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Monday, January 21, 2008

Shouldn’t such collectively funded housing be classified as socialist?

So intertwined are the lives of people in the modern economy that what is perfectly capitalist could also simultaneously be at least imperfectly socialist.
Subprime socialism T K Arun ET 20 Dec, 2007
Once the headless chickens scurrying around in the leading central banks settle down and the world has been saved from a recession, what we’ll end up with is probably a little bit of socialism, in the form of homes funded by society at large.
Testifying before the joint economic council of the US Congress, economist Robert Schiller put the loss in value of American homes in the year to come on account of the subprime crisis at anything between 13% to 20% of $23 trillion, the value of the stock of real estate in the US. That’s $2.99 trillion to $4.6 trillion. Big loss, of course, with the potential to push down consumer confidence and consumer finance in the form of loans against housing property. It could depress consumption in the world’s largest consumer market and trigger a recession. But it also means a whole lot more affordable homes for those who couldn’t afford to buy homes when prices soared. Subprime loans are loans given to borrowers who normally wouldn’t qualify for a loan. The name of a class of subprime loans tells it all, ‘ninja’, for no-income-no-jobs-or-assets, rather than a deadly Japanese assassin.
A whole lot of Asian countries squeeze their domestic consumption, export more than they import, accumulate huge forex reserves and deploy them in developed country, mostly US, government bonds. The trillions of dollars of such external capital inflows combined with loose monetary policy to produce easy money and risky lending. Thousands of loans were pushed to people who couldn’t afford to repay. Many loans were secured by homes. Since home prices were steadily rising, thanks to precisely such easy loans, many borrowers could take a second loan on the same house on the basis of its higher value and use part of the fresh borrowing to service the earlier loan.
So long as home prices rose, there were no largescale defaults on these loans. Based on this good history, credit rating agencies gave their thumbs-up to bonds and derivative instruments based on these mortgages. The fact that those who gave the risky loans in the first place, loan originators, did not carry these on their books, but managed to sell them off to investors after converting the loans into securities encouraging them to undertake more risk than they should have. Credit rating techniques that relied far too much on past performance and gullible investors who could not understand or measure the risk inherent in the complex derivative products they merrily bought by the bushel added to risk.
When the bubble burst, defaults began. Mortgages are being foreclosed. Houses are being taken back by lenders and put on the block. The additional supply of housing and the resultant expectation that house prices would come down further together push down prices further. This feeds into the vicious circle of default. Some of the world’s largest financial players have been hit by the crisis, Citi, for example. A British bank had to be rescued by intervention by the Bank of England. Banks have lost credibility. So the risk premium in lending to banks has gone up dramatically, resulting in the present situation where inter-bank lending rates are markedly more expensive, by up to three percentage points, than the yield on government paper.
When banks enjoyed credibility, this difference was wafer thin. Banks lend and borrow much less, slowing down and freezing up credit, the life blood of the economy. The fear now is that such paralysis of the financial sector would trigger another recession. The one clear lesson that has emerged from the Great Depression is that recessions have to be tackled with easy money. So central banks are opening the tap to provide liquidity to banks, essentially to tide over the crisis of confidence and avert a full-blown recession.
The US government has adopted certain firefighting measures. The Federal Housing Agency is pumping in money to provide relief to subprime borrowers. The treasury secretary has persuaded some private banks to buy back chunks of subprime debt. Add the losses of banks with exposure to subprime loans and the cumulative financing of the subprime mess by taxpayers and shareholders of banks would run to hundreds of billions of dollars. While the financial mess sorts itself out, the additional number of homes that were built because of the subprime-loan-driven housing boom remain as a valuable addition to the stock of housing. Mortgage foreclosures and resales would reconfigure ownership, sure enough.
But what is distress sale for Paul is cheap housing for Peter at the other end of the transaction. From society’s collective point of view, a whole lot of additional housing has been supplied, cross subsidised by the government and shareholders of banks that made losses. Shouldn’t such collectively funded housing be classified as socialist? Clearly, the motivation for intervention amounting to subsidy for housing is fear of financial paralysis and recession, not socialism. But so intertwined are the lives of people in the modern economy that what is perfectly capitalist could also simultaneously be at least imperfectly socialist.

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