PIMCO on the bailout: "A handout to the fool"

If you're up for some pragmatic, pro-bailout, big-picture thinking, check out this interview with PIMCO economist Paul McCulley. I'll summarize and highlight, but encourage you to read it for yourself.

McCulley's take on real estate right now is that no-money-down, underwater homeowners are making a rational business decision by walking away from their mortgages (where have we heard that before? From readers of this blog).  "When you have no skin in the game ...  it’s eminently rational to go into early payment default."  This, McCulley argues, is creating a deflationary spiral in home prices.

One problem with a deflationary spiral like this, he argues, is that smart buyers (of homes) refuse to buy into it. Who wants to catch a falling knife? So prices continue to fall. But won't investors buy the homes as rental properties at some point? McCulley says prices are so far above that point that the decline would be hellish: "That would conceptually be your floor, but that is so far away from here that the economy would have to go through absolute hell to reach that point."

The solution? Like many others, McCulley looks favorably on the Barney Frank proposal, in which banks would write down problem loans rather than foreclose, and then the government would guarantee new loans at lower amounts, in hopes of keeping underwater buyers from walking away. Is it a bailout? McCulley says it is -- it puts taxpayers are risk in the likely case that the re-written loans go bad. McCulley: ".. The inequities smell to high heaven, and that is one of the huge problems in dealing with it. It runs against the streak of basic fairness in a lot of Americans. You’re going to provide a handout to the fool. The fool is going to be rewarded and I, the taxpayer, will be put at risk at the margin for that handout to the fool. When all I did was exactly what I was supposed to do. Where is the fairness here? It’s a hard question to answer."

Thoughts? Comments? Email story tips to peter.viles@latimes.com.
Hat Tip: TW

Comments

[John]

Peter,

What happens if they throw this bailout party and nobody comes?

A lot of these buyers that are walking away from their loans are making an entirely rational decision, as we've discussed here.

But for those homeowners whose payments are going up 30-100% as a result of ARM resets, a "haircut" of 20-25% off the principal may not be enough to entice them to stay if the new payments are based on a 30yr fixed traditional mortgage.

What's your take Peter? Is there a good chance that the proposed bailouts will fail because the people being bailed out would rather hand the keys back to the bank and go back to a nice straightforward rental rather than deal with months of negotiation and paperwork to stay in a house they'll still barely be able to afford?

Keep up the good work. Your management of the Real Estate section and this blog has made the L.A. Times RE section well worth reading.

[tew]

McCulley's choice of words is interesting. He refers to the "fool". ABC - always be closing. He's pitching a bailout and dammit he's going to use a clever choice of words. By referring to careless, reckless, and greedy speculators as "fools" he makes it that much easier to sell the bailout to the rest of us. By naming them "fools" he gives the true suckers (taxpayers without leveraged real estate interests) a feeling of superiority while disarming the recipient of their hard earned cash - the so called "fool" who is taking their money and laughing all the way *at* the bank.

Always remember that no matter how respectable the PIMCO folks are they "talk their book", which is to say they have enormous financial interest in the performance of the debt markets in which they invest. They live in Newport Beach mansions and never need rub shoulders with the unwashed masses (of renters and 20% down sucker-buyers of $700k 2 B/Rs). They need to get paid. They need a return to markets they understand, markets that are stable enough for them to model, but with enough volatility for them to "play").

[Laker]

Just thought about a great idea of a bailout that would be funded by tax money.
You want it or not, the bailout is coming. Now instead of it coming from raising taxes on every one, including renters, i suggest that it would come only from home owners. That is logical since renter completely did not play this game, and should not pay to fix it.
The idea is to kill the mortgage interest deduction, and thus would add substantial billion dollars to the treasury. This way, renter will not pay for it, the elimination of the deductibility of interest, would put pressure on the prices of RE down 10-15% and thus make the housing more affordable. this will also not support flippers and speculators.
Here is a link about a good article on it found a link at patrick.net
http://www.nytimes.com/2006/03/05/magazine/
305deduction.1.html?pagewanted=1&_r=1
what do you guys think?

