Part One of this discussion was published in the Huffington Post today.
You get to see the whole piece here.
Michael Hudson talks with . . . Michael Hudson
Michael Hudson and Michael Hudson are often mistaken for each other. Along with sharing a name, they share an interest in economics, debt and the creative ways that some people help themselves to other people’s money. Michael Hudson the economist – author of such books as Super-Imperialism – teaches at the University of Missouri-Kansas City. In 2006, he wrote a prescient cover story for Harper’s entitled “The New Road to Serfdom: An illustrated guide to the coming real estate collapse.” Michael W. Hudson the reporter is a staff writer at the Center for Public Integrity, a nonprofit journalism organization. He has been credited with being far ahead of the media pack in exposing subprime lenders’ unseemly methods. He is the author of the new book, The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America, and Spawned a Global Crisis.
What follows is an edited transcript of an email conversation between the two Michael Hudsons.
Michael W. Hudson, reporter:
First of all, let me apologize for all the confusion that the publication of my book has caused. I’ve lost count of the magazines and Web sites have identified me as you, and vice versa. I am not trying to assume your identity. I swear.
I first became aware of the “Will-the-real-Michael-Hudson-please-stand-up?” problem in the spring of 2006. I started getting compliments from friends and colleagues for your Harper’s piece about the coming real estate bust. I pushed aside the unworthy impulse to simply say, “Thanks,” and explained that I hadn’t written the story.
A different Michael Hudson, an economist, had written it.
Besides the fact that there was another Michael Hudson out there writing a Harper’s cover story I wished I’d written, the thing that struck me was your willingness to go beyond a “what-goes-up-must-come-down” analysis of the housing run-up. You came right out and declared that “this particular real estate bubble has been carefully engineered to lure home buyers into circumstances detrimental to their own best interests.” I was also intrigued by the way you questioned not only the sustainability but also the ideology of the housing boom, noting how going into debt — taking on a huge mortgage — had become defined as an “investment,” as a path to not only wealth but freedom as well.
As I reported on the mortgage market, one thing that fascinated me was how the impresarios of the housing boom used the idea of the American dream to clear the way. They talked about homeownership as if nothing else mattered. Even Ameriquest, the most notorious of the subprime sharks, called itself “Proud Sponsor of the American Dream” and described its mission as “helping people achieve their homeownership dreams and financial freedom.” There was one problem: Ameriquest almost never made home purchase mortgages. It was a refi shop. In 2004, one quarter of 1 percent of its loans went for home purchases. Rather than promoting home ownership, Ameriquest’s loans increased the odds that borrowers would end up in foreclosure, by ratcheting up the amount of debt they owed on their homes.
The rhetoric worked well, though, on Democrats who worried about minority access to credit as well as on Republicans who embraced George W. Bush’s “ownership society.” Some conservatives have pushed the talking point that liberal Democrats “forced” bankers to make subprime loans. The lenders made these loans, however, not because government required them to do so, but because they were wildly profitable. What the homeownership spiel did, though, was give the mortgage lenders a fig leaf they could hide behind. Whenever somebody suggested tougher rules on home loans, the mortgage industry painted it as an assault on homeownership and equal opportunity.
Michael Hudson, economist:
I first heard of you about a decade ago. A Norwegian economist greeted me at a German economics conference and telling me that he had just bought my latest book. He then proudly held up your first book on consumer debt, Merchants of Misery, and suggested I autograph it.
The next year there was a third Michael Hudson at the same conference, giving an article on Georg Simmel’s Philosophy of Money. The offprints were mailed to me by mistake. I began to wonder if there was something in the numerology of names that led to three Michael Hudsons all dealing with money and credit.
I never heard of the third MH again, but I began reading your articles, especially after you joined the Wall Street Journal. While you were dealing with the abuses on the ground level, I was dealing with the economy-wide debt level. I’m on the economics faculty at the University of Missouri at Kansas City. UMKC is the main alternative to the Chicago School monetarists. Where the Chicago Schoolers speak of “money” and relate it to consumer prices, I focus on credit and relate it to asset prices. I popularized my academic articles for Harpers in 2006, explaining how real estate prices were determined by how much a bank would lend. Lower interest rates, slower amortization rates (“interest-only loans”), lower down payments and easier credit terms enabled millions of Americans to take on huge debts today with the hope of reaping huge capital gains sometime in the future — or simply to avoid having to pay more as home prices rose beyond their means.
