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Haircuts for the Wrong Heads
I was taken aback when the E.U. first suggested that the Cyprus government should impose a haircut on all deposits in the country’s banks, even those below the insurance cap of 100,000 Euros. The E.U. ultimately relented on small deposits, but at the cost of bigger depositors losing an even greater proportion of their money — as much as 30% for the biggest deposits.
While it may be difficult to pity the Russian kleptocrats who will (ostensibly) take the brunt of this hit, it’s not hard for someone in the U.S. to feel a twinge of sympathy for the Cypriot businessman who just took a major hit, most likely at the same time his business is imploding. Americans are no doubt giving silent thanks that it didn’t happen here.
Maybe we should give thanks for something else, however. The always astute Chris Whalen pointed out on the financial blog Zero Hedge that U.S. depositors received a similar haircut in the last five years, courtesy of the Federal Reserve, via record low interest rates on savings.
The Fed’s unprecedented monetary expansion has caused interest rates to plunge. Most savings accounts pay less than 0.5% interest these days, and even the typical CD pays well below 1%. In 2007, average one-year CD rates were around 5.5% when they began their downward plunge. At 5.5%, someone holding the maximum insured deposit of $250,000 would today have over $330,000, after compounding. Instead, in reality they have only $255,000, i.e. $75,000 less, because of lower interest rates. A 20% haircut would be a pleasure compared to what the Fed has done to returns.
How have people responded to low interest rates? By finding other places to park their money, like real estate. Housing prices are booming again, up smartly in most regions of the country in 2012. This has been driven by investors buying up clumps of houses and renting them out, which is precisely goal of the Fed’s exercise.
But does the Fed really deserve the lion share of the blame for the effective haircut on U.S. depositors? No. Congress, rather, is the party most responsible for this situation.
The Fed resorted to its massive monetary expansion and stuck with it largely because Congress could not bring itself to address our moribund real-estate market. When over a quarter of all homeowners owe more on their mortgages than the underlying values of their homes, it serves as a tremendous drag on the economy. People in these mortgages could not refinance or sell their homes to move or do much of anything, and the economy suffered as a result. Something had to be done.
Nevertheless, Congress felt that the notion of someone walking away from a mortgage was somehow immoral (the exact words that Treasury Secretary Hank Paulson used) and as a result we waited around and watched millions of homeowners slowly and reluctantly realize that they could, in fact, walk away from their mortgage without anything terrible happening to them. Those abandoning their mortgages could even live in their house for months (or longer) not paying anything while their default worked its way through various legal channels. Not surprisingly, the economy sputtered in the meantime.
A mortgage cramdown in the context of an individual Chapter 13 bankruptcy reorganization would have sped up the resolution of our housing morass by letting the people living in a house with an underwater mortgage remain in that house and retain ownership. The truth is that someone holding a $400,000 mortgage on a house worth $300,000 will only ever get $300,000 for that house. The important question is — who pays that $300,000 — the current owner or a new owner, and after how many years of stasis?
Ultimately, notions of morality got in the way of the economically expedient — just as they did during the Great Depression — and the federal government sat on its hands. Sometimes, doing nothing is the right answer — when it comes to spending tens of billions of dollars on high-speed rail in Florida or rural California, for instance — but the housing crisis needed our government to act with haste. The banality uttered around D.C. that economic growth will cure what ails the housing market neglected the inconvenient fact that it served as an effective barrier to growth.
It’s probably too bad that some of the most egregious Wall Street financiers who bet against a financial collapse did not have to pay a bigger price for their perfidy — not because it would help quench our desire for vengeance but because it has set a terrible precedent for future reckless gambles to get bailed out as well.
The home-mortgage market won’t be at risk of a relapse soon, not with mortgage lenders and the buyers of MBSs demanding high credit scores and substantial down payments before lending money. But Congress managed to inflict a version of Protestant morality on housing speculators, while simultaneously impoverishing millions of homeowners. And in the meantime, the family that’s been diligently setting aside 5% or 10% of its income in the hope of buying a first home (or a bigger home) for its family, has treaded water. Naïfs.
So go ahead and cry for the Cypriots, but save a few tears for homeowners in the U.S.
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