Home ownership has been elevated to an American right. This belief, directed at mortgage companies and lenders, has fueled the Alt-A and sub-prime mortgage explosion. The results were predictable. The unpredictable part was that the securitization of debt, its aggregation into trading instruments, and the resultant distribution of risk penetrated so deeply into the world financial markets. Unfortunately, distribution of risk is not elimination of risk, as we are now seeing.

The US Census Bureau establishes current home ownership at 68.9%, up from the level sustained from 1980 to 1995. (current US Census data and sustained level.)


Looking at these data, we note that up to Bill Clinton’s effort to provide housing to all in the late 90’s, the percentage of ownership was 64.5%. After Clinton, Bush, the Federal Housing Authority, Fanny Mae and Freddie Mac got into the picture, the US Census numbers (2006) showed 68.9% ownership, a whopping increase of 4.4%. Let’s pull some quick facts from the census. Round off the population to 300,000,000. Of these people, there are approximately 105,000,000 housholds (or potential homeowners). Figure the median value of a home, again approximating the census data, as $120,000. Do the math and you can see that 4.4% increase in home ownership resulted in about 4.62 million new homes or about $554.4 billion in new loans.

Now while this is more pocket change than I’ll ever carry around, it doesn’t quite add up. The 2007 estimate of the US GDP was $13,790 billion. The newly originated loans constituted only 4% GDP. This is approximately the same cost as the annual defense budget as a percent GDP — hardly something that could tank the world financial market.

Yet we see the numbers in the papers all the time. Banks have liquidity problems. Credit default swap derivatives exposure is estimated at $26 trillion.

  • 2/28/2008 Fannie Mae posts $3.56 billion loss
  • 1/25/2008 Societe General posts $7.2 billion loss
  • 2/27/2008 Bond Insurer MBIA default loss estimate $13.7 billion
  • 2/25/2008 Bond insurer AMBAC looking to raise $3 billion in capital
  • 2/18/2008 National Rock bank London nationalized to secure $107 billion
  • 2/22/2008 Credit default swaps loss is $2 trillion

The answer to this is clear. The current mess has very little to do with homeownership per se and everything to do with investing. If we only had an increase in 4.4% ownership, then the additional debt must have been acquired by people purchasing real estate for investment purposes and homes to flip, also for investment purchases. Add to that the clever derivatives instruments, where a lot of financial engineers and derivatives traders boasted of their multi-million dollar salaries, and you can see that the core of the “irrational exuberence” is based on making very risky bets on an upside market.

When the bubble bursts, and the risk becomes apparent, and bites you in the ass, the taxpayers of the United States are once again called upon to bail out Wall street and stupid, greedy investors. So now we are engaged in assuading the market through rate cuts to resolve liquidity problems, forcing the dollar lower and inflating the cost of essentials like food and energy. All because of the dictum:

 

What affects Wall Street eventually affects Main Street

 

Thanks to the Angry Virginian for comments and suggestions as to breaking this rant into digestible chunks.

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