Your articles showed how the mortgage brokers and other pilot fish for Wall Street increased debt pyramiding by outright fraud. These sleight-of-hand lending practices at the local level were enabled by junk economics at the highest level. Alan Greenspan became a Bubblemeister, applauded by CNBC and the media for convincing them that prices bid up by debt leveraging was “wealth creation.”
This wealth creation really was debt creation. That’s what was bidding up real estate prices — just as was the case with leveraged buyouts bidding up stock prices during the takeover wave. And a rising proportion of this debt was “empty” debt, without any corresponding real value. Much of it simply represented hope that real estate prices would rise all the more. And much of it was based on fictitious income statements, fictitious appraisals, fictitious mortgages filled in by crooks — thousands of people all involved in financial crime. As my UMKC colleague Bill Black has noted, not a single major player has been indicted in the recent financial scandals — except for the one person who walked into a police station with his hands up and surrendered (Bernie Madoff).
Michael W. Hudson, reporter:
Getting people to load up on debt required not only crooked tactics, but also changing their attitudes about debt. First, the finance industry stopped calling it debt. Debt meant you were in the hole. You owed. Calling it credit removed the stigma of going into deficit and instead replaced it with a sense that you were being conferred an admirable distinction. As a consumer attorney once told me, nobody wants to eat a horse mackerel. Call it tuna fish, and it sounds much tastier.
In the 1950s and ’60s, the finance industry worried about ministers preaching about the evils of debt. It began offering seminars and educations materials to the clergy. “When the ministers stopped telling the people that credit was a sin,” a former industry lobbyist recalled, “they began to realize that this really was a way of life.” Then there were the TV commercials that slyly suggested — even as they denied it — that having a credit card could make you happier, smarter, sexier.
By the Reagan years, the finance industry was inundating American homeowners with advertising campaigns designed to encourage them to borrow against their homes to take dream vacations or pay their children’s college tuition. One print ad showed a couple beaming in front of their home: “We just discovered \$50,000 hidden in our house!” A former Citibank executive later recalled in the New York Times: “Calling it a ‘second mortgage,’ that’s like hocking your house. But call it ‘equity access,’ and that sounds more innocent.”
Michael Hudson, economist:
The marketeers did their jobs well. Throughout most of history, people tried to steer free of debt, above all when it came to “mortgaging the homestead.” This is the first time in history when people imagined that the way to get rich and rise in the world was to run into debt, not stay out of it. There is a belief that rising housing prices make people — and the economy — richer. But what they actually do is raise the access price for housing to new buyers. This obliges them to take on a lifetime of debt. And that raises their cost of living. All this makes economies with highly financialized real estate markets less competitive in world markets.
My first real job on Wall Street was as an economist at the Savings Banks Trust Company from 1962 to ’64. (It was at this point that I changed my given name, Huckleberry — my father’s favorite book had been Huckleberry Finn — and took the name Michael. Somehow Huck Hudson didn’t sound weighty enough for someone working in the capital of high finance.) Savings Bank Trust was the “central” commercial bank for New York State’s savings banks. My job was charting deposit statistics and tracing how they were recycled into mortgage loans. It became clear to me that most deposits grew simply by accruing quarterly interest – and hence, growing at an exponential rate.
The more savings grew, the more was lent out as home mortgages – and the banks’ receipt of interest was recycled continually. Instead of imagining that real estate prices rose simply out of inertia or because of the rising population density (the “man/land ratio” as it was called), I saw the exponentially rising credit/land ratio as being more important. What I learned on Wall Street wasn’t anything like what I’d been taught in my graduate economics courses at New York University.
My “money and banking” course had been taught by an abstract professor who taught economics as if it were science fiction about a parallel universe. He followed the usual academic tendency to teach students MV=PT, relating the money supply only to consumer prices (and wages). Nobody even today relates money and credit to asset prices. That amazes me, because it is the core of “wealth creation” Alan-Greenspan-style — loading the economy down with debt to inflate asset prices. What surprised me somewhat more was that followers of Henry George likewise had little interest in understanding the dynamics that bid up property prices.
