Today we must return to it because economics demands it. What Obama should do (aside from the million other things I have suggested in previous posts) is set a trade deficit limit. “These rules apply once the deficit reaches ‘X’ amount of dollars and/ or another country owns ‘Y’% of our national wealth.”

We are facing an economic meltdown in the US. It is affecting the world. No other country could have such a meltdown and have the same influence. That in and of itself sets us apart. For those who have ever flown on a commercial airline, you might recognize the following set of instructions. “In the event of an emergency, oxygen masks will drop from the ceiling. Please secure your own before helping the person next to you.” This is to ensure that you do not pass out in the attempt. Here in the US we need to do whatever it takes to secure out own economic prosperity before we start back helping to bring our brand of prosperity to the world.

If you want to know who would actually loose wealth to the US taking a more isolated approach, look at who is complaining. What you will see is that the people who we hold the largest trade deficits with are the biggest complainer. What would you tell the person on the other end of the line if your credit card company called and said that you are not spending enough? That is basically what the opponents to “protectionism” are doing.

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