Should housing and other asset bubbles and busts (and related banking crises) that occurred throughout the developed world, raise doubts as to whether nonconforming mortgages and securitization caused the U.S. housing bubble, as many claim?
“The mainstream view is that the U.S. financial crisis was primarily caused by reckless nonconforming mortgage lending and securitization, which caused an unsustainable housing bubble that eventually burst. I don’t think that is correct. Even Fed Chairman Bernanke in his November, 2009 interview before the Financial Crisis Inquiry Commission disputed this mainstream view: ‘It wasn’t subprime mortgage per se. Subprime mortgages were just the trigger that set off a whole bunch of other bombs.’ Mr. Bernanke also discussed various macroeconomic factors that he believed could have been the cause of the crisis; his personal favorite being “the global savings glut”. Throughout this blog, I have provided much evidence documenting why I don’t believe this mainstream view is correct. Let me try one more time.
I read a WSJ article on November 7, 2013, discussing Spain’s banking crisis:“For Spain’s Lenders: Realidad”. The full article is below, but here is an excerpt:
“For years following the real-estate crash in 2008, analysts say, lenders applied an “extend and pretend” approach by refinancing ailing developers. Ultimately, banks were forced to recognize those losses, spurring last year’s €41 billion European Union bailout of Spain’s banking system.”
This article reminded me about a relatively simple argument (that I developed, but never published) that I believe refutes the mainstream viewpoint.
Spain, Ireland, Portugal, the U.K., and many other developed countries experienced even bigger housing bubbles and busts than the U.S (and other asset bubbles and busts and banking crises). So how does this disprove the mainstream view: that the unsustainable U.S. housing bubble was caused by reckless nonconforming mortgage loans and securitization?
My argument is three-fold: First, these others countries didn’t have nonconforming mortgages or securitization like the U.S.. Isn’t it most likely that since these unsustainable housing bubbles all occurred in roughly the same timeframe, that they were caused by similar factors? Second, pre-crisis, there were many other types (not just housing) of unsustainable asset bubbles in the U.S. and other developed countries: commercial real estate, stocks and bonds, sovereign debt, collateralized loans, etc. Isn’t it more likely that given the myriad of various types of unsustainable asset bubbles, all around the same time, that they were caused by similar factors? Obviously, nonconforming mortgages and their securitization had nothing to do with these other types of asset bubbles. Finally, does it make sense that private, bankers and other lenders, who compete in diverse lending markets and diverse countries, and have different government bank regulators and owners, would all decide to become ‘reckless lenders’ at exactly the same time? Never mind all of the other evidence I have provided on this blog, I believe these simple and logical arguments alone are devastating to the mainstream view that reckless nonconforming mortgage lending and securitization caused the unsustainable U.S. housing bubble.
So what did cause these unsustainable asset bubbles and banking crises throughout the developed world?
I and others have provided empirical evidence to show that the U.S. housing bubble (and other asset bubbles) was primarily caused by the well-intended policies of our government, including the Federal Reserve System, to encourage home ownership and sustain economic growth. With the benefit of study and hindsight, I have made the case on this blog that the Fed’s loose monetary policies pre-crisis, low interest rates, and excessive money supply growth toxically combined with our long-running massive foreign trade deficit to cause trillions of dollars of unquestioning foreign money to flow primarily into U.S. debt instruments in our financial system. (Nearly every time this has occurred in developing countries, it has created unsustainable asset bubbles and banking crises.) The Fed, to meet its full employment mandate, wanted to keep the economy growing and their loose monetary policies seemed to be working well, as the unintended negative consequences of their policies were not captured in traditional consumer price indices. (As an aside, this prevented natural, smaller business cycles from occurring; which are critical to credit cycle discipline.) The Fed largely ignored the asset bubbles that were building in U.S. real estate, bonds, and stocks, caused by their policies and foreign trade and investment imbalances and provided no pre-crisis warnings to consumers, investors, or bankers operating in the micro-economy. I think they didn’t warn because like most economic experts pre-crisis, they believed that markets were mostly right and so they weren’t sure whether these assets were appreciating rationally or not (Think Twitter’s IPO price this week, just to name one example…rational or not?). Also, they believed and said as much at the time, that any decline in asset prices would be ‘manageable’ for the financial system and certainly for the overall economy. Current and former Fed Chairmen, Bernanke and Greenspan, deny any Fed role in fostering unsustainable asset bubbles that led to the financial crisis, and yet today’s Fed touts its current accommodative monetary policies as doing just that: raising the nominal price of real estate, bonds, and stocks to foster “the wealth effect” and a trickle-down economic recovery. Given this fact (and all the other empirical evidence), their denials seem self-serving. Remember, The Fed didn’t admit its role in causing The Great Depression until Chairman Bernanke did so, more than 75 years after the fact.” Mike Perry, former Chairman and CEO, IndyMac Bank
