By John Tobin
We are all too familiar with George Santayana’s admonition that “Those who do not study history are doomed to repeat.” Of course Mark Twain thought that “History does not repeat itself, but it often rhymes.” In either case memory is short especially when it comes to making policy.
With my thanks to the Federal Reserve Bank of Dallas, I want to refer to their Economic Letter, Insights from the Federal Reserve Bank of Dallas, vol. 4, No. 7, September 2009, Fed Policy in the Financial Crisis: Arresting the Adverse Feedback Loop. This issue did a great job of discussing how the housing and credit crisis evolved. I believe that there is a great lesson here for policy makers to consider as they address energy and environmental issues.
The adverse financial feedback loop occurs when a crisis in one sector causes a crisis in other sectors of the economy feeding off of each other in downward spiral. Here the housing problems pushed the credit crisis on to the financial sectors forcing policy makers to deal with institutions that were “too
Bernake to fail”. (Or were they too big to succeed?)
And the Almighty looked down and saw that home ownership was good. Indeed, home ownership should be a part of the hopes and dreams of his chosen people (The American Dream), if not a Constitutional right. Home ownership would bring a sense of responsibility to the masses, encourage those owners to live an environmentally clean life and create construction jobs. But as the Almighty was all too aware, the devil, literally, l would be in the details.
And the leaders of the chosen people who heard these words, but being only human, were seduced by that devil and were blinded and unable to see the future consequences of their actions (and really didn’t care because a part of the seduction was the that they would be out of office when the bill came due).
Therefore, policymakers encouraged (a politically correct term for forced) lending institutions by giving them dispensations from their fiduciary responsibilities to create sub-prime and Alt – A mortgages raising the 30 year average of homeownership of 63.3% from 1965 through 1995 4.9% to 69.2% by 2005.
As with any bubble, be it an unintended consequence of policy or a naturally occurring phenomena, it will burst, and like the man who built his house on sand, the winds will blow and rains will come, and great will be the fall of it. This “correction” started in 2006 and has deepened into 2009 with the withdrawal of marginal buyers, the resting of adjustable rate mortgages, and oversupply. Foreclosures went from a “normal” range of 0.2% to 0.5% to 1.5%.
The feedback loop was formed “as the economy was sinking into recession when the Fed found that two-thirds of banks had tightened their standards for the highest-quality mortgages and three-quarters reigned in business lending. The credit contraction sent spending down and unemployment up, exacerbating threats to the financial sector and dimming prospects for stability in housing.” Housing was an asset backing global access to credit for US economic growth.
"Seeds for an adverse feedback loop are often planted in good times. Following the 2000-01 recession, this feeling of euphoria led to lax lending, excessive borrowing and the housing boom. Such easy credit created many first time homeowners, putting upward pressure on home prices and prompting home builders to borrow to meet leveraged-fueled demand.” In addition to lesser qualified borrowers, the rising home values became a source of funds for regular borrowers as they added to their debt burden by tapping their home’s equity further reinforcing the consumer economy and the mentality of instant gratification.
By 2008 mortgages and home equity loans were at 109% of disposable personal income, up from 65% in 1995. In Q4 2005 new homes hit a 54-year high of 6.3% of GDP, well above the 5.7 % average of the 6 cycle peaks since 1955.
This expansion came about with the pooling and the securitization of mortgages and a shadow banking system. (The first principle of regulation: Politicians write rules; markets develop ways to circumvent rules without violating them. — Meltzer of Carnegie Mellon.) Indeed Fannie May and Freddie Mac joined and pushed this expansion, and they were creations of the government and not really in the shadows.
By the end of 2008 the housing bust began to impact consumer spending, employment and borrowing. Now the efforts to revive the economy are being compromised by the addition of even more debt through governmental actions. Pain will be unavoidable in turning the economy around. Policies directed at a soft landing only will spread out this pain longer.
An unintended consequence of this largesse is that the consumer economy (70% of GDP) will change as even the Treasury Secretary says that We the People will have to save more. Over the years, the US economy has shifted (kicking and screaming in the case of the auto industry and many unions) from manufacturing to a technology and service base. We have been promised “Hope and Change”, but change hurts and here a move away from such a debt based consumption economy to one with more saving could be quite a shock to life as we know it.
The housing crisis is a ponzi scheme allowed by governmental policy.
Please keep in mind that these views from someone who owns his house outright and paid off his mortgage some time ago. Therefore, I have zero credibility on this subject.
Problems come when the “American Dream” of home ownership, etc., are mandated and relied on. Who had the fiduciary responsibility to assure repayment of the loan? A mortgage is a contract between lender and borrower, where both parties are responsible.
Can the lender offload this responsibility by packaging the loan so it “looses” its identity or by selling the loan?
If home ownership is a social constitutional right, did the taxpayer sign on to support this mandate? The answer is probably yes, through our elected officials, but not the selling of the loan or lending to those who cannot be expected to pay.
What’s wrong with renting?
So what went wrong? I believe that it was in part the bubble mentality that home prices (values) would go up forever. In addition, the Fed low interest with high foreign savings buying US debt equaled a high PW (present worth) for the loan. Extended home ownerships to low-credit, low income individuals were paid by the bubble and financed thru government Fanny and Freddie.
