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Both my main man Barry Ritholtz and my Atlanta hero Trader Mike have linked to this Wall Street Journal Article about people with high credit scores getting into subprime loans.

The WSJ describes these Poor Victims as being “caught in the subprime trap.”

I call bullshit. These people are caught in the greedy yuppie peer pressure materialism, keep up with the Joneses, entitled but not responsible trap.

Easy credit opened the gap between what we could afford and what we could qualify for. Even easier credit expanded that gap. Zero interest for 60 months on that new car (go ahead and get the leather and navigation system now). Six percent for 360 months on the new house, or better yet, four percent interest-only with nothing down so you can get into a house you can’t afford. Whether someone takes the bait is their decision.

But the consequences are theirs also. Well, should be theirs. Actually, now they’re becoming mine. Those poor victims.

My credit score is over 800. The house I’m sitting in right now is cheap, and paid for. The house I bought in October cost less than I make in one year. I don’t have to rush as I remodel it. I plan to pay it off before most people would pay off a new car. And then, thanks to these “unforeseen” developments in real estate, I might just buy myself a larger house for half of what its previous owners mortgaged. Those poor victims.

I can grill ribeye steaks for my girls anytime they want, while my friends’ kids are home alone on MySpace chatting with a pedophile because their parents are working second jobs to make the note on the mansion, only to come home and eat Ramen noodles, or else eat out with the Joneses and put it all on the credit card. Those poor victims. (The kids, I mean).

A man is rich in proportion to the number of things he can let alone - HD Thoreau.

The American Dream has run amok. I wrote a post about that, and real estate, almost 2 years ago. But this is all a recent development, a surprise, right? Here’s that post.

We’re all grown up. People should make their grown-up decisions, and take the consequences. Or try to dump them on responsible dummies like me. Whatever. But Jesus, stop all this crying and whining- it’s pathetic.

And as for Alan Greenspan and John Maynard Keynes: Rappaccini! And is this the upshot of your experiment?

I’m going to spend a minute or three on my soapbox (I’m writing this on a Saturday morning after three cups of coffee on an empty stomach, and the kids are still asleep… you know I’ve gotta ramble), then describe a method which, if you’re up to it, can help you to take on little or no debt this Christmas season, yet still buy gifts for the people you love. My personal version of layaway, if you will.

What Happened to Layaway?

It’s been almost a year since Big Daddy Wal-Mart finally gave in and killed its layaway program. It was a necessary business move, as the traditional purpose of layaway- to allow folks to spread the pinch of buying expensive items or multiple gifts over a period of months- has vanished into the smoky abyss of personal debt, or to use the word we’ve all bought into due to its more huggable connotation, credit.

That abyss has opened up for the same reason that our economy has “grown” so extraordinarily since World War II, and that is that someone, somewhere has gradually convinced us all that it’s perfectly fine for individuals and governments alike to spend money they don’t have. Illegitimate Spawn of The New Deal, perhaps.

In addition, our enslavement to personal debt has evolved hand- in- hand with our inability to handle the concept of delayed gratification, a concept which was a part of life for our parents, but which our children can’t even comprehend (hang on, Dad, I’ve gotta switch lines on my cell phone and pause the iPod for a moment so I can take this other call). It’s an important concept which Scott Peck wrote very lucidly about in The Road Less Traveled, and if you’re into that stage of your personal journey, it’s a book I’d highly recommend.

Debt Is Bad, but “Credit” Is Good? Propaganda 101

Did you notice that happening? Me either. The specter of personal debt, which to our grandparents was anathema (especially after the Great Depression), to us is not only acceptable, it’s desirable. Heck, not that long ago there were still debtor’s prisons! How did we get from there to here?

As with all so-called “progressive” societal change, it took place over a number of decades and started with a brilliant manipulation of the language. George Orwell wasn’t right just in a symbolic sense; in many ways he was describing exactly what goes on every day.

We think in language. Much eastern philosophy is based on the forgotten fact that we are capable of so much thought beyond concepts which language can describe, but that’s another subject.

