Why the market is in crisis, as best as I understand it:

Assumption 1: Home prices keep falling
Assumption 2: This is a product of supply and demand, with demand having shrunk due to less credit available for marginal qualifiers
Assumption 3: lenders’ mortgage portfolios will continue to lose value as home prices keep falling
Assumption 4: This fear of lost portfolio value is creating the strangulation of the credit markets, which further impacts assumption 2, and continues a spiral downward…

Bush Solution: buy up the mortgage portfolios with high default rates with an estimated total cost of 1 trillion dollars.

Bush solution Problem: home prices will still continue to fall because of the simple law of supply and demand, with demand having been curtailed by wary lenders, yet supply remains the same.

Proposed solution: Use the 1 trillion dollars to purchase all homes that are currently in default and vacant. Assuming the national median price of $200,000 per home. That is 5 million houses or about 6.6% of all owner occupied housing in the country. Rip the houses down, recycle the materials and let individual cities decide to either resell the lots to neighbors or to developers, or better yet, make them pocket parks, community gardens or other amenities that increase local area housing value. For a while more homes will conitnue to go into default and become vacant, and are bought up by the governemnt and the land recycled to non-home highamenity uses. Not a good social umbrella for people who bought homes way over their head, but it works to the benefit of marginal subprime loans in the long run.

Proposed solution result: The market itself is not messed with through propping up dumb lenders, who are going to continue to have sever problems under the downward cycle of the Bush plan results. Most of the current bad loans are now gone since they were bought out. The housing supply is reduced by 5 million homes – or 6.6 %. Home prices rise from decreased supply. Neighborhoods once blighted by empty foreclosed house now have nice pocket parks or community garden spots. Neighborhood values also increase. Rising home prices increase the value of the mortgage portfolios, freeing up credit.

Simple market solution, with benefits to all – excpet the taxpayers of the future, but they get ripped by the Bush plan as well.

What is wrong with this idea? I’m sure I missed something in here.

We need less political rhetoric and old world (ie, before the internet, e-mail, cell phones and globalization changed everything and increased the velocity of business exponentially) solutions and new creative post-partisan approaches. The Hamilton model provides a great framework for beginning, as old as it is, the loose model remains a brilliant conception waiting to breathe life into a new and more prosperous economy.

It was also a “free market” driven failure because unregulated markets aren’t free, they’re just left wide open to abuse. The reason for regulation is to allow the markets to operate more freely with less political and backroom interference. I’d suggest that excessive deregulation is political interference in the market.

Fannie Mae and Freddie Mac committed accounting fraud a few years ago, and Alan Greenspan pointed out that they don’t lover mortgage rates so what are they good for. To placate Congress, Fannie Mae and Freddie Mac aggressively start promoting “affordable housing” as their mission by buying massive quantities of sub-prime mortgages, creating huge demand to generate those mortgages. The only reason Fannie Mae and Freddie Mac can run this gambit is because they have an almost unlimited supply of capital because there is an implicit, and now explicit, Federal government guarantee of their debt. The demand they created led to a bubble in housing prices, that is the cause of the current crisis.

This is NOT a free market driven failure. This is a politically driven failure, and politicians like Barney Frank need to be held accountable. We don’t need to reform the markets, we need to reform the government to keep politicians from manipulating the markets for their favored constituents.

In Maestro, Bob Woodward quotes Alan Greenspan as saying Clinton was the only President who understood what Greenspan was talking about. (He also served under Reagan & Bush 1, I think we can assume he would have included Bush 2). Clinton might be the only one who could actually take on the whole mess on and fix it, but it would be political poison for anyone to suggest it at this point.

We need an independent non-partisan quasi-governmental body regulating the financial markets (much like State Bars do for the legal profession), a stronger fed and national bank and, generally speaking, a return to the kind of federalism originally proposed by Hamilton. The government is a cash cow and it can make lots of money lending it, thereby reducing the necessity for taxes. The government is the ideal lending body because of the amount of cash it hoards and can claim a right to tomorrow. If its loans go bad, at least the economy was stimulated in the process. Think of those bad loans as the equivalent of spending. Government should be deeply involved in the economic development game, not the taxing and spending game.

What the author proposes has been lost in this discussion. He proposes a classic liberal tax and spend policy. That’s a bad idea generally and certainly no solution to the present crisis.

In a perfect Ayn Rand dreamworld, investors in a totally free market would act rationally with discipline. However throughout recorded history the rich and powerful have manipulated government, although less when there were regulations and controls on them. And since the dawn of capitalism there have been irrational investors acting without discipline, whether in the Dutch tulip bubble or last year’s financial derivatives.

