The Moral Hazard of Being Sub Prime
Posted: December 30, 2007
The present credit crisis in the US brings back a lot of personal memories and thoughts from the past 8 years. For instance, why is US productivity higher than the rest of the G7? I have worked and toured many US heavy industrial installations and I could not physically see why this would be the case. Driving from Alberta to Montana is a case in point. If you observe the ageing Oil and Gas facilities along the major routes it is like night and day. Montana’s industry was obviously just taking what was easy and running antiquated equipment into the ground while doing it … maybe that would give you a good productivity number. Maybe this is the ‘creative destruction’ that Greenspan goes ‘on and on’ about. Maybe the frac units and well maintained equipment in the old oil fields of Southern Alberta is just putting good money after bad.
Then there is the Pulp and Paper Industry with which I am well acquainted and has gone through a 20 year depression. Yes, newsprint manufacturing is concentrated in Canada and therefore by the bad luck of previously abundant power and the right kind of wood we ended up producing this dying commodity. Beyond that however, once again, there is no comparison between the condition of the facilities in Canada and the US. Even with the high dollar, Canadian facilities don’t come close to the general lack of maintenance and decay that exists in US facilities. In newer facilities I’ve visited in the US, there are always disturbing stories about how this or that piece of equipment is now a tank because the internals disappeared or were degraded to the point on being irretrievable due to a lack of inspection and understanding of the risks. It amazed me how often it was just replaced with a new piece of equipment. And as illustrated in many ‘pressure vessel’ incidents in the US, there is no industry immune to this general ‘running capital investments’ into the ground. Not even large petrochemical facilities like BP Texas City which had its famous, tragic, ‘comedy of errors’.
After having these endless ‘street level’ experiences and being a consumer of ‘too much business news’, it became obvious to me that the reason America is so productive relative to many developed countries with much more mature industrial infrastructure was Wall Street. Wall Street is so efficient at moving money that it makes up for and surpasses the deficiencies in American industry. As we have seen however, the endless permutations and combinations of financial instruments and ‘greasing of the wheels’ of commerce that goes on in Wall Street can be a double edged sword. This is especially true when you look at it in the context of paper (‘fiat’ or ‘out of thin air’) currencies and post Keynesian economic policy which is evident with such terms like ‘deflation’ and ‘priming the pump’ and the connotations that arise (‘deflation’ is now evil while in the past under a gold standard it was the norm).
That is where we come to my experiences with credit agencies and the fear that I would feel when I looked at my financial situation in the US when I lived there. I went to the US in 2000 following the NASDAQ bubble bursting. At that time I had become a CNBC and ‘business news’ junkie and was becoming aware of the ‘contrarian’ perspective which was illustrative in these events and explaining them from the advent of ‘central banks’. The strange thing was that I was still in demand at the time in the labor market and unlike many companies in Canada, the company relocating me had a very rich relocation plan. In many ways it hid the reality of my financial situation until later. I was sub prime. Despite having a good job, since I was down in the states on a TN, or temporary Visa, I was on the same footing as other less legal aliens and low income Americans. But, it didn’t matter that Ginnie Mae and Freddie Mac wouldn’t underwrite my mortgage, Wells Fargo just farmed it off their books some other way. There were plenty of takers and the ‘pump priming’ gave all the Wall Street Brokers the liquidity to make tranches of good and bad debt into a myriad of debt vehicles which were flogged all over the world.
Two years later I even refinanced and got an ultra low interest rate with a 7 year ARM (adjustable rate mortgage). I picked the 7 year term to ‘reset’ over the 5 year because I thought I’d be out of the US by then. It was becoming increasing apparent that US immigration was something I could not deal with and I was going to have to leave, but that’s another story. Within 3 years from that point, I sold my large southern house and moved back to Canada, financially intact and ‘out of the woods’. At the time I figured if I wasn’t out to the US within 7 years, I’d have many more problems than just my mortgage.
Over time I learned how the credit bureau’s viewed me. Basically I was an unproven risk and to the American entities my history started the day I moved down there. Canada didn’t exist. And when I moved back to Canada, the five years in the US didn’t exist and much of my history was gone. If I hadn’t established a relationship with 2 large Canadian Banks which ignored my credit report, I would have been ‘up the creek’. Telus wouldn’t even give me a cell phone when I moved back to Canada my credit report was so maligned. I have a Bell phone. So with this experience, I find it incredible that the financial sector placed so much faith in the rating agencies which are just as thorough as the credit bureau’s. I know when I looked at what was going on around me, I was getting more and more nervous about holding onto property in the US financed under the terms I was.
Then came the day I found a job in Canada and moved home the end of 2005. Selling the house and paying off the mortgage were a huge relief even though you always wonder about the timing. Could I have made more money? I even remember articles talking about the housing market in the US as being different and that it wasn’t a bubble but a froth … that there were areas in the US where housing was a bargain and bound to go up. Then August 2007 arrived and the ‘moral hazard’ of the boundless liquidity and imaginative brokers came home to roost. Even in housing markets like Dallas, where prices never ballooned, they are now falling.
Now, at the turn of the year from 2007 to 2008 it is looking grim in the US, worse than anyone thought … but this is probably the bottom. Also, there is so much cushion in our ‘standard of living’ now that a little pain will probably be more fortifying than anything. The biggest concern I have is America is experiencing ‘South American’ disease (unearned spending bonanza) and hasn’t come to terms with it yet. I’m not sure that Wall Street can dance out of this one unscathed as before (i.e.: 2000). I think of the big Sun Belt house I could afford when I was there and can’t help but think it is a metaphor for the future of the US and how the rest of the world views it … and holding its debts.
Foreigners, insultingly called aliens under the US immigration system, are now coming to realize the brick façade on the ‘stick built’ house has only 1/16th inch insulation board behind it with un-graded 2×4’s behind that and the on site ‘stick built’ rafters in the high ‘hip roof’ above may look pretty with the landscaping around the house but it is a ‘false value’ and is only on a thin concrete slab with no rebar. It’s much better to own the aged stone walls on solid foundations in the storied towns in Europe.
len
