Robert X Cringely

This week marks the fifth anniversary of then-Federal Reserve Chairman Alan Greenspan's observation that there was no housing bubble to worry about:

"Although a 'bubble' in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels.... Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications."

Some froth, eh?

Home prices are nationally down 18 percent from that day in 2005 and 30 percent from their 2006 peak with total homeowner equity dropping by a stunning 50 percent. That's more than $2 trillion in homeowner equity down the toilet.

How could Greenspan have gotten it so wrong?

Testifying yesterday before the Financial Crisis Inquiry Commission, former U.S. Federal Reserve chairman Alan Greenspan defended his 21-year tenure at the Central Bank, saying it wasn't he who inflated the housing bubble that caused the Great Recession.

While mistakes were made, Greenspan admitted, he claimed to have been correct 70 percent of his time at the Fed, which sounds pretty good. The unanswered question in all this finger-pointing and next-day quarterbacking, though, is whether being right 70 percent of the time is good enough.

It isn't.

That's not just my opinion. It's a central conclusion of the 1977 Stanford University computer science dissertation of Charles Simonyi, longtime head of Microsoft's application group, the father of Microsoft Office, and now a celebrated space tourist.

The market value of your house is down 20 to 30 percent from its peak and could have further still to go. Jobs are scarce and the idea that home values will rise again seems remote. But this, too, shall pass (yes, your home value will eventually recover). And I can tell you exactly why -- psychology.

The good news is that for all the economic pain and suffering, we've probably just bought ourselves, as a people, 50 years of immunity to economic depression. The bad news is that this immunity has nothing at all to do with house prices, public policy, Bernanke, Dodd, Geithner, or Obama, much less Paulson or Bush. It would have happened anyway.

Yesterday, I wrote a post titled "Who Killed M3?" that explored a Bush-era decision to stop tracking a key measure of money supply, and its link to the housing bubble. Today, I explore that further.

What did George W. Bush have against M3 that made it important enough to risk the world economy to get rid of? It was an inconvenient measure of inflation -- a kind of inflation that Bush really liked, being monetary inflation rather than price inflation. Monetary inflation tends to lower the long-term cost of deficits, because they are repaid with cheaper dollars. But it is inflation nonetheless, and a potential political embarrassment. Was that enough?

It could well have been. Think for a moment about W's character. If there was something potentially embarrassing he really liked, whether it was an arcane type of inflation or cocaine, what better way to deal with it than to pretend it didn't exist?

So M3 had to die.

Not long ago I wrote a post about a National Bureau of Economic Research study that blamed the Great Recession on a bank panic rather than that usual suspect, the sub-prime mortgage crisis. There was a sub-prime crisis, sure, but it was just the catalyst for the much more damaging bank panic that followed.

All this relates back to a little-noticed structural change in the U.S. banking system where Nixon-era deregulation led to the growth of money market funds that killed the savings deposits that had traditionally backed most bank lending. Rising to replace savings (and make a lot more profit) was loan securitization and REPO collateralized inter-bank lending enabled by Reagan-era deregulation. The Great Recession was caused by the banks all losing faith in each other, with commercial lending grinding to a halt as it continues to in many places even today.

Heck of a story, eh? Now that I had a better understanding of the actual crisis, I immediately began to wonder how we can avoid it happening again?

We can't.

The Great Recession wasn't the result of subprime mortgage madness, according to a new report from the National Bureau of Economic Research. It was just a plain old bank panic. Yeah, but weren't bank panics supposed to be a thing of the past, thanks to the creation of the Federal Deposit Insurance Corporation in 1934?

That's the problem.

The report, by Yale economics professor Gary Gorton, says subprime mortgage securitization was a mess -- a house of cards probably doomed to fall -- but subprime by itself simply wasn't big enough to put the entire financial system at risk. That required a failure of the Renew Sale and Repurchase (REPO) market for collateralized securities that over the last 30 years had come to backstop global finance.

The problem here, of course is that hardly anyone has even heard of REPO, which manages to be an unregulated, uninsured $20 trillion business that is absolutely essential to keeping money flowing in the world. Subprime is only $1.2 trillion -- not big enough by itself to wag this dog.

The U. S. Department of Commerce reported earlier this week that housing starts for January hit a six-month high, growing 2.8 percent to an annual adjusted rate of 591,000 new units. Therefore the housing crisis is ending, we're told: end of story, if we build it they will come.

Not.

Housing starts refer primarily to building permits, which have to be in place generally before builders and developers can get construction financing -- financing that is very hard to come by in the current economic climate. So a start doesn't inevitably mean a finish nor even a true beginning of construction. There are other statistics for those -- statistics the Commerce Department in this case chose not to highlight.

The founder of every new business hopes that what he or she creates will eventually become not just a business, but an industry. They want their business to scale -- to get as big as possible as fast as possible. But sometimes businesses are forced to scale when they really shouldn't. That's what I have come to realize is at the heart of the current home ownership crisis. And I blame it all on legendary 1980s white-collar criminal Mike Milken.