As a confirmed and active short seller I agree with you. The ban was probably needed but needs to be taken off quickly or a massive “air pocket” will appear. Probably more transparency is what is needed. I need to think through this.

For those who have called me a “socialist” not a term that really bothers me, but apparently they think is insulting, I cut this from a recent post by “Mish” Shedlock, who along with Roubini and Tanta of CR are some of the most prescient observers of the current scene (Oh yes, I composed the first of my last posts nine months ago but could get no one to even consider them. And the last post before Mish’s AND that is because this stuff is now becoming obvious. AND WILL BE TOTALLY PLAIN IN ABOUT THREE TO FOUR MONTHS:

“Jobs, Jobs, Jobs

I am a libertarian. I do not believe in makeshift government proposals. However, I would rather get something than nothing for $700 Billion. Paulson’s proposal scores a big fat zero in term of providing an jobs or any real economic stimulus.

It is no secret that infrastructure in the US is decaying and needs to be fixed. A collapsing bridge in Minnesota is one key example. And what out our aging energy grid? Instead of giving $700 billion to banks that deserve to go under, I would rather give half that for jobs programs.

To create as many jobs as possible at the least cost Congress needs to scrap the Davis-Bacon Act. It would be better to create 3 construction jobs at $12 an hour than 1 job at $36 an hour. The idea here is to get as most bang for the buck and create as many jobs as possible for the money spent.

Waste In Iraq

We need to admit the mistakes in Iraq. The public never supported this war and the public was correct. The war in Iraq easily cost $1 trillion dollars if you count future medical bills. That is $1 trillion dollars that could have been spent right here in the US.

I propose we declare the war won and get out, totally and completely. Offer returning veterans first crack at any infrastructure rebuilding jobs. It is the least we can do to those who are likely going to be emotionally if not physically scarred for the rest of their lives fighting a war that never should have been fought.”

Yes a libertarian recognizing that we need to get money to people — i.e., Works Progress Administration and Civilian Conservation Corps.

Are these the “end-all” solution? But something like this would show that people are actually talking about the crisis seriously.

Consider the silliness going on now. The Democrats want to pump up housing prices which are still too high. They both want to increase lending in a society that needs to SAVE! Please see my last posts about the New Frugality.

Yes, I can talk and learn from the libertarians and they can learn from us who are more on the democratic left. We need to learn from the past and create a new future (as my friend Andy Hargadon would say!)

Great. So we just get overvalued stocks.

Hey wait a second – isn’t that what’s led to all this in the first place?

They should have read that chapter in The Wisdom of Crowds. It’s funny how history repeats itself.

A couple of points:

1) Socialism is about the state owning and operating certain sectors of the economy. TAt the present moment, we are not on the way to socialism. This is simply crony capitalism from the Bush Administration and the investment bankers that are at this moment running the Treasury.

Taxes have nothing to do with socialism (they have existed in all systems at all times).

2) We need to think creatively about the current catastrophic market conditions. A debate needs to be opened and we need to think more comprehensively about what the solutions to this crisis are. I believe that the contemporary problems of financial meltdown, massive income inequality, and environment are interlinked and we had better start to see this.

3) The problems that we are facing in each of these arenas are massively complex and interrelated. Sorting these problems out will require the greatest amount of creativity we as the human race have ever summoned up.

4) You are absolutely correct that the Democrats were completely and abysmally missing in action on these issues. The current Democrats have and are now showing little creativity or even thought about the current crisis. They absolutely cannot be excused, but let guilt be handed out evenly! The crazy deregulationists in the Republican party deserve primary blame, the Democrats were only accomplices.

New thinking is absolutely needed to spark a debate. I would say let the debate bring in the libertarians like Ron Paul and the environmentalists like Ralph Nader. All sides should marshal evidence for their beliefs as to how to approach this serious meltdown.

There is little to be gained by name calling. We are at a turning point and need an open discussion. What is clear is that the neocon, neoliberal Chicago School of economics has collapsed. The old liberalism of Hubert Humphery collapsed a long time ago.

In contrast to you, I believe there is no leftist or socialist voice in the US and we are the worse for it.

The essence of creativity is to be able to take many perspectives and synthesize them to come to new understandings and solutions.

I have no fear of the libertarian perspectives, which I value. I am an admirer of Ron Paul because he has been truthful during this crisis, while few others in our Congress Democratic or Republican have been.

At a minimum, like during the New Deal we need serious hearings with serious questioning on what happened and who might be the responsible parties.

Martin

PS: I hope you are not including as “positively” creative those on Wall Street who created the Ponzi schemes that have now collapsed.

PSS: New Deal reforms such as a strict SEC regulation, Glass-Steagall were critical to what made the US financial markets the envy of the world. Destroying these institutions and eliminating these regulations were enormous mistakes.