US Government Freezes Interest Rates for Subprime Borrowers

Bill Bonner - Mon 03 Dec, 2007

Its called the teaser freezer program and it could be announced as early as today. Whats the idea? Well, its quite simple just pass a law! Actually, were exaggerating. The discussion so far, as we understand it, is to ask for voluntary cooperation from the mortgage lenders. They are supposed to let the teaser rates ridefor people who cant afford an increase...

“I’d wait for him to get home. Then, I’d listen for the car in the garage…and stand by the door until he came out.”

Elizabeth ’s grandmother was explaining what it was like during the Great Depression. Her husband, a stockbroker, has lost almost all his clients…and maybe all his money. Some men couldn’t take it. They sat in their cars with the motor running until the stock market disappeared forever.

It is hard for us to imagine what it was like. Hardly anyone alive today remembers. Instead, what we remember is a long period in which nothing went wrong. Credit default swaps – insurance against non-payment – grew like mushrooms, up 9 times in the last 3 years...to more than $45 trillion.

And why shouldn’t they grow? It cost almost nothing to insure against default...because nothing ever defaulted. Even if you wanted to default – whether on a commercial loan or a mortgage – it was hard to do; there was always someone waiting to lend you more money.

But now…things have changed:

“Suddenly the mood has darkened,” reports the London Sunday Times. “Just when bankers and investors were hoping the worst was over, a second devastating wave of writedowns from major banks has rocked confidence. In recent weeks, Citi announced it would write down a further $6.4 billion in losses related to the sub-prime mortgage crisis. Merrill has also revealed more losses, while HSBC last week said it would take $45 billion back onto its balance sheet by rescuing two structured-investment vehicles. Last month Barclays wrote off $1.3 billion.

“More pain looks inevitable. Analysts expect Citi to be hit with a further $15 billion of writedowns. Investors will be nervously scrutinising a Royal Bank of Scotland trading statement this Thursday when the bank is expected to reveal sub-prime-related losses of more than £1 billion. Goldman Sachs analysts have estimated that the total sub-prime-linked losses could reach a whopping $500 billion – far higher than Federal Reserve chairman Ben Bernanke’s initial estimate of $50 billion, later revised to $150 billion.

“To add to the gloom there are mounting fears that the problems could engulf other types of American debt – credit cards, car finance and unsecured loans.

“What has happened is that the risk has been spread so far and wide that no-one really knows where the pain is being taken. The financial bombs just keep going off,” said one senior investment banker.

“There will be wave after wave of problems. This has barely started and it is going to get more bloody,” said one senior UK fund manager”

Last week, none of our milestones were hit.

Gold didn’t rise above $850. The euro didn’t go above $1.50. Oil didn’t hit $100.

Well, there’s always next week!

You will recall, dear reader, that we are watching a titanic traffic accident. The unstoppable force of inflation is running smack dab into the immoveable object of falling prices.

We don’t yet know how it is going to turn out…but we’re sure of one thing: sparks will fly when these two collide.

Last week, the European Central Bank announced that it “fears inflation more than a slowdown,” according to the Financial Times. But most of the news points to an increasing danger from falling prices, not rising ones.

Commodities were down on Friday. Gold fell $13. It could go as low as $700 in this correction. Buy the dips, dear reader.

“Foreclosures are piling up,” says the Associated Press. And now comes this shocker from the Commerce Department: the median house price in the US fell 13% over the 12 months ending in October. The median house now sells for $217,800. Hmmm...that’s about $2.6 trillion in disappeared value from the national balance sheet.

But we have a long way to go. Wives are not listening to their husband’s automobiles; not yet. 

*** As anticipated, here comes the Bush Administration with a plan to make the subprime situation worse.

It’s called the ‘teaser freezer’ program and it could be announced as early as today. What’s the idea? Well, it’s quite simple – just pass a law! Actually, we’re exaggerating. The discussion so far, as we understand it, is to ask for voluntary cooperation from the mortgage lenders. They are supposed to let the teaser rates ride…for people who can’t afford an increase.

“Deal in the Works to Freeze Rates on Subprime Loans,” says the Washington Post. Of course, if such a deal made sense, lenders and borrowers could work it out on their own. And if it were possible to eliminate the problem – or even ease it – by government decree, it would be a very different world than the one we live in. When people owe money and can’t pay it back, someone is going to take a loss. You can diddle with the details all you want...all you’re going to do is to shift the loss from someone who deserves it onto someone else. The great innovation of the recent credit boom was to create a stick that was long in the middle and short on both ends. On one end, the borrowers are now losing their houses. On the other, the investors are losing their money. The financial intermediaries – notably Goldman Sachs – are sitting pretty. They made their money by putting the two dumbbells together. And now, the Bush Administration is taking the time honoured tradition of pushing more of the losses away from the borrowers...and towards the other end of the stick that is, towards the lenders. Why? Hey... where have you been, dear reader? We live in a democracy. One man, one vote. How many subprime borrowers are there? How many subprime investors are there? You do the math. And expect more meddling as the crisis continues.

