Page 2 of 3 The hard and simple maths of crisis
By Julian Delasantellis
Mortgage defaults are not randomly distributed events, but highly related. One
borrower defaults, is foreclosed upon, then, when the house undergoes a
low-priced foreclosure sale, the rest of the comparable houses in the
neighborhood also lose value. These homeowners can't refinance out of their
adustable rate mortgage option resets, so they default too. A surplus of homes
develops, so the homebuilding and renovation industries contract, causing job
losses, which cause more defaults
The whole cycle is what tipped the US and world into the financial crisis. In
the case of Li, it drove him back to China, where he now works for China
International Capital Corporation, one of the country's leading investment and
research firms. CICC press officers shield Li from all media inquiries seeking
a comment on
the devastation his model has wrought, with the exception of this brazenly
ingenuous 2005 quote regarding the model from Li: "The most dangerous part is
when people believe everything coming out of it." He has not spoken publicly on
it.
Li's 2000 paper and Salmon's critique of Li in Wired are so chockerblock full
of near indecipherable algebraic algorithms and formulae that they would keep a
mathematical genius like autistic savant Raymond Babbitt, from 1988's Rain Man,
from pining away for his K-Mart underpants for hours. That alone, I would
contend, qualifies it as the hard way to understand the financial crisis.
Then there's the easy way, offered by one Elizabeth Warren, the Leo Gottlieb
Professor of Law at Harvard Law School, also the chair of the congressional
oversight panel created to oversee the US banking bailout. Yes, she's the
Troubled Assets Relief Program (TARP) cop.
It is probably in the latter position that you have recently heard of Professor
Warren. Her appointment as chair of the TARP oversight panel was something of a
surprise, since little in her background as a law professor and prominent
public intellectual seemed to qualify her to deal with the TARP's complex
issues of financial architecture and regulation. Her forte has been more in the
fields of corporate and bankruptcy law, specifically, on the kinds of
contemporaneous economic and financial pressures driving middle-class American
families into financial ruin and bankruptcy.
But bringing this background to the oversight has been a breath of the freshest
air possible, well needed with a program designed in secret and on the fly by
former Treasury secretary Henry Paulson during the tail end of the George W
Bush administration and pitched to a skeptical public not on its merits but
with a warning of financial Armageddon should it fail.
At a time when President Barack Obama's chief economic advisor Larry Summers is
seen falling asleep during a White House meeting that was seeking answers to
how Americans can gain relief from usurious credit-card rates, and when
Treasury Secretary Timothy Geithner's job responsibilities seem to have
devolved to just being the towel boy at the Big Banks Country Club, only Warren
seems to be looking out for the interests of the taxpayers and the people.
In a recent interview on Comedy Central's Jon Stewart Show (where, since
the serious news shows have become a joke, more and more serious news is being
made), Warren explained the philosophy with which she approaches her new
position.
My job is to stand on the outside and basically to say, I
want more transparency. I think we should have more accountability, up and down
the line. And I think we need to have more clarity - you know, better
articulation of what the government's policies are here and better explanation
of what's going on ... You know, we started this process when Paulson basically
said, "Here's $350 billion," to the financial institutions, and he did it on a
kind of a "don't ask, don't tell" policy ... what he [Paulson] said at the
beginning is that, in effect, what Americans are gonna do, we're gonna make an
investment, and the investment's gonna be that we're gonna put money in, and
we're gonna get stock back. And the good news will be, there'll be money in
banks, and that'll free up credit, and there'll be plenty of credit, and at the
same time, the American taxpayer won't lose anything' - he kept calling it an
investment. said, "We're gonna do some independent investigation on that."
So our panel sent him a letter, and said, "Now, you're telling us this is a
fair deal, the amount of money we're getting?" And he said, "You bet!," in
effect ... And that's what he told us. And we could've accepted that and
stopped, but instead we said, "We're gonna do some independent investigation on
that."