MADRID—It has puzzled Spanish bank analysts for years: Why did the country’s mortgage delinquency rate rise so slowly even as unemployment soared above 26%?A big part of the answer—shown by a spate of bank earnings reports in recent days—is that Spanish lenders had been making their books look healthier than they really were by refinancing loans to struggling homeowners and businesses.The lower interest rates and easier terms of refinancing helped hundreds of thousands of Spaniards like Juan Carlos Díaz, who stopped making mortgage payments more than a year ago, remain in their homes and keep their businesses afloat longer than would have been possible otherwise. It also helped banks bury a rising risk in their credit portfolios and avoid recognizing losses on debts they are unlikely to recover.Now, more stringent disclosure guidelines from Spanish banking authorities are bringing these risks into the open. Partly as a result, mortgage delinquency is rising fast—a trend that could damp recent investor enthusiasm for a bailed-out banking industry rebounding from a property-market crash.Spanish banking stocks have declined 5% since the first third-quarter results came out in late October.The Bank of Spain, the central bank, began forcing banks in April to re-evaluate and disclose their refinanced loan books out of concern that some lenders had been taking advantage of relatively loose guidelines to mask the deteriorating creditworthiness of their clients.The bank reviews should apply stricter guidelines for classifying the health of refinanced loans, the regulator said. For instance, if a borrower spends more than half his monthly income on interest payments or is benefiting from a lengthy grace period, his loan can no longer be classified as normal, it said.The results have been striking. Since December 2012, the amount of refinanced home mortgages gone sour has doubled at Spain’s six largest banks even as their refinanced loan books grew a little, according to the banks’ financial statements. The Bank of Spain has said banks had refinanced roughly one of every 12 outstanding home mortgages, or €50.8 billion ($68.5 billion).Banco Santander SA, Spain’s biggest bank by assets, reclassified €2 billion of mortgages as nonperforming due to the rule change. In 2011, the bank offered a three-year grace period to customers who had seen their income drop more than 25% and were having trouble servicing their loans. By June, the bank says, just over 22,000 customers had signed on to the moratorium. Many of these loans have now been reclassified as nonperforming. A Santander executive in July said that the bank continues to receive monthly mortgage payments on 93% of the loans that were reclassified.
Banco Bilbao Vizcaya Argentaria SA has moved €3 billion into its pool of nonperforming refinanced mortgages since the beginning of the year. A chunk of that came from a savings bank BBVA took over last year. A spokesman said many of the mortgages labeled as nonperforming still are being serviced.
Spanish banks are devoting billions of euros in provisions to cover refinanced loans newly recognized as bad. The hit, though large, is manageable for Spain’s banks. But it will drag on profits this year and likely next year, said Santiago López, analyst with Exane BNP Paribas.
Questions also have arisen about whether banks have continued to sweep loan losses under the rug, a concern that has dogged the sector since the start of Spain’s economic crisis.
For years following the real-estate crash in 2008, analysts say, lenders applied an “extend and pretend” approach by refinancing ailing developers. Ultimately, banks were forced to recognize those losses, spurring last year’s €41 billion European Union bailout of Spain’s banking system.
For Mr. Díaz, a 49-year-old account manager at a company that makes chemical pumps, the extend-and-pretend approach worked for a while. In 2007, he took out a €600,000 mortgage on a suburban Madrid home. At the time, his wife’s fast-food restaurant was going gangbusters, selling roast chicken and sandwiches to construction workers during a big housing bubble.
In 2008, the bubble burst, leaving her business with few customers. Her take-home pay dwindled, and paying the mortgage started eating up most of the household’s monthly income.
In 2010, Mr. Díaz asked his bank, Caixabank SA, for help. The bank agreed to refinance the mortgage, allowing him to lower his monthly payments by paying only interest for four years. The lender also gave him a second mortgage, for €32,000, to pay off credit-card and other bills.
By 2012, the family’s finances were stretched so thin that Mr. Díaz began drawing from savings to keep his wife, two children and himself in their home. In July last year, he stopped paying the mortgages, rebuffing his bank’s offer for an additional grace period.
Caixabank has begun the process of foreclosing on his home. A bank spokesman declined to comment on Mr. Díaz’s situation.
Mr. Díaz said he has few good options. “I realized paying the mortgage was like having bread for today and going hungry tomorrow.” He said: “Whatever happens now, let it come.”