By manipulating the words we use (and think), we can be made to unconsciously take on a particular attitude or position about a subject, favorable or unfavorable, without even realizing it. We think it’s our personal opinion, when in fact it’s an opinion that has been given to us.

This is what used to be called propaganda, but in the greatest self-makeover in history it is now known by its more favorable moniker, marketing. Get people to think and speak in your terms, and they unknowingly adopt your opinions as their own. For instance, anything that ends in “-phobic” automatically connotes “bad,” or at least unreasonable, and the use of that suffix is very effective at changing people’s attitudes simply by getting them to use (and think in) those terms.

Imagine if we spent the next three decades universally referring to people who don’t eat meat as carniphobic instead of the we’re- so- enlightened- don’t- you- want- to- join term vegetarian. Geez, who on earth would want to be a carniphobe? And so the graduating class of 2045 would be 99.9% meat-eaters. (By the way, I just came up with this example off the top of my head, but Beef Association, take note and feel free to send me a check).

Are You Ready To Stop Your Addiction to Deficit Spending?

It takes years to break the habit. To get into a position to even have that option, frankly. But those years are well-spent, and once you’ve broken the bonds of enslavement to the consequences of your past impulses, you become much stronger in deciding whether to act on (or more importantly, to not act on) new impulses.

In fact, you finally learn the true feeling of “I want it, but can I afford to pay for it in present dollars (cash), and do I really want it that badly?” And that power is awesome.

To use the propagan…, er, marketing technique I described earlier, learn to think of yourself and others like you, who have reclaimed their financial power, not as “Debtophobic” or “Creditophobic” (which of course would be unreasonable, un-American even). Instead learn to think of yourself as a freedom-o-phile. Someone help me here, there’s got to be a catchier word. But you get the point. It’s a positive thing.

Refusing to add debt for Christmas is just one step, but it’s a very significant one. And you can still buy nice gifts without taking on debt, by paying for those gifts over time, in advance, just like layaway.

Here’s how:

Next time you’re going through the checkout at your major retailer of choice, buy one of these reloadable gift cards. Start out with 20 or 25 dollars. Then, each time you pass through the checkout line in the future, get out that card and have them add five or 10 dollars to it. That’s often less than the sales tax on your other purchases, and you’ll barely notice it. (And you are paying for these purchases, not charging them, right?).

If you start this scheme in the summer, or even at the end of September (!), by the time those big Christmas sales hit, you’ll be able to knock out gifts for the majority of people on your list, all prepaid and at sale prices, no less. No interest, no buyer’s remorse. You’ll be purchasing with full-powered current dollars, not future dollars which have been depreciated by a print-happy Federal Reserve and by the interest due The Master (aka the banking system).

Keep the card, and start the five dollar gig in January next time. Get cards from two or three major retailers. By the time the next Christmas rolls around, you can give more nice gifts to more people than you ever imagined (you don’t have to cut so many off the list due to lack of funds, you can do it just because you don’t like ‘em!), and guess what… you can get to a point where you even have money left over!

It’s very liberating. The politicians don’t want you to do it. The retailers don’t want you to do it. The Federal Reserve doesn’t want you to do it. And the banks sure as hell don’t want you to do it.

Think about it- are those the people you want to please? Be a true anarchist. Pay your debts. Take personal responsibility. Take your power back, and just watch ‘em all squirm!

It is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions. (from Ben Bernanke’s Aug. 31 speech)

The Chairman is exactly right, and I’d go a step further: It is also not the responsibility of the taxpayers to protect lenders or investors.

As I’ve mentioned, one of my core beliefs is that true adulthood and maturity are the result of learning to accept and deal with the consequences of our own decisions. More importantly, it’s learning to consider the consequences before we commit to a decision, not just whether “I want it.”

Giving others (our children, our spouses, entitlement recipients, Katrina victims, subprime borrowers, Citibank, Long Term Capital Management, the United States Congress) the freedom to make decisions without having to consider the consequences does nothing but induce a spiral of more and more irresponsible behavior.