In 1994 I was hired to become research director of the Henry George School of Social Science here in New York. My main job was to create a set of national income and product accounts (NIPA) statistics, IRS statistics and Federal Reserve flow-of-funds statistics to explain the role of real estate rent and capital gains. (In economic terms, “rent” is not the monthly payment from tenants to landlords, but rather the wealth that one accumulates simply by owning something.) These statistics showed that, for homeowners, most net rental income was absorbed by mortgage interest. That wasn’t something “Georgists” wanted to hear.
Most members of the board were in their 80s or 90s, because the sect was dying out. I was a couple of decades too young to pal around with them. I had known of Henry George only that he popularized the Single Tax on land and, in the 19th century, had spoken out against economic inequality — not that he had moved far to the right of the political spectrum, or that his followers were mainly von Misians and the school was basically a feeder into the Ayn Rand “objectivist” cult that had been an early training ground for Alan Greenspan. They didn’t want to hear about finance, largely because George had treated the economy as if it operated on barter — and whatever errors or shortcomings he had, they felt obliged to adopt them. They still focused on rising population density as explaining real estate prices, and told me that they were uninterested in statistical analysis. As a result, I left there pretty quickly.
Michael W. Hudson, reporter:
My first job out of college was as a reporter at the Roanoke Times, a daily newspaper in the mountains of Virginia. It was the mid-1980s. I covered the police and courts beat. I spent my days talking to cops, prosecutors and defense attorneys. Many evenings I did what one old-time newsman once called “foot-in-the-door” reporting — showing up at the homes of victims and suspects of crimes and trying to get them talk to me and tell their sides of the story.
Later, I began investigating big bureaucracies, such as Virginia’s juvenile prison system. I learned that in large institutions the best sources of information generally didn’t come from the top. Often the people in charge didn’t know what was going on, or they had a vested interest in putting a happy face on things. I found better information by talking with low- and middle-level folks working in the trenches. This experience, I think, prepared me for reporting on the rise of the subprime mortgage industry, from the end of George H.W. Bush’s term in office through George W. Bush’s second term. I talked to dozens, then hundreds, of former mortgage workers who described how their employers were using “boiler room” sales tactics to peddle mortgages with Rube Goldberg-like structures designed to obscure their true nature. I saw it more as a police story rather than a market or economic story. This was not a case of a few bad practices thriving around the margins, as the free market corrected itself.
Fraud had become central to the mortgage market and its explosive growth. By tracing the practices on the ground to the financiers who were bankrolling them, I could see that lots of people on Wall Street knew, or should have known, what was going on. As far back as 2003, a civil trial in Southern California had unearthed information about the relationship between Lehman Brothers and a subprime lender called First Alliance Mortgage Co. In 1995, a Lehman vice president who checked out the lender wrote a memo describing the lender as a financial “sweat shop” specializing in “high pressure sales for people who are in a weak state,” a place where employees checked their “ethics at the door.”
This didn’t bother Lehman much. Over the next few years, it helped First Alliance raise hundreds of millions of dollars to bankroll its lending.
Michael Hudson, economist:
By 2005 it was clear to me that the economy was painting itself into a debt corner. To the extent that a real estate bubble is debt-financed, it simply increases the economy’s debt overhead. From the outset of my graduate economic studies, back in the 1960s, my mentor Terence McCarthy had urged me to concentrate on the debt problem. That has been the main focus of my studies all my professional life.
Here’s the problem as it pertains to real estate: A property is worth whatever banks will lend. “Loosening” lending terms mean increasing the degree of debt leverage. The result is that debts rise beyond the ability of people to pay. This is the case not only with homeowners, but indebted students, corporations, cities and states as well.
Solving this debt problem by writing down debts strikes many people as unimaginable. There is a moralizing tendency to imagine that all debts can be paid – and that if they are not paid, it must be the debtor’s fault. This is an ideology well popularized by the financial sector. You might call it the opposite of “truth in lending.” It encourages gullibility. The prospective borrower is treated as a “counterparty” – itself a rather hostile term.
Thinking that debts can’t be paid strikes most people as cognitive dissonance. Yet Adam Smith wrote in The Wealth of Nations that no government ever had paid off the public debt. The “magic of compound interest” makes it impossible for all debts to be paid over time.
