I agree with Harun that getting rid of bad debts quickly is the way to best way to go. When you are sick, take the medicine sooner rather than later. It minimizes the suffering and improves the chances of actually being effective.

Now, another reader gives a counter argument to the above and tries to rationalize the "benefits" of a bailout. The error in ALL of these rationalizations lies in the "hidden man" fallacy. That is to say, government intervention will have beneficiaries that are highly visible, while the deleterious effects are usually hidden.

For example, bailing out home debtors clearly will have highly visible beneficiaries. But where is the wealth (not money, we can print up as much as we want, but it’s not wealth. Wealth is savings) going to come from? Government can either

1) tax – forcible seizure of someone’s wealth,

2) borrow – driving up real interest rates, and hence making otherwise viable new enterprises, who need to raise capital, stillborn at the margin,

3) and of course, it can inflate, just print money, thereby making past savings (wealth) worth less. So it’s really an issue of who will pay the piper. The visible beneficiaries or the “hidden man”.

The other reader uses the Chrysler bailout as an example of a successful bailout. OK, so where is the U.S auto industry today? GM has a massive negative net worth, Ford has put up all of its assets, bet the company, as collateral to raise capital to reinvent itself so that it can compete. And Chrysler, got bought by Daimler, then by Cerberus (the mythical dog from hell) Capital, a private equity company. It is squeezing its workers, suppliers with a "we don’t need to answer to anybody, we’re private equity" mentality. Gee, you think this effects GM and Ford?

Yes, GM and Ford are the "hidden men" here and clearly it would have been better for the domestic auto industry, and our economy, if the some of the Chrysler assets would have been bought by the more competitive companies. Does the phrase "creative destruction of capital" ring a bell here?

What the other reader fails to address here is EXACTLY how was the economy was better served by bailing out Chrysler? Obviously, simplistic answers like "it saved Chrysler jobs" are superficial, at best. And to the present, EXACTLY how will bailing out home debtors who paid far too much for their homes and paid little or nothing down help the American economy and make homes more affordable. The lower home prices go, the wealthier we are!

Why? Are you better off paying 20% of your income for a nice home or 40%, or 60% or 75%? The more your dollar buys – the wealthier you are. Doesn’t that make sense? High home prices are a sign of poverty. The hidden man here would be all of those who aspire to buy a home, be they a waitress or gardener, who can’t afford one because of high home prices – which the other reader wants to "rescue" for the benefit of a few highly visible beneficiaries! Then I guess he will schedule a Triumph down Pennsylvania Avenue. Hail Caesar!

* * * * *

Whether Chrysler paid back the loans or not is immaterial. Should you, or I, receive a, say, $5M dollar loan from the government, I’m sure we would put the capital to good use and pay it back as well. And, yes, we would be beneficiaries by reaping revenues in excess of the loan and interest. But, wouldn’t only the politically connected – the Halliburtons – really only get access to this source of capital. So there is a moral argument here.

But more importantly, there is the concept of mal-investment associated with intervention. For example, consider Jones, whose family has owned a nice family run lodge on some Caribbean Island. Due to good management, the lodge has earned a nice following and although not fully booked throughout the year, is profitable, and has been for a couple of generations.

Then it came to pass that Maestro Greenspan decided to rescue us from the Internet bubble and lowered interest rates down to 1% via intervention, another rescue attempt. So, Wall Streeters awash in bonus money by packaging MBSs into CDOs begin to book at Jones’ Inn – it got a nice reputation as a getaway. Soon his 12 rooms are fully booked year round and he finds himself making serious money. With interest rates low, due to the aforementioned intervention, he begins to build a 20 room annex. Initially, everything is great as he is able to now meet the demand for his rooms. But with the inevitable collapse of the credit boom, Wall Streeters bonus money evaporates, his bookings go way down, and soon he isn’t even to profitable let out the original rooms, let alone the rooms of the newly constructed annex. Jones ends up defaulting on the loan for the annex and loses the Inn that had been in his family for generations.

