The Economy: Is the plug about to be pulled?
I’ve been watching both the Occupy Wall Street (OWS) movement and the overall economic situation very closely. I was going to devote this post to my thoughts on OWS, but will have to come back to that topic later as there’s something far more urgent afoot that will drive this movement and others.
We need to be clear about what the problem is with the economy. Stated simply, it’s debt and tons of bad loans that have been passed throughout the world by the Wall Street crowd in their mad rush for profits. (Closely related to this is fraudulent activity for which no one has been brought to justice). This is creating a crisis that is becoming acute in Europe and soon to leap across the pond to these shores. The short of this is that when a bank has issued loans that have soured, those with deposits in those institutions are at risk. This is what occurred during the Great Depression and many institutions wound up getting shuttered with depositors losing life savings. It was this experience that spurred the creation of the Federal Deposit Insurance Corporation (FDIC) and other similar agencies to provide deposit insurance for people with savings in banks, credit unions and brokerage houses. This is also why the level of deposit insurance was doubled in 2008.
The strength of any banking system revolves around the soundness of its lending and that’s what really protects deposits. When people fear the safety of their money, they tend to withdraw it en masse as they lose confidence. A bank run is a problem for a few reasons; the main one being that your typical bank doesn’t have sufficient currency on hand to handle that. Bank runs during the Great Depression usually resulted in bank closures while placing the entire system under stress. Because many of banks have interlocking financial arrangements involving loans among each other, problems tend to spread quickly and otherwise healthy banks wind up being brought under depending upon the nature of the systemic problem. Essentially, no bank is an island and systemic problems affecting a few banks can quickly spread. This is what makes the situation in Europe very problematic.
But the problems of Europe aren’t the only headwind, I ran across this headline today that I found simply astounding. Here’s a very brief excerpt:
The sputtering U.S. housing market will result in more prime borrowers being pushed further underwater on their mortgages, according to Fitch Ratings in a new report. Recent analysis by Fitch shows that more than 30 percent of all prime borrowers in private-label securitizations are currently in a negative equity position on their mortgages.
“With home prices likely to decline another 10 percent, roughly half of prime borrowers will wind up underwater on their mortgage,” said Managing Director Grant Bailey. Fitch also found over 12 percent of all prime borrowers are seriously delinquent on their mortgages. “Prime mortgage default rates will stay elevated as home prices fall further and unemployment remains high,” said Bailey.
Allow me to translate. First, Fitch is a bond rating agency and their job is to rate bonds based on risk of default or non payment. What does this have to do with mortgages? Most of them are repackaged as bonds and purchased by insurance agencies, pensions and etc. So, Fitch’s role is to provide a rating so these guys can assess risk. In other words, it’s like a FICO score for you and I. If your FICO is poor, you’re going to be charged a higher interest rate because you represent a higher risk for defaulting and not paying. It works the same way here except that Fitch is looking at broad classes of securities and their makeup.
A prime borrower is someone who had a top tier FICO score at the time their loan was taken out, so these borrowers are the crème de le crème and aren’t expected to have problems, but they are. The main problem they face is being “underwater” or being in a situation where the mortgage outstanding is greater than the value of the property. The problem with this is that many people who are in this situation simply default. The thing that’s significant about this is that Fitch is saying that it believes that 50% of all prime mortgages will be “underwater”. What we don’t know is what percentage of the sub-prime mortgages that are in the same condition. I’d hazard to guess that the percentage is at least comparable, if not higher, based on the abuse that was heaped on sub prime borrowers. There will be massive defaults still yet to come from housing that will put the banking system under severe stress without even considering the situation abroad. A jobs program or any other program short of a massive debt restructuring isn’t going to stem this tide.
If that’s not bad enough, we’ve got the quickly unfolding situation in Europe. In the clip below, we’ve got a IMF advisor quietly suggesting that we face a near term banking meltdown, but it seems like they’re being very careful to not sound the alarm, but instead are couching the solution to the problem as one of “bank recapitalization”. That’s a fancy term for a bailout and the only way these institutions will be “recapitalized” is either via using the public purse, seizing depositor’s savings or both. Since the banking system is interlocked globally, this will effectively be a backdoor bailout of US banks as well. This will most certainly be done at the risk of peace and tranquility on that continent and the political dithering is simply about trying to find a sleight of hand way to pull this off. That will be next to impossible as the people aren’t stupid.
Generally, the only real solution to this mess is to make the banks eat those losses, but you’ll notice that’s not mentioned. Instead they’re planning to grab all the lifeboats and jump ship.