Problems, arising from the bursting of the housing bubble, continue to escalate. On Friday, the Wall Street Journal reported on a pending agreement between the Bush administration and lenders. The agreement would freeze interest rates to troubled borrowers for up to seven years at low, introductory, teaser rates.
My post Something for Nothing wrote of the resentment that such bailouts will create. At his outstanding blog, Mish Shedlock explains why the bailout will fail—those who have negative equity in their homes will have every incentive to fall behind on their loans in order to receive a bailout. Mish writes:
It will fail because it is in the best interest of those underwater on their loans to make it fail. People are going to understand they are way upside down on their home loans, and those people along with everyone who resents others being bailed out will have every reason in the world to walk away. So walk away they will.
Last week also saw Wall Street rallying on the possibility that Bernanke will cut interest rates by another half-percent. No doubt we will see continuing actions and proposals to bailout the financial sector—at the expense of the economy.
At the same time, there is little to indicate that the public has had enough of all of this. A dangerous belief has strengthened over the past decades—the belief that Fed is an omnipotent director who can navigate the economy away from harm. Doug Wakefield writes of crowd behavior:
Until we understand our human tendency is to extrapolate the past, and embrace stories that support our feelings of a current trend, we will fail to search beyond our feelings and passionately seek for signs of the END of a current trend.
In other words, until we are forced by circumstances to confront our beliefs, we usually don’t. This basic fact of human nature makes it almost a certainty that the current economic crisis will continue to escalate.
The fact that anyone can still have faith in the institutions that by their policies created the mess, is strong evidence for how hard it is for human beings to reflect on cherished beliefs.
Many independent financial writers and economists (myself included) predicted this housing crisis. Robert Prechter wrote in 2002:
What screams “bubble”—giant, historic bubble—in real estate today is the system-wide extension of massive amounts of credit to finance property purchases. As a result, a record percentage of Americans today are nominal “homeowners” via $7.6 trillion in mortgage debt.
Or, consider what Warren Brussee wrote in 2004:
Come 2008 the number of people giving up on making house payments will skyrocket. Since many of the recent mortgage loans were adjustable rate or had little or no collateral, banks will be forced to foreclose on the homes and sell them, causing a glut of homes on the market and a deflation of home values. In the 2000 market drop almost no banks went belly up because people had not bought stocks on leverage. This is not true in housing, where people and banks are leveraged. As the current inflated home values go down many people will have mortgages greater than the value of their homes, and they will happily give their homes back to the bank rather than fight their mortgage payments. Unless the federal government comes to their rescue, many banks will fail in this downturn. This is because banks also got too confident and optimized bottom line results with little consideration for the risks they were taking with marginal mortgage loans.
I could have included other prescient forecasts, but the point is this—our current crisis is not an unfortunate result of unpredictable events. Instead, it is a direct consequence of exceptionally poor policies. Many treat seriously proposals coming from the same institutions that implemented these poor policies—that in itself is a sign of how far away we are from the end of this crisis.
Consider this current sobering forecast. One financial writer was asked to use a baseball metaphor for how far we are into this economic crisis. He was asked: “Would you say we are in the seventh inning?” His response: “Hardly, they are just playing the national anthem.”