By Swami Iyer - TOI - 25/ 02
The Obama housing plan seeks to return to the pre-crisis situation that was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
INDIA cannot grow fast again till the US economy recovers. And US recovery depends on reviving the housing sector, whence the downswing began. Alas, the Obama Plan for housing is a crutch, not a cure. Putting all the blame on insufficient regulation and overpaid, greedy lenders cannot rectify the structural flaws of US housing. Equally to blame is the political illusion that by tweaking markets and arm-twisting lenders, you can make all Americans home owners.
The Obama Plan has three main components. One, cash incentives (totalling $75 billion) for lenders and home owners to renegotiate mortgages. Two, allowing those whose mortgages exceed home value to refinance, up to 105% of the home value. Three, fresh capital of $200 billion for government agencies (Fannie Mae and Freddie Mac) to expand mortgage lending.
The Obama Plan aims to raise distressed home values by $6,000, cut foreclosures, and prevent entire localities from becoming ownerless and derelict. Whether lenders will be able to renegotiate millions of mortgages remains unclear. Many mortgages have been sliced and bundled into CDO bonds, and any administrator who writes down a mortgage risks being sued by disgruntled bondholders.
Refinancing mortgages up to 105% of home value will be disastrous if home prices fall further. The crisis owes much to the slack lending standards of Fannie Mae and Freddie Mac, yet the Obama Plan provides these agencies additional capital to extend substandard lending. This risky approach will work only if home prices rise soon. Otherwise, it will cause another housing crisis within two years.
The Obama Plan addresses current distress, but ignores two fundamental flaws in the whole housing system. One is the limited liability of home owners. In most countries, a mortgage is secured by the value of the home plus a personal guarantee of the home owner. So, if he defaults on mortgage payments, the lender can go after his salary or other assets. This is called a full recourse loan, and encourages home owners to do their best to repay loans.
But the US has non-recourse mortgages, secured only by the house. The lender cannot go after other assets of the borrower. If the market price of a house sinks below the mortgage outstanding, the owner can simply walk out and mail the house keys to the lender, with no further liability. This “jingle mail” loophole encourages wilful default. European countries have full recourse mortgages — the lenders can go after all assets — and so have far lower default and foreclosure rates.
The Obama Plan is silent on closing the jingle-mail loophole. Politicians currently paint all lenders as crooks and borrowers as victims, and don’t want the supposed crooks to go after the other assets of the supposed victims. Such populism ignores the perverse incentives of jingle mail, which erode the foundations of the housing market.
The second, more fundamental flaw is the political determination to tweak housing markets to somehow attain the ideal of universal home ownership. In a market system, monthly mortgage payments are necessarily higher than monthly rents. People with uncertain incomes should rent cheaply, not borrow expensively to buy houses. Renting is an essential part of a housing market, not a deficiency.
POLITICAL measures to subsidise ownership and discourage renting have contributed to terrible lending and borrowing practices that caused the current crisis. Instead of reforming these, the Obama Plan provides billions to subsidise those same terrible practices. These practices survived for 60 years because of a quirk: US home prices never fell after World War II. Yet in a market system prices must fall as well as rise. When finally US home prices fell in 2007, the system collapsed. The US must, like other countries, have a housing system that can cope with declines as well as increases in home prices.
US politicians aim for universal home ownership in four ways. One, unlimited tax exemption for interest on home loans. Two, the creation of Fannie Mae and Freddie Mac, agencies with quasi-government guarantees to underwrite more mortgages than markets alone would find prudent. Three, federal mortgage insurance. Four, several laws — including the controversial Community Reinvestment Act — obliging banks to lend to all areas, and not discriminate against poor or crime-ridden neighbourhoods.
Though well intentioned, these measures are the wrong instruments. If you seek universal home ownership, the best way is massive public housing followed by privatisation (sale to the renters). Governments should build low-cost houses and rent these cheaply to people with low or uncertain incomes. Renters who pay rent for a specified period — say 12-15 years — will become owners. Margaret Thatcher in Britain converted millions of government tenants into home owners.
This is not socialism. Even in pre-communist Hong Kong, which came closer than any other country to laissez faire, almost half of all housing was public housing. It was a non-market measure for a non-market aim.