[srla]

Peter, if I hear one more alleged expert assert that the damage to "the economy" would be untenable if housing were to come back down to Earth, I seriously think I'm going to lose it.

Untenable to whom, and in relation to what? To major investors in financial stocks and derivatives, sure. But would the overall effect (in terms of jobs lost, wages lowered, etc) on the average worker even approximate the effect of trade policy over the past 15 years? Most certainly not.

It is shocking how many reporters at major news outlets repeat this line that "the economy" would be hurt by falling housing prices, yet at the same time tacitly supporting "free trade" policies that have gutted the wages of the very same people that have been priced out of the housing market.

A little more competency and even-handedness amongst financial reporters would go a long way towards helping the average person understand how this all truly effects them.

Peter, you truly get it, and your approach is evenhanded - you always make sure to present opposing points of view (as is evidenced by your presenting this man's point of view). We can only hope more people in the financial media eventually follow in your footsteps.

[Teresa Rothaar]

If a lender VOLUNTARILY decided to write down a loan because they feel they would incur less of a loss by doing so in lieu of foreclosing, I would not be against it. Yes, I realize it's a bailout, and I wouldn't LIKE it, but I also support the right of a private business to do whatever it wants.

What I'm against is the government FORCING lenders to write down loans. I'm also against the government guaranteeing said loans.

I support the free market being allowed to work unimpeded by gov't interference.

[Gina]

"it puts taxpayers are risk in the likely case that the re-written loans go bad."

Something seems to be missing from this copy.

"The fool is going to be rewarded and I, the taxpayer, will be put at risk at the margin for that handout to the fool. When all I did was exactly what I was supposed to do. Where is the fairness here?"

That's sort of like saying fire companies shouldn't put out fires that are caused by careless smoking or faulty wiring. "Well, if he didn't smoke, this wouldn't happen, so we'll let his house burn down." "If he had checked his wiring on occasion, this would not have happened, so let the house go." The problem with that kind of approach is that a burning house puts more than the careless homeowner at risk. Same for foreclosed property; it's pulling down everyone's values.

Here's a newsflash: Life is not fair. Some people will always make out better than others. Homeowners get a big handout in the form of a tax writeoff on interest and real estate taxes, something a renter does not. Is that fair? Depends on who you ask. No-bid government contractors get a huge advantage over normal contractors; many are awarded no-bid contracts simply because they're politically connected. This costs every taxpayer. Is that fair? Depends on who you ask -- the greedy rich contractor who's a friend of the president or the taxpayer who gets the short end of the stick.

[kat]

I predict that it's just a matter of time before this whole bailout scheme turns racial. The majority of these sub prime borrowers are minorities. Soon Maya Angelou, Al Sharpton and Oprah will take up the cause. I'm sure they will come up with a "da man" angle on the whole thing before it's all over.

How long before someone willl call me racist for pointing out the elephant in the room on this whole mess?

.

[The Dude]

Not only is it rewarding the fool, but it is crushing the hopes and dreams of young families who aspire to actually not renting for the rest of their lives.

The debate is always framed in terms of homeowners who borrowed foolishly, and those owners that were cautious in their borrowing. And yet there is a huge population of younger people who have been sidelined because of the bubble, saw its popping as salvation, and now the government wants to take that away. Time to move to Georgia!

[Truth2Pwr]

By the time the government actually takes action on a bailout, it will be like every other government action...too little too late. This whole situation demanded attention back in (pick your date, 2000, 2004, 2007). Instead we got Greenspan encouraging people to do ARMs, "see no evil-ism" during the run up because everybody was getting rich, and talk of how prices were expected to start increasing again around late summer of 2007 and how that would be a great time to buy.

I don't claim to know what the feds are gonna do, but whatever it is, I'm sure that it'll do more harm than good. The REAL CRISIS ended in 2007. $500K homes in Fontucky? That's what I call a crisis. A return to affordability for normal families so we can all (yes, first-time buyers are people too) afford to have a house AND a life? That's not a crisis... that's a cure.

Chemo sucks too, but it beats the hell out of dying of cancer!

[sunsetbeachguy]

McCulley needs to remember hoping the deadbeat and bailed out once, borrower will regain his fortitude and willingness to repay isn't much of a strategy.