Wha happened? The market was giving him false signals that there was a certain demand that really wasn’t which resulted in mal-investment. Similarly, the Chrysler intervention resulted in over capacity in the auto industry which not only hurt the other large auto companies, but also new prospective innovative startups that would have been able to compete with the big boys, who of course, would have been cranking out standard issue McCars. But the overcapacity choked off opportunities that might have presented themselves in the area of innovation because prices were now less than costs.

It doesn’t take a lot of mental strain to see that this is exactly what has happened to the housing market. The distorted market was telling homebuilders that there was a demand for their product that wasn’t really there, and sure enough they overbuilt. We have almost 2.5 million vacant homes n the US today – a record.

When I say that the lower home prices go, the wealthier we are as a society, I do not refer to the nominal price which is completely arbitrary. Five dollars a day was a great wage during the Model T days, and of course, a worker could buy a house for a couple of thousand (that’s price, not down payment). I am referring to the percentage of income that is required to meet a certain need, be it food, clothing, or SHELTER. In a poor society, shelter is minimal and a good part of one’s income goes to meeting one’s family’s food need. In a less poor society, food needs are more readily met and the residual income can go to acquiring better shelter. But the dynamic is always the same, the lower the % of income that a society needs to meet a basic need, the richer it is. So a society where one must surrender 50% of one’s income to acquire a standard American house, is poorer than one where only 25% of the income is needed, or only 15% is needed. The more your dollar buys, given a fixed amount of dollars, the richer you are. The current level of home prices is just a barometer of where our economy stands – at a precipice. Lower home prices will free up capital to invest in building up the capital goods capacity of the nation resulting in more jobs, better paying jobs as labor rates are directly correlated with capital/labor ratios, a smaller trade deficit, etc.

The whole housing bubble is just a cancer sucking out the nutrients that economic body needs. It must be removed – the sooner the better.

When malaria is in remission, the fever diminishes. When we begin to cure ourselves of our economic malaise, we will necessarily see, and want, the housing temperature to diminish as well.

You wrote:

I would like to add one point not mentioned elsewhere here, which is that the majority of failed thrifts were located in Texas. Why did so many fail? Some causes have been listed above, but another is oil: specifically, the collapse in oil prices in the mid-80s which gutted the Texas economy and made all those condos, subdivisions and commercial buildings which had been thrown up with all that easy S&L money essentially unsellable at anything but truly fire-sale prices (10 cents on the dollar, etc.).

I knew guys that worked on bad loans in TX and while the drop in oil prices was a big hit to the economy it was fraud that took down most of the S&Ls.

A typical Texas fraud in the late 80's went something like this:

Kevin, Charles and Sam are friends and live on big ranches that have been in their families for a long time worth about $3K and acre.

Kevin "sells" Charles 100 acres of his 5,000 acre Family ranch for $5mm ($50K and acre), but Charles can't get a loan since land in the area has only been selling for $3K an acre. Charles then "sells" 100 acres of his land to Sam for $5.5mm (prices are going up) and Sam get's a $2.75mm 50% LTV loan based on the "sales comp" of Kevin's 100 acre sale to Charles. Kevin then buys 100 acres of Charles' land for $6mm and gets a $3mm loan, and Charles buys 100 acres from Sam and gets a $3.5mm loan (these guys convince that bank that once development in the area starts the property will be worth more than $200K an acre).

Kevin, Charles and Sam never get around to doing any developing and go hunting together as the bank takes back the 300 acres that is "security" for almost $10mm in loans. The three then "buy" the property back from the RTC (after the bank fails) for about $1K an acre keep (almost) all the money (they did have to pay tax on the debt that was "forgiven"m but remember this was back in 1989 in TX when $2mm was still a lot of money). Some of the guys in TX that took even more money from taxpayers (remember all the bank deposits were insured by the government) gave big chunks of their cash from loans secured by almost worthless land to politicians, appraisers and bankers to make the process flow a little smoother...

P.S. I read the great book below back in the early 90's:

The Daisy Chain

I lived through through the insane runup of housing prices in the Bay Area in the 90s, and saw the ugliness up close; and Kip S. is correct in thinking that some of those loans will NEVER be repaid.