If Obama is serious, he must grasp some nettles. He cannot have both responsible lending practices and universal home ownership. If he wants responsible lending, he must explicitly abandon the goal of universal home ownership, and aim for affordable rents. This approach implies limiting or abolishing tax breaks on mortgage interest for home owners, and instead providing subsidies for lowincome renting. It implies full recourse mortgages. And it implies that prospective home buyers must put down 20% of the price of homes, so that the housing system can withstand a 20% fall in home prices. This will, of course, mean less home ownership and more renting.
If on the other hand Obama wants to aim for universal home ownership, he should opt for massive public housing followed by privatisation. Renters of government housing should eventually become owners.
Alas, the Obama Plan refuses to face up to this hard choice. Instead, it seeks to return to the pre-crisis situation, which was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
Wednesday, February 25, 2009
Tuesday, February 17, 2009
Capitalism is reinventing itself
By Swami Iyer - TOI
As the recession deepens, people across the ideological spectrum declare that capitalism has failed. Almost every economic news report carries words like ‘crisis’ and ‘disaster’. Yet, recessions are not aberrations of capitalism but an intrinsic part of it.
Markets create boom and bust cycles, arising from human tendencies to swing from euphoria to fear and back. A bust is an occasion for cleaning out deadwood and failed experiments, and re-inventing capitalism.
In my youth, the Communist Party politburo would meet after every recession and declare “capitalism is now in its final death throes.” In fact, capitalism re-invented itself and grew constantly stronger, while the recession-free communist system collapsed.
Two decades ago, economist Jerry Muller chronicled never-ending predictions of the demise of capitalism, by its friends as well as foes. In the 1850s, Karl Marx claimed capitalism was dying. Rosa Luxemburg wrote in
The Accumulation of Private Capital
(1913), “Though imperialism is the historical method prolonging the career of capitalism, it is also a sure means of bringing it to a swift conclusion.” Lenin harboured similar illusions: his 1916 book was titled Imperialism: the Last Stage of Capitalism.
The Great Depression of the 1930s provoked further predictions of capitalism’s demise. Ferdinand Fried, of the German radical right, made waves with his 1930 book The End of Capitalism. In the US, Howard Scott’s technocracy movement predicted the replacement of market prices by central planning. British sociologist Karl Mannheim asserted in Man and Society in An Age of Reconstruction
(1940) that democracy could survive only by delinking from capitalism.
World War II came and went, but obituaries of capitalism continued. Historian AJP Taylor declared on BBC in 1945 that “Nobody believes in the American way of life, that is, private enterprise. Or rather, those who believe in it are a defeated party, and a party which seems to have no more future than the Jacobites in England after 1688.”
Economist Joseph Schumpeter, a great protagonist of entrepreneurship, nevertheless suggested in Capitalism, Socialism and Democracy that capitalism could die through self-inflicted wounds. Nikita Krushchev was certain history was on his side: “We will crush you”.
All capitalist nations became welfare states after World War II, devoting unprecedented sums to the sick, aged and poor. This was interpreted by some as meaning that capitalism was fading away. The stagnation of capitalist economies in the 1970s fuelled new hopes in the European Left, and Francois Mitterand came to power in France on a platform of breaking with capitalism. He nationalised major French industries, raised taxes, shortened working hours and lengthened holidays. He would not, he said, take the Thatcher-Reagan path to disaster. But soon France was in even deeper recession than the US or Britain. A disillusioned Mitterand later re-privatised nationalised companies.
Why have so many intelligent, learned people been constantly wrong about capitalism? First, the word capitalism has been used by some people to mean a system with no role for governments at all, whereas modern capitalism is very much a government-business joint venture. Second, critics have constantly underestimated capitalism’s ability to re-engineer itself and evolve into new forms that get rid of some of the old defects.
The current bust certainly calls for some re-engineering of markets. Yet, economists and politicians have been quicker to condemn existing flaws than propose comprehensive reforms that will nip financial crises in the bud. Ever since the Asian financial crisis, we have heard much talk about a new financial architecture, yet in practice that has not gone much beyond suggesting higher IMF quotas for developing countries, which is desirable but of marginal importance.
We hear talk of doubling or tripling the lending power of the IMF. That will enable the IMF to rescue some developing countries or East Europeans, but not to end the housing and credit busts in the US and EU.
Everybody agrees that financial markets need more regulation. We will doubtless see more controls on financial derivatives and stricter lending norms. Yet, recessions and financial crises occured in earlier decades when lending controls were much stricter, and financial derivatives did not exist.