*** Among the many investors in subprime debt were state and local governments. Now, the press reports that Florida schools are “flat broke” as a consequence. And they’re not the only ones. We’re read about a couple French banks that have taken huge hits. And in last week’s news was a report from north of the Arctic Circle, where towns in Norway had – you guessed it – invested in subprime debt. Citibank sold them the toxic stuff. Now, the poor Norwegians are not going to be able to retire in the style to which they had hoped to become accustomed.

So you see how it works? What goes around comes around. A fellow buys a home he can’t afford. Wall Street sells the debt to a pension fund. The guy defaults on his mortgage. He loses his house...and his pension! The Wall Street financier, in the meantime, puts a new wing on his palace in Greenwich.

*** But don’t worry. Another rate cut is coming – in less than two weeks. Let’s see how this works again...people get into trouble because they’ve borrowed too much money. Then, the feds come to the rescue – by offering to lend them more at lower rates!

But what’s this? The banks aren’t cooperating. While the feds lower…the banks raise. They ask for higher rates to protect themselves from the growing losses.

Part of the problem is that there is so much credit around...of such dubious quality…that the banks (and investors generally) don’t know what to make of it. Double-A mortgage-backed credits are now trading at half their prices three months ago. It may be true that investors are overreacting. But after such a long period of not reacting at all…what would you expect?

And isn’t is possible that the Fed, like the Bank of Japan before it, is now in the unenviable position of no longer pulling on the string of credit…but pushing on it? Isn’t it possible, that the market no longer welcomes cheaper credit, but fears it? And isn’t it possible, as we guessed last week, that the Fed is no longer driving the price of credit - by lowering rates - but following along behind what the market is already doing? US treasuries are dear; yields are low. The 10-year note is already below the yield of the Fed Funds rate. People are happy to lend to the government, because they know they will get their money back. But woe betide the borrower without the US government behind him.

Will a lower Fed rate encourage the mortgage lender to finance another house in the Detroit area? Will it encourage a builder to put up more condos in Miami or Las Vegas? Will it entice the marginal homebuyer to enter into another ARM contract?

Maybe not. That’s the trouble with the immoveable object of deflation. It can be stubborn. Sometimes, it won’t budge.

*** Poor Henry. The 17-year-old has to write his college essay. He’s applying to various American universities…and to Cambridge in the UK. But he’s also going to one of the toughest schools in France…where he is doing math that bears no resemblance to anything tackled by the Class of ’66 at Southern High in Anne Arundel County, Maryland.

The problem for Henry is that he has to try to keep up with his work in school…while also figuring out where to go to college and getting together his applications.

“Sorry, Henry, I have no idea what any of this stuff means,” we had to tell him…after trying to figure out one of his math problems. “But maybe I can help with your essay.”

“Well, I’m supposed to write something that tells a bit about who I am…about something that influenced me…or a book that made a big impression on me. I was thinking of writing about ‘To Kill a Mockingbird.”

“Don’t do that,” was our advice. “They must get thousands of kids writing about ‘To Kill a Mockingbird.’ And what are you going to say that hasn’t already been said a thousand times? Instead, I would choose something that is specific to you. Original. Don’t try to talk about big themes…don’t try to sound smart…or wrestle with global warming or ethical issues. Just tell a story. Write with your eyes and your ears. Tell it as it happened. Tell what you heard. What you saw. What happened. Let them see who you are…by seeing the world that you see… through your eyes. Don’t try to explain who you are or what you think. Don’t come to a conclusion; let the reader do that. Don’t use big words…and no Latinate words; stick to Anglo-Saxon words.”

“Hmmm….then maybe I should tell about that time I helped Damien. That was an experience. We were working with power tools in the rain. It was shocking. Heh heh. And Damien practically cut his finger off.”

*** This from our Pittsburgh correspondent, Byron King, upholding the military tradition of the Italians…and setting the record straight….

"There go my men. I must follow them. For I am their leader."

- Attributed to an Italian general

OK, I understand the joke about Italian military prowess, but…

During the North African Campaign of World War II, at El Alamein in Egypt, the point of furthest advance was made by an Italian brigade attached to Rommel's army. At that spot, along the highway between Alexandria and El Alamein, is a marker erected by the Italians after the war. It marks the event, and reads "Manco la Fortuna, non il Valore!" ("We lacked good luck, not bravery.") I have seen this marker during my travels.

The Italian troops at El Alamein were known as "Bersaglieri," sharpshooting mountain soldiers whose origins date back to 1836. By historical records, they fought like lions at El Alamein. In fact, in his after-action report General Rommel had this to say. "At El Alamein our German Army astonished the world. And the Italian Bersaglieri astonished the German Army."

High praise. I think.