On the other hand, I know of many homes that were bought for completely unrealistic prices because they were bought for cash by people just out of college and who received equally unrealistic bonuses for joining a dot-com, or had just made a fortune on an IPO -- it was all "found money!"

These CHILDREN, who had DONE NOTHING yet to earn any of this money and who had no understanding of what they were doing, nor any of the long-term consequences of their youthful folly on the larger housing market -- on the national economy for that matter (and many frankly didn't give a rip) -- consequently THOUGHT NOTHING of shelling out double what a home was realistically worth ( a half-mil or more for a two/one shack next to a freeway was not untypical) just so they could get their starter home in The Center Of the Universe. (What I've never seen discussed is the culpability of the VCs who in their role as sugar daddy enabled all this madness and who deserve to swing for their sins against the rest of us.)

Yeah, yeah, a house is worth whatever someone is willing to pay, blah, blah. Actually, over the long haul, that little bit of capitalist blather is not true. There are far larger dynamics that, over time, determine a house's actual worth. As we are seeing now. The supply-and-demand logic DID drive prices up -- there's long been an undersupply of decent housing in the Bay Area -- but the natural upper limit on bidding was totally distorted by that quantum leap of instant money that was thrown at the market.

Which brings us to today: a boatload of people stuck with gargantuan mortgages in a declining economy. It will take some time for prices to readjust, but it will happen. A lot of people will suffer -- some deservedly, some not.

In today's essay, it was stated that the Chrysler bailout saved jobs and cost the government nothing. Iacocca himself said it was a loan guarantee, not a bailout.

In the 70s Ford Motor wasn't doing too well, either, and was forced to borrow money at a higher rate than Chrysler. In an indirect (but very real) way, the Chrysler loan guarantee from the government was therefore at the expense of Ford and GM. The government artificially lowered Chrysler's operating expenses, doubtless costing Ford market share.

Also, I'm not so sure de-regulation caused the S&L disaster. I thought it was a major change in the tax laws that caught real estate investors off balance. Interest payments were no longer tax-deductible for corporations owning real estate. At least, that's how I remember it, and I am certainly willing to be corrected.

I was just watching something on TV. Some average people were talking about who they would vote for. One of them said that he looks at the polls and he didn't want to throw away his vote. To me that's a scary concept. People are afraid to "throw away" their vote. They want to vote for the winner. So, it doesn't matter what that person stands for. They just want to be on the winning side.

It makes me wonder how much influence this constant showing of poll numbers by the media influence who wins. I am starting to think these poll numbers shouldn't be shown prior to the primaries. Also, the primaries should all be held on the same day with out exit polls. I believe that would force people to make a decision for themselves not jump on the band wagon. The campaigning on the ground would be tough but we have much more technology to interact with people than when the system way invented. Back then there were no poll numbers. You didn't know who won what state by the time your primary happened. You just voted for the person that you felt would be the best candidate. That was how the system was intended to work.

I could go about campaign money etc.

The other thing that I also think is a problem, for the smaller elections, is putting the party affiliation on the ballots. I have met far too many people in this country that I would consider to be a "check box Republican/Democrat". When they go into vote they check all of the boxes that say R or D without knowing anything about the candidate. They could be voting for someone out at the fringes of the party that don't match their ideals. If the party affiliation was removed many people would be afraid to vote for the wrong person and abstain, leaving more informed people to actually vote for the particular candidate.

If anyone tells you real estate "can not" crash 80% or more, they just need to research Anchorage, Alaska 1984 thru 1996. If they tell you 70% of the Banks, and Savings and Loan Co. can't go Bankrupt.......try Anchorage, Alaska 1984 thru 1996.

In point of fact real estate can go to negative value; what with the carry cost (taxes, insurance).

If your readers think todays post sucks, just wait till you inform them how their "FREE and CLEAR", fully paid for Real Estate well be lost through Deficency Judgements.

Hell hath no fury like FDIC.