After having demanded for decades a greater say in the global financial system, developing countries now have a chance to actually press for reforms. They now have unprecedented clout: Asian forex reserves greatly exceed those of the IMF. The world is looking seriously for new ideas, and wants to hear from Asia. Yet, developing countries — including India — have little to suggest except larger quotas for themselves in the IMF, and bigger IMF lending. So sad. If you have nothing to say, why demand a greater say? Montek Singh Ahluwalia, here’s your big chance.
As the recession deepens, people across the ideological spectrum declare that capitalism has failed. Almost every economic news report carries words like ‘crisis’ and ‘disaster’. Yet, recessions are not aberrations of capitalism but an intrinsic part of it.
Markets create boom and bust cycles, arising from human tendencies to swing from euphoria to fear and back. A bust is an occasion for cleaning out deadwood and failed experiments, and re-inventing capitalism.
In my youth, the Communist Party politburo would meet after every recession and declare “capitalism is now in its final death throes.” In fact, capitalism re-invented itself and grew constantly stronger, while the recession-free communist system collapsed.
Two decades ago, economist Jerry Muller chronicled never-ending predictions of the demise of capitalism, by its friends as well as foes. In the 1850s, Karl Marx claimed capitalism was dying. Rosa Luxemburg wrote in
The Accumulation of Private Capital
(1913), “Though imperialism is the historical method prolonging the career of capitalism, it is also a sure means of bringing it to a swift conclusion.” Lenin harboured similar illusions: his 1916 book was titled Imperialism: the Last Stage of Capitalism.
The Great Depression of the 1930s provoked further predictions of capitalism’s demise. Ferdinand Fried, of the German radical right, made waves with his 1930 book The End of Capitalism. In the US, Howard Scott’s technocracy movement predicted the replacement of market prices by central planning. British sociologist Karl Mannheim asserted in Man and Society in An Age of Reconstruction
(1940) that democracy could survive only by delinking from capitalism.
World War II came and went, but obituaries of capitalism continued. Historian AJP Taylor declared on BBC in 1945 that “Nobody believes in the American way of life, that is, private enterprise. Or rather, those who believe in it are a defeated party, and a party which seems to have no more future than the Jacobites in England after 1688.”
Economist Joseph Schumpeter, a great protagonist of entrepreneurship, nevertheless suggested in Capitalism, Socialism and Democracy that capitalism could die through self-inflicted wounds. Nikita Krushchev was certain history was on his side: “We will crush you”.
All capitalist nations became welfare states after World War II, devoting unprecedented sums to the sick, aged and poor. This was interpreted by some as meaning that capitalism was fading away. The stagnation of capitalist economies in the 1970s fuelled new hopes in the European Left, and Francois Mitterand came to power in France on a platform of breaking with capitalism. He nationalised major French industries, raised taxes, shortened working hours and lengthened holidays. He would not, he said, take the Thatcher-Reagan path to disaster. But soon France was in even deeper recession than the US or Britain. A disillusioned Mitterand later re-privatised nationalised companies.
Why have so many intelligent, learned people been constantly wrong about capitalism? First, the word capitalism has been used by some people to mean a system with no role for governments at all, whereas modern capitalism is very much a government-business joint venture. Second, critics have constantly underestimated capitalism’s ability to re-engineer itself and evolve into new forms that get rid of some of the old defects.
The current bust certainly calls for some re-engineering of markets. Yet, economists and politicians have been quicker to condemn existing flaws than propose comprehensive reforms that will nip financial crises in the bud. Ever since the Asian financial crisis, we have heard much talk about a new financial architecture, yet in practice that has not gone much beyond suggesting higher IMF quotas for developing countries, which is desirable but of marginal importance.
We hear talk of doubling or tripling the lending power of the IMF. That will enable the IMF to rescue some developing countries or East Europeans, but not to end the housing and credit busts in the US and EU.
Everybody agrees that financial markets need more regulation. We will doubtless see more controls on financial derivatives and stricter lending norms. Yet, recessions and financial crises occured in earlier decades when lending controls were much stricter, and financial derivatives did not exist.
After having demanded for decades a greater say in the global financial system, developing countries now have a chance to actually press for reforms. They now have unprecedented clout: Asian forex reserves greatly exceed those of the IMF. The world is looking seriously for new ideas, and wants to hear from Asia. Yet, developing countries — including India — have little to suggest except larger quotas for themselves in the IMF, and bigger IMF lending. So sad. If you have nothing to say, why demand a greater say? Montek Singh Ahluwalia, here’s your big chance.