Hope is not a strategy!

[Michael Snyder]

Laker,
What are you thinking?!? Although removing that mortgage deduction my look good while you're collecting your renter's credit; losing it would signal not only the death knell of home ownership for most Americans, it would cost the average American the only substantial tax deduction they have left. It's far easier to pick up a phone when something breaks than it is to pick up your tools or a checkbook. Apartments have gardeners & pool folks built into your rent but that doesn't mean you're not paying for that right along with the owner's PTIT & liability insurance. But that few hundred dollars the PRC (Peoples Republic of California) sends you is worth flushing your own opportunities down the tax toilet right along with your children's.

There is no amount of consumer bailouts or corporate welfare that will cure this crisis. As we speak the Fed has began the largest money laundering scam in history as it accepts subprime infected collateral at it's discount window. It may look like the perfect way to unwind the largest Ponzi scheme in history; but in reality it just insures our decline into a debtor nation.
The regulatory dog & pony show trotted out by the Bush Brain Trust has little chance of even reaching the congressional floor before this administration joins Elvis & "leaves the building". And just like the crowd, the pain of their actions will linger for a generation. Paulson's purposed regulations are more of a thinly disguised power grab by the Fed than any real regulatory change. But it makes for a great sound bite.

If you really want to get scared log onto http://www.bloomberg.com and check out, "Arabs' Dollar Doldrums Fail to Shake Central Bankers (Update2)" which gives an international prospective to our situation. At one point in the article, Matthew Brown reports, "While a booming economy has pushed the average rate of inflation to above 7 percent in Saudi Arabia and the five other Gulf Cooperation Council members, none say they will follow Kuwait and resolve the problem by ending their fixed exchange rates to the dollar. That's because doing so may spark a new dollar crisis, said Simon Williams, the chief Gulf economist at HSBC Holdings Plc in Dubai, a move that would slash the value of their $500 billion of assets denominated in the currency.

``The Gulf states may be decoupled from the U.S. economy, but they are still shackled to the dollar,'' Williams said. ``While they recognize the shortcomings of the status quo, policy makers seem minded to maintain it, at least for now.''

The survival of the pegs shows how hard it is for major economies to break from the dollar, regardless of its 13.7 percent decline on a trade-weighted basis in the past 12 months. Saudi Arabia keeps the riyal fixed at 3.75 to the dollar by purchasing or selling the greenback with the local currency."

If you're wondering what that really has to do with real estate, ponder the question the next time you belly up to a gas pump. Now cut that price you just paid in half and multiply times the number of fill-ups in a month and you'll see my point. That's what you can no longer contribute to the rest of the economy because you're being "taxed at the pump". If these Gulf States decide to uncouple their currencies that price will rapidly make $4.00 a gallon look like a bargain &, we'll be toast. The only good news on the horizon is their dependency on America for a primary market for their goods.

One way or the other all of the over leveraged positions related to the market's subprime "acceleration of money" need to be excised like the cancer that they are, Merely laundering these assets through the Fed will only serve to undermine what little credibility the Treasury has left. There is no "bail out" plan that will not simply shift the problem onto the taxpayer.

If you've ever read "The Richest Man in Babylon" or any thing like that they all prescribe two basic foundations for wealth: Pay yourself first, (save 10%) and own your own home. Just as the innovation and motivation of small business is vital to a healthy economy, home ownership is vital to a stable society. Instead of a wilily-nilly rush for more today, we need to encourage a return to these basic principles. Your "solution" is just another step towards the new age feudalism Reganomics was designed to propagate.

[sunsetbeachguy]

The real follow up question from McCulley's diatribe is hell for whom?

Markets revert to the mean all the time, it doesn't mean hell.

LIfe will go on, the sun will come up, rain will fall, crops will grow, jeez, now the bailout crowd are the tin-foil hatters.

[Keith - LetItSink.blogspot.com]

My initial reaction to the idea of a bailout was rage. Now I see it for what it is - talk. It's not going to happen because it can't happen. It might make sense if your brain is limited to black and white. But if you consider the hundreds of scenarios under which people buy and finance homes, it's easy to see that, short of another bumbling Bush check writing spree, there is no plan that can work.