Before Milken revolutionized the junk bond market at Drexel Burnham Lambert in the 1980s, banking was both more regulated and more sedate -- precisely the attributes being called for in bankers lately from both sides of the aisle in Washington. But with President Reagan working back then to reduce regulation and guys like Mike Milken pushing the envelope on what was possible (ethical, even legal -- remember Mike went to prison), the world of finance quickly changed. Milken was master of a killer new financial technology, the phone bank, and used it to sell enough junk paper in 1987 to score himself a salary and bonus of $550 million (more than $1 billion today), setting in every way the trend we see now.

That trend is using technology to force increases in both supply and demand -- increases that, absent the enabling technology, would have appeared absurd on their face.

A perfect storm is coming in the housing market. Millions of mortgages are in default or foreclosure, mortgage rates are firming and mortgage issuers are significantly raising both borrower requirements and fees. The Federal Reserve, which has been propping up the housing market by buying mortgage-backed securities, says it plans to stop buying at the end of March. The $8000 first-time and $6500 homebuyer tax credits are scheduled to end for mortgages that close after June. Meanwhile stocks are up and economists talk about the recession being technically over, which might be true, but for how long?

We're in big trouble and, so far at least, nobody seems to have a plan.

And then there's the mystery of Fannie Mae and Freddie Mac, those Government Sponsored Entities that House Finance Committee chairman Barney Frank says have effectively become policy tools of the federal government and ought to be reorganized to reflect that. Yet, in the Fiscal Year 2011 federal budget released this morning there is no sign of Fannie and Freddie's combined $7.2 trillion total corporate debt and mortgage obligations.

"What the Hell is going on? " I asked my friend Jack, the world's smartest mortgage banker.

Robert Shiller, he of the Case-Shiller Housing Index, wrote in the last Newsweek issue of 2009, "My data show that between 1890 and 1990 real home prices actually didn't increase. "

Say what?

It's true. If you look at U. S. home prices over an entire century, corrected for inflation, they don't change much, if any, until after 1990. This covers wars and depressions and -- most importantly -- conversion from an era of low home ownership and nonexistent mortgages (the average mortgage in 1890 -- if you could get one -- was a term of less than five years) to one of high home ownership and huge leverage. What came after 1990, then, can be viewed as a bubble that finally peaked in 2006, popped in 2008, and is still deflating.

Important word there, "deflating."

Home prices are down 34 percent nationally from 2006, though your city may vary. If prices are truly headed for that corrected 1890-1990 line, they have another 22 percent to go, which will take four more years and put tens of millions of homes effectively under water.

Mortgage modifications were going to help up to four million Americans save their homes, remember? That was the claim of the Obama Administration when it announced its Making Home Affordable program in early 2009. Yet more than three million applications later, only about 100,000 mortgages have actually been modified under the widely-vilified program.

But what about those 100,000, the lucky folks who actually had their terms modified? For my friend Ralph, it is a story with a happy ending.

Watching the CEOs of America's largest banks testifying this week to Congress about their roles in starting The Great Recession with varying levels of contrition and defiance raises the question: exactly who are banks really accountable to in these post-TARP days?

Who's the boss? Shareholders? Taxpayers? Customers (whom they routinely bet against)? The government? Some banks have repaid their TARP money but still borrow nightly from the Fed for next to nothing. Where do their allegiances lie?

The second, third, or maybe Nth shoe to fall in the ongoing real estate crisis is commercial real estate -- offices, factories and to a certain extent rental apartments -- which tend to trail the owner-occupied housing market as leases end, jobs are lost, and businesses close (or recover). Alas, commercial real estate couldn't be much worse, according to a new report the commercial property research firm Trepp LLC.

Delinquencies on commercial-mortgage backed securities rose to 6.07 percent in December, from 5.65 percent in November and 1.21 percent one year ago. This is the highest delinquency rate ever recorded. The total value of the commercial mortgage-backed securities market was $724.5 billion in 2009. This is significantly smaller than the $5+ trillion market for securities backed by home mortgages, but $700+ billion is still a significant exposure for the U. S. economy and one that is going down, not up.

I recently detailed the trouble that's coming for American home owners with the end of the recession (except not for us), the recovery of the big banks (but not commercial lending), the rise of the stock markets (but not jobs), and the likely further declines for housing as what little stimulus was being applied there (less than five percent of the total) finally expires. Now I'll turn to what can or will be done to fix this mess.

But first let me share what I was told recently by the managing partner of a New York hedge fund after reading my earlier post. "Unfortunately, I agree with you," he said. "However, in this Alice in Wonderland world, sometimes what is bad for Main Street is good for Wall Street."

There are three interested parties here -- big business and Wall Street, the federal government, and the American people. We got where we are because big business and Wall Street offered us cheap loans and we took them so we could buy that RV and put our kids through college. When the housing bubble burst, government protected big business and Wall Street, seeing them as essential to any eventual recovery. Government didn't do much to help the American people because Washington was too busy helping business and Wall Street, and we weren't going anywhere, were we?

The recession is over, we're told by Bernanke, Geithner, and Summers, it's time for an exit strategy, to wind down the economic stimulus before it turns inflationary. Big banks are booming, TARP funds are coming home to roost, the market's up, the Fed has stopped buying mortgaged-backed securities, and the first-time home buyer tax credit will end in a few months.

Why, then, are we all still so nervous? Because the recession really isn't over, not for you and me. And, absent renewed stimulus -- for which there seems to be no political will -- we're screwed.

Here's a look six months in the future if the U.S. continues to follow its current economic course.