Monday, February 9, 2009
Higher Forex can worsen this recession says Swami
By Swami Iyer - again
High foreign exchange reserves have, in the current global recession, saved Asian countries (including India) from the travails they suffered in the Asian financial crisis of 1997-2000. So, they must aim for rising forex reserves in future too, right? Wrong.
In truth, high Asian forex reserves are an important reason for the current recession. High reserves promise safety in a storm. But, beyond a point this safety becomes illusory, because rising forex reserves worsen the global imbalances that have precipitated the recession.
The global recession has many roots. One is the erosion of traditional US household prudence. US households used to save 6% of their disposable income. But in recent years they went on a borrowing and spending spree, and household savings dropped to virtually zero. Corporations and financiers also ran up record debts, partly to buy assets such as houses, stocks and commodities. This created huge bubbles in all three markets.
When the bubbles finally burst, US households, corporations and financiers found themselves in dire straits. Many financial giants were rescued by the government. Meanwhile households, sobered by the turn of events, started saving 4% of disposable income, up from zero. More saving meant less spending, and made the recession deep and sharp.
Most Asians are smugly blaming US imprudence and loose financial regulation for the crisis, while portraying themselves as innocent victims. Yet, they must share the guilt too. US profligacy did not arise in a vacuum. It arose in part because Asian insistence on high forex reserves meant that they poured dollars into the US to buy US securities. This flood of dollars from Asia drove down US interest rates, making it very attractive to borrow. That spurred the borrowing spree, and the accompanying bubbles.
Historically, rich countries had surplus savings, manifested in a trade surplus. Poor countries lacked savings, manifested in trade deficits, with the deficit being plugged by an inflow of dollars from rich to poor countries. For the world as a whole, current account surpluses and deficits of countries must necessarily balance. Historically, the surpluses of rich countries were offset by the deficits of poor ones.
But after the Asian financial crisis, something strange happened. Asian countries, above all China, began generating huge savings surpluses, manifested in huge current account surpluses. Many used undervalued exchange rates to artificially create trade surpluses, which were then invested in US treasuries (that is what foreign exchange reserves are).
However, poor Asians could not run huge surpluses unless others were willing to run huge deficits. Remarkably, the rich US began to do so. This arose partly from the sophistication of its financial system, which found many ways — too many, in fact — of converting the flood of money from Asia into a borrowing and spending spree. This sharp rise in US spending boosted the global economy, and created the record global GDP growth in 2003-08. US demand sucked in huge quantities of manufactures and services from Asia, above all from China. Asian manufacturing sucked in huge quantities of commodities from Africa and Latin America, raising incomes there too.
Alas, this boom was based on huge global imbalances that had to be corrected at some point. No country, not even the rich US, could keep running gargantuan trade deficits forever, to offset the surpluses of Asia. US asset bubbles burst, the boom ended, and US spending and imports plummeted.
Ending the consequent recession means reducing global imbalances to manageable proportions. Americans will have to save more, spend less and export more. Asian countries, especially China, will have to consume more, save less, and export less. This re-balancing will restore global balance, and enable global growth to rise sustainably again.
However, such re-balancing means that Asian countries must stop piling up ever-rising forex reserves (and trade surpluses). Such reserves represent excessive saving, excessive exports and insufficient imports. Excess forex reserves have provided apparent safety to Asian countries in a recessionary crisis, yet are also a cause of that very crisis.
What will happen if Asians insist on trying to keep savings and forex reserves high? Well, if Asians keep savings high and Americans and Europeans do so too, then world demand will collapse and the recession will become a Depression. Asians must recognise that high forex reserves serve as a safety cushion only up to a point, and beyond that exacerbate global imbalances that threaten disaster. Saving too much can be as harmful as saving too little. Unless Asian countries recognize this and go slow on future reserve accumulation, the recession may become worse than anyone dares imagine today.
High foreign exchange reserves have, in the current global recession, saved Asian countries (including India) from the travails they suffered in the Asian financial crisis of 1997-2000. So, they must aim for rising forex reserves in future too, right? Wrong.
