Financial Armageddon

'The Single Most Drastic Error in Policy in Modern History'

PBS Newshour has posted a brief but fascinating interview with David Stockman, Director of the Office of Management & Budget during the Reagan era. Despite -- or, perhaps, because of -- his political and financial industry background, he pulls few punches in his remarks about the financial crisis and its aftermath. Here are a few excerpts:

On the relationship between Wall Street and Washington --

DAVID STOCKMAN: ...we have gotten into this syndrome, I think, over the last 20 years, where policy of the Treasury and of the Fed has been dictated by Wall Street, that, if Wall Street threatens to have a hissy fit, or the stock market is going to go down, the Fed has basically capitulated and is creating a very unstable and dangerous financial system in our economy.

On the AIG bailout --

DAVID STOCKMAN: The fact is, the heart of the bailout was AIG. That was $80 billion worth of CDS that was going to go sour.

[PBS Newshour business and economics correspondent] PAUL SOLMAN: CDS meaning?

DAVID STOCKMAN: Credit default swaps, OK? And we weren't bailing out AIG. We were bailing out the banks, because the banks had bought a lot of low-caliber or subprime loans, wrapped some insurance around it from AIG, and said, presto, we have a AAA, a security on our balance sheet.

They didn't. They had garbage on their balance sheet. And the bailout was to make sure that they didn't suffer multi $10 billion write-downs on that AIG-supported loan.

PAUL SOLMAN: So, if you had been in the administration after Lehman Brothers, you wouldn't have supported bailing out AIG?

DAVID STOCKMAN: No, absolutely not. It was the single most, you know, drastic error in policy in modern history, going back to the 1930s. This was exactly the wrong thing to do.

It's destroyed any basis for fiscal discipline in the United States. I was a member of Congress, and I know how they think. And they think by analogy. If you did it for John, you have got to do it for Bob. There is no way that any congressman is ever going to vote against farm subsidies or ethanol subsidies or housing subsidies or anything else, refrigerator subsidies, once we have made this tremendous bailout for Wall Street, and we stepped into AIG.

On the outlook for tax rates --

DAVID STOCKMAN: I think the lesson of the last 25 years is that it doesn't work. You can keep cutting taxes until you reach the point where this year -- or the year just ended, we spent $3.6 trillion, and we only collected $2.2 trillion.

So, we are now so far out of kilter that it's irrelevant. Taxes are going to have to be raised. And the beast needs to be trimmed back. But it can't be starved enough to even begin to cope with our fiscal problem. And this is where I think all the politicians are faking in both parties, but the Republicans especially.

The Republicans think their mission in life is to cut taxes. Sorry, game -- game over. We're now in the tax-raising business. And we're going to be in the tax-raising business for the next decade.

To read the full transcript, click here.

Otherwise, here is the video:

In Sum, Still Pretty Bad

The Federal Reserve Bank of Minneapolis has posted an interesting interactive feature at its website, "The Recession and Recovery in Perspective," which allows visitors to visualize the length and depth of 11 postwar recessions in various ways. Here are two examples:

Despite continued speculation on Wall Street and elsewhere that economic recovery is upon us, these images sum up just how bad things have been during the current downturn.

Click here to explore the other options, including an ability to compare recessions by state.

(Hat tip to Zero Hedge.)

My Latest Market Observation

Once a month or so I write a Market Observation for Financial Sense. Here is an excerpt from today's edition:

As the following graph illustrates, those European nations that have spent too freely and borrowed too much are discovering that there’s a price to pay for their profligacy. With the market price of insuring against default increasing rapidly, odds are that Portugal, Greece, Spain, Italy, the United Kingdom, and Austria, among others, will find it increasingly difficult to remain in control of their economic destinies.

Of course, not of all the basket cases are located outside our shores. In the United States, there are plenty of municipalities -- not to mention the federal government itself -- in financial distress because of poor planning, corruption, misguided policies, and a failure of leadership. Here again, more and more investors and creditors are putting their money where their mouths are and saying: “enough is enough.”