It is our job, as parents, friends, citizens, fellow humans, to maintain the connection between Freedom and Responsibility. That’s how they become independent and self-sufficient, instead of mewling, manipulative exploiters unable to control themselves and always needing someone else to bail them out.

The Problem With Subprime Defaults: The Deflationary Shock

Unfortunately, the consequences materializing from the actions of irresponsible lenders and borrowers don’t affect just them. Otherwise the solution would be easy- let the bums feel the sting! Trouble is, that sting is like a firecracker under a butane tank, the butane tank which is our entire economy- and those consequences would snowball into something that seriously hurts all of us.

You see, due to the way our fiat money system works, debt is money. Banks create money by loaning their excess reserves (how much excess exists in the system at a given time is one way the Fed exerts its influence). These loaned dollars (someone’s debt) are in turn deposited by the recipient, and the bank gets to count that money on its balance sheet, and turn around and loan most of it back out, which is then re-deposited somewhere else, etc.

This multi-generational money creation machine (think biblical- “10 dollars begat 9 dollars which begat 8 dollars…”) is how a few billion dollars added to the system can balloon into many many billions of new dollars floating around our economy in search of a product to purchase (or a 3BR, 1.5BA w/ 2CG and WBFP).

Now the ugly flip side: It works the same way in reverse. Drain a few billion dollars out of the system, and it results in many many billions fewer dollars floating around, since the cornerstone of the pyramid has been removed.

Fewer dollars chasing the same products- that’s also known as deflation, and as it ripples through the economy it affects us all. A deflationary spiral occurs when such a ripple adversely affects other borrowers (deflation makes debt more expensive and harder to pay off with future earnings), and those borrowers begin to default, which removes more money (debt) from the system, which compounds the problem and makes the deflation worse, and on and on…

Eventually the system can contract so much that massive defaults begin to occur even in “prime” loans. If we get that far, we’re in another Great Depression.

How To Prevent The Losers From Triggering A Depression - Refinance

As with your kid who’s been arrested for getting caught smoking pot naked in the back seat of the Lexus with the preacher’s daughter… it’s a little too late to go back and say, “DON’T DO THAT, YOU IDIOT!”

What we’re faced with is a choice between the lesser of evils. To do nothing and “let the bums feel the sting” is to do great damage to our own financial future through the mechanism of debt-deflation.

To write hundreds of billions of dollars of taxpayer-funded checks to the banks and relieve the bums of their responsibility is even worse. As I described above, that would just encourage more of the same behavior, from the bums and from the banks.

As much as possible and although we hate it, we need to prevent the bums from defaulting, but we need them to continue to carry their debt and make payments on it. The answer? Some type of refinancing solution. In this scenario, the banks take a little hit, the taxpayers take a hit (the refinanced loans would doubtless involve some type of government backing, which means it would cost us… but significantly less than actually taking on the debt itself), the irresponsible bums keep their loans at a lower rate which (hopefully) they can make payments on. The debt-money stays in the system, and we have a much better chance of weathering the coming recession. Oh yeah, did I mention that?

I believe this is why Chairman Bernanke is encouraging banks and legislators to pursue a refinancing solution, as in his letter to the honorable Chuckey Schumer:

The federal banking regulators have encouraged banks and thrifts to work actively with troubled borrowers to modify loans or to refinance as needed to avoid default or foreclosure…

and

It might be worth considering at this juncture whether the private and public sectors, separately or in collaboration, could help the situation by developing a broader range of mortgage products which are appropriate for low-and moderate-income borrowers, including those seeking to refinance. Such products could be designed to avoid or mitigate the risk of payment shock and to be more transparent with respect to their terms.

In short, there is no easy way out of this mess. There’s painful, and there’s more painful. Those are our choices, our consequences for allowing a system which rewards greed, immediate gratification and irresponsibility.

Jeff over at A Dash of Insight has written another excellent article, this one entitled “Do Internet and Media Resources Help the Individual Investor?” However, he makes a couple of points which themselves reveal a bit of bias, and I’d like to look at them through my particular shade of Rose-colored glasses.