In truth, high Asian forex reserves are an important reason for the current recession. High reserves promise safety in a storm. But, beyond a point this safety becomes illusory, because rising forex reserves worsen the global imbalances that have precipitated the recession.
The global recession has many roots. One is the erosion of traditional US household prudence. US households used to save 6% of their disposable income. But in recent years they went on a borrowing and spending spree, and household savings dropped to virtually zero. Corporations and financiers also ran up record debts, partly to buy assets such as houses, stocks and commodities. This created huge bubbles in all three markets.
When the bubbles finally burst, US households, corporations and financiers found themselves in dire straits. Many financial giants were rescued by the government. Meanwhile households, sobered by the turn of events, started saving 4% of disposable income, up from zero. More saving meant less spending, and made the recession deep and sharp.
Most Asians are smugly blaming US imprudence and loose financial regulation for the crisis, while portraying themselves as innocent victims. Yet, they must share the guilt too. US profligacy did not arise in a vacuum. It arose in part because Asian insistence on high forex reserves meant that they poured dollars into the US to buy US securities. This flood of dollars from Asia drove down US interest rates, making it very attractive to borrow. That spurred the borrowing spree, and the accompanying bubbles.
Historically, rich countries had surplus savings, manifested in a trade surplus. Poor countries lacked savings, manifested in trade deficits, with the deficit being plugged by an inflow of dollars from rich to poor countries. For the world as a whole, current account surpluses and deficits of countries must necessarily balance. Historically, the surpluses of rich countries were offset by the deficits of poor ones.
But after the Asian financial crisis, something strange happened. Asian countries, above all China, began generating huge savings surpluses, manifested in huge current account surpluses. Many used undervalued exchange rates to artificially create trade surpluses, which were then invested in US treasuries (that is what foreign exchange reserves are).
However, poor Asians could not run huge surpluses unless others were willing to run huge deficits. Remarkably, the rich US began to do so. This arose partly from the sophistication of its financial system, which found many ways — too many, in fact — of converting the flood of money from Asia into a borrowing and spending spree. This sharp rise in US spending boosted the global economy, and created the record global GDP growth in 2003-08. US demand sucked in huge quantities of manufactures and services from Asia, above all from China. Asian manufacturing sucked in huge quantities of commodities from Africa and Latin America, raising incomes there too.
Alas, this boom was based on huge global imbalances that had to be corrected at some point. No country, not even the rich US, could keep running gargantuan trade deficits forever, to offset the surpluses of Asia. US asset bubbles burst, the boom ended, and US spending and imports plummeted.
Ending the consequent recession means reducing global imbalances to manageable proportions. Americans will have to save more, spend less and export more. Asian countries, especially China, will have to consume more, save less, and export less. This re-balancing will restore global balance, and enable global growth to rise sustainably again.
However, such re-balancing means that Asian countries must stop piling up ever-rising forex reserves (and trade surpluses). Such reserves represent excessive saving, excessive exports and insufficient imports. Excess forex reserves have provided apparent safety to Asian countries in a recessionary crisis, yet are also a cause of that very crisis.
What will happen if Asians insist on trying to keep savings and forex reserves high? Well, if Asians keep savings high and Americans and Europeans do so too, then world demand will collapse and the recession will become a Depression. Asians must recognise that high forex reserves serve as a safety cushion only up to a point, and beyond that exacerbate global imbalances that threaten disaster. Saving too much can be as harmful as saving too little. Unless Asian countries recognize this and go slow on future reserve accumulation, the recession may become worse than anyone dares imagine today.
Saturday, February 7, 2009
Indy Set to beat China in growth rates
All it the brighter side of the current downturn. India may pip export-dependent China in the last quarter of FY09 and emerge as the
As China’s GDP growth rate dropped to 6.8% during the October-December quarter and is expected to go down further, the Indian government has become hyper-active to achieve at least a 6.5% growth in Q4 to register a win over China.
If India achieves a better growth rate than China even for one quarter, the message will go across to the world and help India in wooing foreign capital, waiting to chase growth stories. Already, government officials in India have been highlighting reports of a few investment analysts who doubted China’s official GDP numbers and claimed that it could just be in the positive territory in the last quarter.
Friday, February 6, 2009
Bubble !!
Guys what you see here is the bubble ! all the financial newspapers are talkin abt . I masef found it unbelievable when i first saw it ! but it is real ! So i can add nothing more as the pic speaks for itself
Subscribe to:
Posts (Atom)