So we crunch a bunch of numbers and we get some other academics to help us take
a look at it and take a look at these models, and it turns out, after he told
us it's even, dollar for dollar, it turned out that for every $100 we put into
these companies, we got back stock and warrants that - on the day we got them -
were worth $66 ... when you do that enough times, it turns out that we gave
away $78 billion ... some of the money has been committed to the mortgage
foreclosure plan, which I think is a really good idea.
The
final point is important, for only Warren seems to be asking whether all the
largesse slathered on the banking industry with TARP and other government
rescue programs is actually making a difference in terms of more easily
accessible and reasonably priced mortgage finance. So far, according to Warren,
it hasn't.
In the early years of this decade, Warren made her name with groundbreaking
studies on just what factors were driving American families into the bankruptcy
court. According to Warren, after an extensive analysis of the voluminous data
sets that the US government keeps on Americans' spending patterns, the common
cliches about excess spending on clothes, cars, appliances, or fancy vacations
don't hold up.
From a 2005 Warren article in Boston Review, co-authored with her daughter,
Amelia Warren Tyagi:
There is no evidence of any "epidemic" of
overspending - certainly nothing that could explain a 255% increase in the
foreclosure rate, a 430% increase in the bankruptcy rolls, and a 570% increase
in credit-card debt. A growing number of families are in terrible financial
trouble, but despite the accusations, their frivolity is not to blame.
Americans are not straining under the back-breaking burden of financing their
luxuries, but of their necessities.
A generation ago, the one-income
family committed about 54% of its pay to the basics - housing, health
insurance, transportation, and taxes. That is, the one-income family spent
about half its income to make the "nut" - the basic expenses that must be paid
even if someone gets sick or loses a job. Today, these basic expenses,
including child care so that both parents can work, consume 75% of the family's
combined income.
And what are those basic expenses that are now
costing Americans so dearly? One is, of course, health care. With close to 50
million people now uninsured, for this population any medical expense much more
serious than something that could have been handled by old-fashioned family
doctors such as Marcus Welby, from the 1970s' ABC network drama, is going to
lead to penury.
Also, instead of dividing the country into the binary poles of insured/not
insured, Warren suggests a new category - the badly insured. These are those
whose health insurance will peter out once the bills get very serious, leaving
the family defenseless against the howling financial gales of gold plated
American medical care.
But according to Warren and Tyagi, the number one greater expense these days is
for housing, particularly owned, versus rented housing.
Over a
generation, the average number of rooms in a home increased by 7% as average
mortgage expenses increased by 69% - at a time when other family expenses were
falling. The impact of rising mortgage costs has been huge. The proportion of
families who are "house-poor" - that is, who spend more than 35% of their
incomes on housing - has quadrupled in a single generation. Today it often
takes two working people to support a mortgage. A police officer or
elementary-school teacher earning an average salary could not afford to pay the
mortgage of a median-priced home in two thirds of the nation's metropolitan
areas.
If it's not all those McMansions driving up home prices
(and, of course, by extension, mortgage payments) what is?
When a
family buys a house, it buys much more than shelter from the rain. It also buys
a public-school system. Everyone has heard news stories about kids who can't
read, classrooms without textbooks, and drug dealers and gang violence in
school corridors. Failing schools impose an enormous cost on the children who
are forced to attend them, but they also impose an enormous cost on those who
don't. Talk with an average middle-class parent in any major metropolitan area,
and she'll describe the time, money, and effort she devoted to finding a slot
in a decent school. In some cases, the story will be about mastering the
system. In others, it will be about leaving the public-school system altogether
and opting, as middle-class parents have increasingly done, for private,
parochial, or home schooling. But private schools and strategic maneuvering
will only help a minority of families. For most middle-class parents, ensuring
that their children get a decent education means buying a home in the small
subset of well-reputed school districts ... A 1999 study conducted in suburban
Boston showed that two homes less than half a mile apart and similar in nearly
every aspect would command significantly different prices if they were in
different elementary-school zones. Schools that scored just 5% higher than
other local schools on fourth-grade math and reading tests added a premium of
nearly $4,000 to nearby homes ...
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