The Chicago School talks about “money,” but not of debt. Yet all money and credit is debt. That is a basic balance-sheet relationship. I often wish that economics students be taught accounting so that they see that savings = debt, and also money = debt. When you factor in the mathematics of compound interest, you see why financial crises occur: debts tend to outstrip the ability to pay.
At Kansas City we focus on the theories of Hyman Minsky. It is clear that economies develop bubbles as a means of carrying their debts. Banks lend borrowers the money to pay the interest, and this increases the debts that new buyers of real estate need to take on. The process becomes economy-wide, affecting industry and agriculture, and government itself. So crises are inevitable.
The question is, how will society resolve these crises? Who is going to lose? There are only two choices: either to bring the debt burden back within the ability to pay, by wiping out debt; or let creditors foreclose, transferring property from debtors to creditors.
Given the rising political power of financial wealth, economies are opting for the foreclosure option. But that slows economic growth and results in shrinkage over time.
Michael W. Hudson, reporter:
However preordained the financial crisis was, it’s remarkable how long its architects kept the game going. They managed to sustain the unsustainable for five years – roughly 2002 through 2006. As I was trying to write a new book on consumer debt, I came to see how the financial and mortgage markets had come to resemble a giant Ponzi scheme – or a least a vast collection of interlocking mini-Ponzis. The key to keeping the thing going was to keep more and more money flowing in, giving everyone wiggle room to cover up the fact that underlying transactions – mortgages and various investment vehicles such as “CDOs” – were based on smoke and mirrors.
Lenders created the illusion of low default rates by refinancing customers whenever their low initial “teaser” interest rates began climbing upward, rendering the monthly payments unaffordable. The refinancing extinguished the old loan – allowing it to go on the books as paid off, “successful” transaction – and provided a new loan that was temporarily affordable thanks to a new teaser rate. A homeowner trapped in this process of serial refinancings might take out five loans in as many years before finally collapsing under the growing weight of the fees that the lenders slipped into each new transaction. This process would go down in the books as four successful loans and one foreclosure. The truth was, though, that all five transactions had been bad loans, doomed to fail from the start.
The lenders also hid their reckless lending by outrunning their bad loans, growing their mortgage volume so rapidly that their customers’ rates of default were obscured. Thanks to teaser rates, it might take a year or two before borrowers ran into trouble and, even then, they might be able to stave off failure another few months by shifting money out of their 401(k)’s or borrowing from pawnshops or relatives. As lenders doubled or tripled their loan volumes every year or two – Ameriquest, for example, grew from \$6 billion in loans in 2001 to \$82 billion in 2004 – borrowers’ defaults from previous years began to look like statistical blips. They represented a tiny percentage of what had become a much enlarged pool of loans.
All the refinancings and exponential growth was possible so long as housing values continued to climb higher and higher. It was only when the real estate prices leveled out, and then began to fall, that the hidden, slow-moving disasters for millions of families became a crisis for us all.
Michael Hudson, economist:
The constraint on this Ponzi scheme was the ability of income to carry the rising debt. As long as interest rates were falling, a given rental revenue or equivalent homeowners’ value could carry a rising debt. But once interest rates reached their minimum, by 2006, there was no more leeway left. Homeowners had to pay debts out of their take-home wages, which have not risen in real terms for over thirty years now. The debt charade no longer could be concealed.
This leaves us with the problem of where we go from here. The Obama Administration’s “solution” is for the economy to “borrow its way out of debt.” The Fed is flooding the economy with credit to get the banks lending again – in the hope that new mortgage lending will restore high prices (that is, high housing costs to new buyers), saving the banks’ balance sheets.
But with much of US real estate already in negative equity, banks are not going to start lending again on a large scale. The government doesn’t want to confront the fact that we have entered a period of debt deflation. When debtors pay their creditors, they have less to spend on goods and services. So market demand shrinks, corporate profits fall, investment declines and unemployment rises.
To mainstream economists, this is an anomaly. This shows the extent to which creditor-friendly views have swamped common sense in academic economics and in Congress. It reflects the power of financial lobbyists to persuade many policy makers to embrace illusion over reality.