Ignored in the Big Shitpile

There are three big problems, laid on top of one another, in the financial mess known as the Big Shitpile:

1. Bad loans were mixed with good ones and sold as securities, even options.
2. Millions of adjustable rate mortgages are re-setting to higher rates over the next three years.
3. Homes are priced at twice their value.

There are a lot of "solutions" being proposed by both parties for the first two problems. (Picture from Bayareahousingbubble.)

No one is even talking about the third, because its implications are too massive to contemplate.

But this is the stark reality. What we're reading now, even the pessimists' argument, is not yet even realistic.

When any bubble bursts, the actual value of things gets cut in half. Usually it over-shoots this mark, then it resettles at the halfway line and starts proceeding upward again, slowly.

• This is what happened to the NASDAQ after the tech bubble burst. It fell from 5,000 to under 2,000, but now trades at around 2,600.
• This is what happened to the Japanese stock market after it peaked in 1987 at around 37,000. It now trades at about half that value, and investors are happy to be there.

This is also what happened in the 1970s, the last time we had a housing crash. Homebuilding stopped in most markets -- at least those outside the oil patch. The price you could get for an existing home fell to much less than its replacement cost, and stayed there. Renting made sense.

That is where the U.S. housing market is headed. That's where it has to be headed in order to regain free market equilibrium. That's the way markets operate.

But you'd never know that from the nonsense being proposed right now:

• Easing the pinch on some "sub-prime" borrowers does not make more credit available for new mortgages. 
• Enabling refinancing of adjustable-rate debt doesn't make the value of the underlying home any greater.
• Giving developers incentives to price some homes below-market is useless.
• A moratorium on foreclosures sounds nice, but it's just delaying the inevitable.

Here is what is inevitable. Many, if not most, home mortgages taken out over the last decade are going underwater. That is, the principal amount is going to be more than the value of the underlying asset, at least for a time. All this value has to be written-off. That's how you make housing affordable, by letting its price drop to an affordable range.

This is going to be a drag on Americans' income, and the banking system, for several years. It just is -- there's no way around it. People are going to have to pay off loans used to buy assets which have depreciated. They have to start thinking of this as rent, and homes as being more like cars than diamonds. Getting folks' heads around this sad fact is the real test of leadership.

Just as borrowers have to be forced to pay the piper, forced by strict enforcement of bankruptcy loans to pay-off on bad deals, banks have to be allowed to hold this kind of paper. This stretches out the time during which they're taking losses, and allows the impact of that to be depressive rather than destructive.

Home lending will, as a result, return to something approaching normal. That is you don't get the loan unless you can pay it back, principal and interest, over 30 years, without it taking more than 25% of your disposable income. If you can't meet the standard you don't get the loan. You get a smaller loan. You get a smaller house, one you can afford. Returning to these standards will extend the length of the housing depression (and it's not a mild recession, but a depression) but that needs to be the goal, a normal market.

What we're looking at is five years of continuing losses for those who lent money on stupid terms, on all those who borrowed more than they could afford, and on the economy as a whole. The market exacts its penance in all things, you pay a price for all speculation, and I believe the market is right.

This is just one of many penances we will have to make, all of us, for the crimes of the last decade. Our currency is going to suffer. We're going to have to take jobs making things. The world will remain suspicious of us, and force us to dis-arm. That's the way it is.

If you really want to do something useful, change the Constitution so the person who gets the most votes, from now on, wins.