It's no coincidence that the Bush administration is putting out one message, the Fed another, and Paulson another. Their strategy is to make it look like they are doing something until the lame duck is sent back to the ranch, where his only duties will be to pick which bibles and comic books will go into his library at SMU.

And the Democrats have given this issue to the true nut jobs of that party. The bottom line is that nothing can be done, nor should it be. Irresponsible borrowers should be ruined. This is America. You have the right to get rich, and you have the right to get poor. And all the noise in the media is for the benefit of the clueless TV watcher/voter.

[mike]

LAKER??

you are a renter obviously. if they eleminate the interest deduction, it will fall on the backs of you . the renter. a homeowner would never suggest the interest deduction be eleminated.

[sfgal]

and PIMCO's Bill Gross weighs in.......

http://www.pimco.com/LeftNav/Featured+Market+
Commentary/IO/2008/IO+March+2008.htm

[apenny saved]

You're not racist, kat, just ignorant.

[MyLessThanPrimeBeef]

Where is the fairness in this? That's a hard question?

Mr. McCulley, it's not a hard question to answer.

It's only hard because you're an intellectual. And I say that with all the disdain I can muster.

Just say no. No to all bailout proposals. Free the market. Proclaim our financial emancipation! Let freedom reign! Defend her! Be a patriot!

It's as simple as that. Not hard at all.

Stop thinking too much, Mr. McCulley. Human brain, as it exists now, is very limited. Not until the next evolutionary breakthrough will we, or more precisely the next coming species who will replace us, perceive the world in a less suicidal manner. Our current brain is not capable of that, not the way it's constructed now, I am afraid to say. It has an enslaving tendancy, both to itself and others. And it can only to be enticed to be productive when its selfish and greedy self is satiated, forming, according to Adam Smith, the basis of capitalism. Of course, a different brain will necessarily and thankfully negate that solid foundation.

Meanwhile, I suggest all the intellectuals expose themselves to more cosmic radiation. Let's count the days until the next, natually occurring, genetic mutation that will herald the coming of the Future Man...before it comes out of some monstrous lab, through artificial manipulatin for some rich, powerful guy's evil desires.

[GDC]

Kat,

Why would YOU bring race into this when nobody else has mentioned it. I don't think anyone except the extremes on both sides (including you) will even bring up the topic. The fact is that there are many poor credit, low income WHITES that bought in places like Victorville, Palmdale, Lancaster even Santa Clarita that are in trouble and need to be bailed out. This is not a race issue. It's an economic/financial issue.

You are not a racist. Just extremely ignorant. And filled with hostility.

[Laker]

Michael Snyder,
If you read the article from NYT that i linked, you'll see that many home owners do not use the interest deduction since they don't itemize. Basically those that use it, have the expensive loans $700,000-1M, and if these can buy $1M houses, they sure can afford the mortgage.
The middle class and sure the pure do not benefit from it, and this is a regressive tax. Bottom line, it is great for the rich, but has no value for the poor or middle class.
If you eliminate it, the purchasing power will decrease by that amount, and would lower the prices accordingly.
Look at other countries like UK, most of Europe, Australia, i believe they don't have the mortgage deduction.
(And Michael, I don't rent an apartment, but SFH. I don't care what happens to my rent money as long as I'm paying about half of if i was to buy it in 2006)

mike,
true, I'm renting today SFH, paying 1/2 of mortgage for same house...
(I was home owner before, and cashed out early.)
I aggree that if you ask the cats of they want their milk to be taken away from them, they will say NOOO.

[TC]

I am OK with that sort of bailout as long as when I go to sell my house the government guarantees that I will get peak price for it. That way, I can go get an upgraded home based on current pricing that will put me into their new relative scale of price controlled housing.

If they can't do that, please let me know who qualifies so I can refi and take max cash out and then miss payments and then get my government bailout and drive off in my new Escalade to the airport to take an exotic vacation.

I would also settle for a check, I will let them buy me off for 50% of my lost equity between 06 pricing and the start of buyout. 75k is gonna feel real good in my wallet.

