“The largest and costliest venture in public misfeasance, malfeasance and larceny of all time.” These words, describing a lending and liquidity meltdown of unprecedented dimensions, are from a) Fed Chairman Bernanke, b) Treasury Secretary Paulson, c) Mad Money guru Jim Cramer, or d) None of the above?
The correct answer is “d,” or none of the above. Twenty-five years ago, the late economist John Kenneth Galbraith was weighing in on the U.S. Savings and Loan crisis of the late eighties and early nineties, and the colossal bailout of $125 billion by the U.S. government (with another $25 billion from non-government entities). Over 1,000 S&Ls failed, and tens of thousands of foreclosed properties went on the market through the government’s Resolution Trust Corp. The huge budget deficits that followed destabilized the stock market and consumer confidence, slowed the real estate market to a crawl, and induced the 1991-92 recession.
Never mind Congressional reformers who established new regs and oversight committees and swore this kind of corruption would never happen again. What’s happened in the last four years makes the S&L crisis look like a mischievous child who broke into his piggy bank. In panic mode that liquidity would virtually disappear from the capital markets, the Fed, in sync with other Central Banks, have pulled gears and levers they’ve rarely if ever used.
Among other steps, the Fed opened its discount window to the Goldmans and Lehmans of the world (after throwing Bear Stearns and its shareholders down the stairs, because somebody had to feel the pain), began offering special auctions for banks to draw emergency funds, and allowed banks to swap out their bad mortgages for Treasuries. The major money center banks as well as investment banks had balance sheets so swollen with sub-prime and related bad debt that even sovereign funds and private equity firms are coming to the rescue, taking equity positions and/or injecting fresh capital. Some are buying the bad loans at heavy discounts, because not all bad loans are equal. If seventy percent of the loans are not okay, but thirty percent are, and you pay (cost average) twenty cents on the dollar for the loans, you can make a gross profit of thirty three percent.
Worldwide, from Central Bank interventions to private capital infusions, hundreds of billions of dollars will ultimately be needed to restore liquidity and confidence to the capital markets. It makes the S&L bailout look like pocket change.
Just winnow this latest crisis to an anniversary date, and Hallmark will make a greeting card. The Father of All Bailouts has followed the Mother of All Meltdowns. Ten years from now, maybe a Central Bank or two will collapse and once again spin the financial world into even worse chaos.
What began as a stunningly simple and shameless idea—make it as easy as possible to loan money to home buyers who are least likely to pay it back—has resulted not only in the near wipeout of credit markets, but in the vaporization of $8 trillion of housing wealth nationwide, at least on paper, from pinnacle to trough (so far). Between 1986 and 1992, as the economy reeled from the S&L crisis, new home construction dropped from 1.8 million to 1 million units, the lowest rate since World War II. In 2003-04, the apex of the last housing boom, housing starts were 1.85 million in 03 and 1.93 million in 04. In 2005, they dropped to 1.84 million. In 2006 and 07, as the defaults and foreclosures accelerated, and major home builders and banks finally admitted there was a problem, annual housing starts were dropping month by month.
As of March 08, according to the U.S. Census Bureau, housing starts are projected at an annual rate of 1.065 million (down from the previous month’s estimate of 1.071 million). Many economists believe the year will end close to or below 1 million units, but stabilize in 2009, assuming employment doesn’t deteriorate significantly.
There are many gauges to measure a housing collapse, but if we hit 1 million housing starts by December, this is the same nadir—and almost the same retrenchment percentage—as experienced in 1986-92, and not too dissimilar from 1939-1944.
Maybe it’s just coincidence, but it seems that the size of the bailout magically fits the size of the crisis. This time, on one level, it was to inject liquidity and stabilize world credit markets, but arguably as important, it was to stop a housing collapse. Maybe one million annual housing starts is the sacred threshold. Home ownership (and the industries it supports) remains the keystone of consumer contribution to GDP. Equally certain in the next five to ten years is that home sales and prices (particularly if inflation accelerates) will rebound to new heights; then, on some unknown date, they will just as surely fall back to earth, and will have to be rescued all over again. The more things change, the more they stay the same.