Click here to read the rest.

'You Cannot Buy Groceries with Your House'

One of the many (dubious) assumptions that Wall Street rocket scientists made before the housing and credit bubbles burst centered on what mortgagors would do if the economy hit a "speed bump" (back then, of course, the conventional wisdom was that severe downturns had been eliminated by expert policymaking, reams of academic research, and the wisdom of the ages).

Generally speaking, they believed that homeowners who ran into financial difficulties would behave in the same way that others had before them -- that is, they would make sure the monthly mortgage bill was among the first to be paid.

Well, as with the notion that house prices never go down, this theory turned out to be wide of the mark, as Reuters reports in "More Consumers Pay Credit Card Before Mortgage: Study":

More and more consumers are giving greater priority to paying credit card debt than making a mortgage payment, showing increased financial duress, according to a report released on Wednesday.

As the economy climbs out of the worst recession in decades and unemployment remains high, financial strains have forced consumers to prioritize monthly debt payments in order to maximize cash flow.

The percentage of consumers delinquent on mortgages, but current on credit cards rose to 6.6 percent in the third quarter of 2009 from 6.3 percent in the previous quarter and 4.9 percent in the same quarter a year earlier, a new study developed by TransUnion showed.

The trend first emerged in the first quarter of 2008 when it was at 4.3 percent, Chicago-based TransUnion said.

Less emphasis on mortgage payments could portend higher delinquency rates and perhaps even more foreclosures. That does not bode well for the hard-hit housing market, which remains highly vulnerable to setbacks.

"This goes against conventional wisdom and that has always been that, when faced with a financial crisis, consumers will pay their secured obligations first, specifically their mortgages," Sean Reardon, the author of the study and a consultant in TransUnion's analytics and decisioning services business unit, said in an interview.

By making a minimum payment on a credit card before a full mortgage payment it gives consumers monetary leeway to go about their daily activities, especially if they have lost a job.

"You cannot buy groceries with your house," he said.

The study, obtained exclusively by Reuters prior to its scheduled release, was conducted on consumers that had at least one credit card and one mortgage, and examined 30-day credit card and mortgage delinquency data between the second quarter of 2008 and the third quarter of 2009.

Conversely, the percentage of consumers who were delinquent on their credit cards and current on their mortgages decreased to 3.6 percent in the third quarter of 2009 from 4.1 percent in the first quarter of 2008.

"The 'flip' in payment hierarchy in the lowest scoring segment was evident earlier during the fourth quarter of 2007, compared to the first quarter of 2008 for the total market," Reardon said.

The delinquency rate for consumers with the lowest credit scores who were delinquent on their mortgages, but current on credit cards during fourth quarter of 2007 was 19.1 percent, and rose to 29 percent in the third quarter of 2009.

In a trend similar to that of the total market, the percentage of consumers delinquent on credit cards, but current on mortgages decreased from 18.1 percent in the first quarter of 2008 to 14.5 percent in the third quarter.

CONSUMER CAUGHT IN CONUNDRUM

"The implosion of the mortgage industry over the last 24 months, the resetting of adjustable-rate mortgages and the weak job market came together and redefined how consumers are managing their finances and meeting or not meeting their credit obligations," Ezra Becker, director of consulting and strategy in TransUnion's financial services business unit, said in the interview.

The analysis shows changing consumer preferences, he said.

"The financial services industry must recognize and adjust to the payment hierarchy shift," he said.

In California, the percentage of consumers delinquent on mortgages, but current on their credit cards increased from 3.5 percent in the third quarter of 2007 to 10.2 percent in the third quarter of 2009. In Florida, this same variable increased from 5.1 percent to 12.4 percent.

In this same time frame, the United States increased from 4.0 percent to 6.6 percent.

In contrast, the number of California consumers delinquent on their credit cards but current on their mortgages declined from 3.3 percent in the third quarter of 2007 to 2.7 percent in the third quarter of 2009. In Florida, this variable declined from 5.0 percent to 3.9 percent, the report showed.