Monday, June 07, 2010

Closing the Gap

"The fundamental problem is that we have not, as a global economy, accepted the word "restructuring" into our dialogue. Instead, we have allowed our policy makers to borrow and print extraordinarily large band-aids to temporarily cover an open wound that will not heal until we close the gap. That gap is the difference between the face value of debt securities and the actual cash flows available to service them. The way to close the gap is to restructure the debt. This will require those who made the bad loans to accept the associated losses. By failing to do that, we have failed to address the essential problem faced by the world, which is that we have created more debt than we are able to service."

Of course, Hussman isn't the only one who's been saying that for the past 18 months. 

"I remain convinced that the other shoe to drop is not Greece or Spain or Hungary, but rather a second wave of major credit strains here in the U.S. related to fresh delinquencies from exotic adjustable rate mortgages.  "

On this note I'm somewhat skeptical, but only because of a single anecdotal data point I have from a friend of mine who has a negative amortizing ARM which will reset soon.  The reset rate will actually be lower than the current rate, since the treasury index which the reset is based off of is trading with such a low yield.  It's been established that there will be a crap-ton (technical term) of adjustable rate mortgage resets in the coming 2 or three years, but I don't have data on what the relevant reset rates look like.   It's entirely possible that my friend has a more benign structure, despite all the buzzword boxes being ticked (neg-am, I/O) - and that other borrowers have much higher reset structures.

EDIT:  a commenter pointed out that Hussman was probably referring to mortgage recasts.  In interest only ARMs, like the one my friend has, a bigger problem is that in addition to the interest rate reset, you also have to actually start paying back the principal. In other words, the "interest only" stipulation goes away, which results in much higher payments, even at low interest rates.

"At best, what people call "stimulus" can only occur if the dollars spent by government are more productive than they would have been if they were allocated privately. I cannot imagine how allocating public funds to the same reckless stewards of capital that made the bad loans in the first place can possibly be a productive use of capital."

I took this quote slightly out of context (emphasis mine), for fear of inciting the MMT'ers with the paragraph that precedes it in Hussman's piece. I encourage readers to read the whole piece.


Anonymous said...

I believe Hussman is referring to the "recast" of payments, as opposed to the reset of the rate...meaning borrowers no longer have the option of paying the teaser rate (ie. 1-2%), but must now pay the full rate on the higher notional balance. So if the borrower was paying 1%, and his reset rate is now 4%, his monthly payments still quadupled...

Kid Dynamite said...

doh. right - i'm sure that's what he meant, thanks Anon - but i would guess that it's not quite in the way you described.

in case readers didn't catch that: at some point, your interest only mortgage ceases to become interest only, and you have to actually start paying down the principal! even if interest rates are lower, your payment still gets jacked up, since you're actually paying back the mortgage now, instead of just the interest (or a fraction of the interest!)

Andrew said...

What is "MMT"? You used it today and also used a week or 2 ago and I meant to ask then. Usually I can google acronyms I don't understand but I couldn't find any that made sense for MMT.

Thanks for the blog-I learn something every time I come here.

Kid Dynamite said...

sorry andrew - MMT - modern monetary theory. see Bill Mitchell's blog for a verbose introduction:

getyourselfconnected said...

if you dont want your head to explode do not try that link!

Andrew said...

I followed the link because I was curious. The 2nd sentence in the first post told me everything I needed to know.

"It was amazing to see just how comprehensive the impact of the deficit terrorists..."