[jdj]

McCulley wants it both ways: He says home values are too expensive for incomes, so they must come down, and then he says if prices come down the amount necessary to make them affordable, we will go into Great Depression 2. If the prices don't become affordable who is going to buy them, and more importantly, who is going to loan money to buy them.

In addition, I don't understand his logic that reducing home values, in huge swaths of bubble areas, by 25-30% will create a floor under prices. Why should it? If you go to buy a home in these areas after that kind of price adjustment how much do you think a bank will lend you for a home? Certainly no more than 20% less than the comp values of the discounted homes. Which in effect will continue to drive down prices, not create a floor.

[puckhead]

Laker,

Your post about RE deductions only benefiting the rich is so much BS I don’t know where to start. For 2008, the IRS standard deduction for a single filer is $5,450. If that single person has a mortgage loan of $240K at 30 years (NOT what I would call a high income) person, that person would have paid approximately $15K of interest on the loan in his first year. ALSO, that person would be able to deduct the RE taxes AND income taxes on his tax return. The combined deductions would make his $5,450 standard deduction look puny. I bought my first condo way back when and my loan was about $100K. Even with this puny loan, I was able to save a great deal of taxes at that time. To say that the tax benefits of owning a home only benefits the rich is just plain wrong. If you don’t or can’t own a home, fine, but don’t try to rationalize it as some sort of conspiracy that the rich has perpetrated on the US taxpayers.

[150 multiple choice questions]

I think everyone here is missing the point.

No matter what happens, the value of housing is going to return to the "point of pain" he describes - as it always has - to the point where it makes financial sense over renting / pencils to own and rent out. Because even if the taxpayers "pay the fools" who have already bought a house for 3x what it's worth, THE ASSET WILL BE WORTH THE MARKET RATE, WHICH IS GOING TO BE VERY NEAR THE "HELLISH" NUMBER.

McCulley knows the government can do nothing to prop up valuations, what he wants is to get the debt off of his and his borrower company's books and become the governments responsibility. He doesn't want to bail out the fools, he wants to bail out himself.

I hope karma finds McCulley and those like him... and if you happen to think his and Frank's plan will work, don't forget, they're the kind of geniuses that got us here.

[Corntrollio]

Pitying the fool would be okay, but not bailing out the fool.

But I think 150 multiple choice questions is right. The assets people have, whether we're talking about CDOs, houses, etc., aren't worth what's posted. That means someone has to take a loss -- banks, homeowners, whoever. Getting the government to take the loss is most people's "solution."

But if we really have as robust a financial system as has been claimed, shouldn't the market be able to take care of this? The market got fat for the last 7 years or so off of the profits, so it's time to give some of them back, because they were phantom profits. You can't have the good times without the bad.

If banks want to write off loans, fine, but I don't understand why the government should guarantee the written down loans because I don't understand why the government should get involved in rewriting financial instruments that were made at arms-length. There is a good argument for loaning money to deal with Bear Stearns, whether you agree or not, but I don't see why the government needs to start being more proactive than it already has been.

[Laker]

puckhead,
You have to agree with me that poor people, the ones that live paycheck to paycheck and rent, those are subsidizing the people that can buy and afford mortgages. This is also called regressive tax.
Indeed, you might benefit from it if you have a mortgage, but this is because you are loan owner. A true home owner that has no mortgage, gets ZERO from it. The government wants people to be in debt, that is why the deduction is there. If you take it away, in broad sense, government will have "more money" and then could tax us less.
It is similar to the point where massive tax evasion, increases the tax burden on the tax paying people. Since, if every body paid and there was a zero tax evasion, tax rates could probably be half.
Don't get me wrong, i totally understand the numbers and like in your case, see that you can save much on your income taxes with the deduction.
But again, if you put that aside, don't you agree, that by eliminating it, your (and everybody else's) purchasing power will be decreased and that would decrease the prices???
Also, why (1fter 1986) the credit card interest is not longer deductible??? What is the difference between Joe 6pack owner that uses home equity line to buy LCD TV and get the interest deducted from his taxes versus John 6pack renter that uses his Visa to buy same LCD TV, and he is a shmuck, and because being a renter, can't deduct the interest on the LCD from his taxes....