This inventory of questionable loans can only be cleared through working off the inventory of homes and those financing or refinancing those who can pay. New debt, buying, and building delay the day of reckoning.
Did the American dream of “affordable” housing (or affordable financing) guidance from government have any culpability in the current financial crisis?
The Discount Rate for Political Capital – A digression
I may be assuming too much at this point regarding the readers understanding of the time values of money, however, I will make that leap of faith to make this point.
The SEC in its requirements for reporting reserves assumes a 10% discount rate. This simply means that a dollar seen in about 7.3 years is worth $0.50 today.
Most energy companies use a discount or reinvestment rate of at least 15%. Here this half-life or $0.50 value today is seen for that dollar earned only 4.9 years from now. In other words, the higher the discount rate, the less future dollars are worth.
So far we have been talking about coin of the realm or legal tender. Now let us shift to an equally powerful form of capital that can be invested: political capital. Here we see the rush to act while the mandate from a recent election is hot. I suggest that, at most, political capital has a half-life of one year and probably even shorter than that. If it is one year, then the implied discount is 100%.
In other words political capital only has value today. Results from spending it on policy really do not matter, as politicians are seldom held accountable for their actions in the next election as they can promise something new on a totally different topic.
This observation probably dooms my hope that the pending efforts at energy and environmental policy will actually look to the possible future results of their actions.
Could the efforts toward home ownership have been crafted differently if the bubble were anticipated? What’s wrong with renting? Should current actions at turning the economy consider the consequences of low interest and expanding debt? As with Iraq and Afghanistan, is there an exit strategy for this monetary and fiscal policy?
And the Almighty looked down on DC and saw such confusion and the expulsion of hot air that he was sorely vexed that this too was adding to global warming. This time he saw the devils hand hard at work, diverting attention from informed, well-reasoned policy that might actually offer cheap, abundant, and environmentally cost effective energy to fuel his global economy.
Energy policy that at best shows benign, or worse yet, blatant neglect for the 80% of our energy supply can easily discourage investment. While the US is said to be responsible for 20% of global green house gases, it has lowered this footprint over time as the nation moves away from manufacturing and has invested in technology to lower it production costs associated with energy input.
What would happen to global greenhouse gas production if the US refining industry were to go offshore? Would the US still consume the same amount of gasoline, but now from foreign sources? Could US Cap and Trade costs be applied to foreign production?
This becomes a sort of “Whack-a-Mole” game. The winner is the player who targets the biggest mole. He gets the biggest bang for his buck. Several years ago, there was an effort here in Colorado to improve gas mileage. While some noble souls converted their 30-mpg cars to compressed natural gas seeing some incremental improvement, the environment did not improve as the fleet of high-polluting cars was still there. Fast forward and we now see pollution survey vans along the highways that let you know annually that if you drove by such a van and passed its sensor’s test, you would not have to get the car inspected no less repaired.
So are Cap and Trade and higher CAFE standards getting the most bang for the taxpayer’s buck? Are these concepts really just responding to the discount rate for political capital?
This is a hope that policy will result in sound, economically viable change. Yet it must also obey the 3 Ts; Timeliness, Targeted, and Transparent. Long-term energy policy timeliness not only reflects the urgency of the day but the economic impacts in the future when that policy is fully in force.
Now let me offer you my dream or hope. Picture a future when there is a concerted effort to minimize the carbon footprint of our energy usage. With some new technology addressing nuclear waste and/or feasible fusion power, it is conceivable to produce close to 100% of our base-load electricity with nuclear power. Add some breakthrough technology in battery storage, and the majority of the economy’s transportation needs could be served by electric power.
This would free up hydrocarbons for their highest economic end-use in such areas as plastics and fertilizers, etc. A dream or hope? Yes. Consume less oil, natural gas and coal? Who knows? By the time such an energy economy was in place, the world might truly be past the Peak Oil point, and such valuable resources as these hydrocarbons would be reserved for these non-energy applications.
Today, the industry is using various forms of energy to produce more energy resources that have the highest economic end use. Heavy oil in California is being produced partially with energy from photovoltaic solar panels. Canadian oil sands are produced by using natural gas. In the future, oil shale may be produced in-situ using direct nuclear power to heat the rock. Synergism is a wonderful thing.
We must remember that it is hard to shame some people into something if they have no shame in the first place. Is such a dream really possible with our 535 in D.C.?
There is nowhere else to turn except to you, dear reader, who must on behalf of We the People take energy policy into your own hands and get the 535 to act in your best interest. Remember, the Almighty is watching and is holding you accountable for being good stewards of his creation.
John Tobin has been the Executive Director of the Energy LITERACY Project, Inc. and has been a Distinguished Lecturer for the International Society of Petroleum Engineers. His 45 years of experience includes positions with ARCO, Scientific Software Corp., Martin Marietta and Eastman Kodak. He has BS (1964) and MS (1966) degrees from the University of Rochester in Mechanical and Aerospace Sciences.
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