A Brief History…

Mickey Kaus has some doubts about the housing crisis. A drop of 6.6% in average prices after the run-up of the past five years doesn’t seem like much of a “crisis” to him, or to me. I remember 1993 when we had a real crisis in California. I bought my house in 1991 when prices were already soft. I had gotten divorced a few years before and swore I was through with expensive houses. There is an old saw among doctors I know that goes, “You don’t have to get married. All you have to do is find a woman you can learn to hate in ten years and buy her a house.” I bought a couple of those. Anyway, I was determined to stick with a smaller house and buy it as cheap as I could. I made low offers on a couple of houses. One was so low that the realtor refused to submit it to his client. I waited 72 hours (as specified in the offer) and bought another house from a seller who was willing to counter. I got the house for about 15% under the asking price. Two years later, the value had dropped by 25% on an appraisal. It eventually recovered and the house is now worth three times what I paid for it. The people in trouble are those who bought more than one house in order to “flip” them, or those who paid too much assuming that trees grow to the sky and prices never fall. I have little sympathy for any of them. The decline in prices in California is a fraction of the rise of the past few years. Houses are not selling in my neighborhood but that is probably a function of buyers anticipating price drops and sellers refusing to go along. I don’t know who is right but, aside from overpriced condos, nobody will lose money by waiting, at least in the California market. Of course, that doesn’t help left wing newspaper reporters who need a story to bash Bush.

UPDATE: Sad news today (1/16/08). John Nagl is retiring. His doctoral thesis became one of the textbooks of COIN warfare. He has been on Petraeus’ staff in Iraq but why is he still a LT colonel ? The Army was reluctant to adopt COIN tactics. Now he is leaving. Remember that Aaron Bank retired as a colonel. He founded Special Forces but that was not what the Army rewarded in those days. Nothing has changed.

 The lefties, once again, are crowing about how the Army is having problems retaining junior officers. There is a similar problem with senior noncoms. The left would have you think it is all about Iraq. Some of it is. Some of it is much older than the present war. Prior to 9/11, I read a critique of the US Army that pointed out reasons why we were losing high quality junior officers. Nothing, or little, has changed. Iraq has, in fact, improved morale and retention as war fighters are reluctant to leave comrades behind when they seek out high paying jobs and better career opportunities. Another interesting book is The $ 5 Billion Misunderstanding about the Navy’s A 12 program and, indirectly, about the problems of the procurement system that gives more power to appropriators like Murtha, who slanders US Marines, than the troops who fight the wars. Now, a new report points out some of the real issues. To anyone who has read WEB Griffin novels about the military, they will sound familiar. Not all senior officers are wise and not all junior officers are willing to put up with illogical promotion systems and personnel practices. Military bases have tended to be in the boondocks (read Griffin’s novels about Fort Rucker in the early days of Army aviation) and military families, especially of highly intelligent and educated young officers, may chafe at the lack of cultural amenities. In addition, the booming economy offers alternatives, not just to officers with college degrees, but to well trained and educated noncoms with language skills and other technical training in great demand. A high tech Army must be aware of the competition for its highly qualified personnel. It’s probably no more of a crisis than it was ten years ago but we need the Army more right now, especially the cadres to build a larger Army. The Air Force has another problem. The manned aircraft is going away even faster than I previously believed.

The NY Times today has a story that the bail-out plans for the “liar loans” is not going to happen. The 1980s S&L crisis was another crisis created by reckless lending. My ex-wife was a mortgage banker and worked for the RTC for a while. She found lots of bad behavior in the institutions she reorganized or liquidated. This all began some years before when the Jimmy Carter inflation was raging. Fernand St Germain was a Congressman from Rhode Island. I don’t agree with everything in that link but it has this right.

One night in 1980, Representative Fernand St Germain (D-Rhode Island), whose $10,000-to-$20,000-a-year restaurant and bar tab was paid for by the S&L industry’s chief lobbyist, proposed raising federal insurance on S&L savings accounts from $40,000 to $100,000- even though the average size of an S&L account was $6,000. He waited until after midnight, when only eleven representatives were still on the floor of the House; they approved his proposal unanimously. But St Germain was just getting warmed up. In 1982, he cosponsored a bill that removed all controls on what S&Ls could charge for interest and released them from their century-old reliance on home mortgages.

This version is a bit less emotional. The reason why this bill was passed was not just St. Germain’s bar bill. The S&L industry was founded in the Depression to support home ownership. The movie “It’s a Wonderful Life” tells the story of the origins. Here is a law professor’s version of the movie. It makes the same point. The S&L paid 4% interest on savings and the money was loaned at 6% to finance homes. The deposits, as depicted in the movie, were supposed to be long term savings. This worked well until inflation took off in the 1970s. Then we had the consequences of what is called “lending long and borrowing short.”

My medical partner built a new home in 1978. His construction loan had an interest rate of 19%. When the home was finished, the permanent financing had an interest rate of 21%. His neighbors on either side, both professionals, could not qualify for the permanent financing of their homes and both houses went into foreclosure. How did this happen ?

It began with Lyndon Johnson and his decision to fund the Vietnam War at the same time he expanded the welfare state with The Great Society. The pressure on the currency eventually resulted in Richard Nixon taking the country off the gold standard. The effect, as noted in that link was to confound the Keynesians. Maybe gold was not really an archaic relic, after all. Anyway, the result was wild (Not of Weimar magnitude but unique in US history) inflation. This produced huge pressure on interest rates and efforts to take a middle course resulted in “Stagflation” or a combination of inflation and a weak economy.

The effect on S&Ls was disastrous. Regulation Q limited the interest rates that S&Ls could pay depositors. If inflation was 10% and interest rates on deposits was 4%, the depositor was losing 6% per year on his money. I remember this time well. New vehicles appeared for investment. Previously, only banks and major corporations could find higher returns on investments. What happened was a surge in buying of houses, with corresponding inflation of home prices, and of art objects and gold.  I put much of my pension plan into second trust deeds on homes in Mission Viejo that paid 20% interest. I had US Trasury bonds that paid 16% interest.  The ownership of gold, except for jewelry, had been illegal for US citizens since 1933. Many friends of mine put money into gold coins in Switzerland, even at negative interest rates.

UBS History   1972- In Switzerland new restrictions on bank lending enter into force combined with new negative interest rates of up to 10% per quarter (40% p.a.) on the growth of foreign deposits in Swiss Francs with domestic banks. The restrictions are in force until 1975/1979.

The S&Ls hemorrhaged money. Congress came to their rescue with the St. Germain law. Not only would they be allowed to pay higher interest rates to keep depositors, the FDIC for S&Ls (called FSLIC) would now guarantee deposits to $100,000. The train wreck was now inevitable.  It arrived on Reagan’s watch, a timing that has confused many people (some purposely) about the origins. It began with government subsidy and the failure to allow the bad decisions to result in bad outcomes has resulted in more bad decisions.Let’s hope that wiser heads will prevail now. The bailout of the S&Ls guaranteed the “liar loan” crisis we have now. Maybe somebody learned something. I wish I was more optimistic.