I Reject the Facts Based on my Anecdotal Observations

Jeff points out that Ms. Olick from CNBC overgeneralizes based on what she sees as “typical behavior,” implying that her view on real estate is unreasonably biased. He says that

“Homeowner behavior is a distribution, not a unique point.”

I completely agree, which is why Jeff’s example (his Utopian neighborhood where the homeowners are thriving and confident, the men are strong and all the children are above average) is at least as misleading as Ms. Olick’s.

Homeowner behavior is a distribution– one which has already shifted significantly due to uncertainty about the future value of our homes, and which will continue to shift as this uncertainty becomes a self-fulfilling prophecy of negative sentiment and reduced spending.

Rising home equity has fueled the spending binge which has largely contributed to keeping our economy afloat the last decade. As that equity stops rising (or worse, begins to fall), we’ll get an extreme slowdown in spending as people find their credit card balances bouncing up against their limits (again), but this time discover they’re unable to “cash out some equity,” pay down the balance, and keep on spending. It will take some time for the credit cards to max out (pay $200, charge $300, balance gradually and inexorably creeps upward), so the most serious slowdown in spending will lag the recession in home prices by some months. In other words, the worst is yet to come.

I Have More Letters Behind My Name Than You

As for the impressive credentials of Mr. Blinder and Mr. Gault, they do imply that these gentlemen are far more qualified to talk theory than Ms. Olick (or me). But it doesn’t make their opinions about the future any more valid than those of a reasonably intelligent person who has taken the time to educate himself, examine the evidence and form a considered opinion.

How many experts were alerting us to danger in 1999, compared to the number using the words “New Paradigm”? How many experts publicly warned of falling home prices before the fact hit them in the head like a brick? (I’m no expert, and even I saw this coming).

As a matter of fact, I’d argue that those same credentials often insulate people from reality, leading the “experts” to ignore even flagrant evidence if it contradicts them. Thus catastrophe sometimes results as these people begin to think of themselves as infallible. Remember Long Term Capital Management? Myron Sholes and Robert Merton, both Nobel prize winners. Two of the smartest guys on earth. Lots of letters behind their names.

How about the multitude of hedge funds which are currently in the process of imploding or at least unwinding? Many of them populated with Ph.D. “experts” from the top educational institutions in the world. Not a single secretary or cotton farmer to be found among them. Does that mean that the secretaries and cotton farmers can’t see what’s going on with the economy and that their opinions about the future are less valid?

Personally, I found Ms. Olick’s (limited) part of the segment to do a great job of making a connection between the jargon of the experts and the concerns of the average person. The expert guests both agreed that the housing slowdown is a fact, and nothing Diana said contradicted them. Here’s her part, as best I could get it from the CNBC video (which I kept having to restart until I finally gave up):

It’s about sentiment. Obviously people feel that their wealth is in their home. For Americans, it’s their biggest investment by far. So when you feel that your home is not worth what it once was, that you can’t pull home equity out of your house like you might have been able to a couple of years ago, you just don’t feel as wealthy as you once did, and that of course translates into consumer spending and how we’re going to spend our money.

We’re already hearing from the homebuilders that renovations are starting to fall… and that dribbles over into places like Home Depot that fuel everything that goes into our houses. All of these things have a ripple effect, so when you feel that your home is not worth as much as it was before, even if you’re not putting it on the market, it definitely has a fundamental effect on how you see your own wealth.

I Agree With Jeff

The above being said, I wholeheartedly agree with the premise of Jeff’s article: that the media and much of the “information” on the internet are likely to do more harm than good, particularly by misleading investors into thinking this stuff is easy, and usually with the hidden motive of trying to sell them something. I hate marketing disguised as information or education, and I think Jeff has hit the nail on the head with that point.

From Barry Ritholtz’s post of an email from a friend, the “CDO Insider”, explaining what motivated them when they knew they were in for trouble as early as 2003. Very interesting read.

A Larry Kudlow piece today contained an analogy by one of the guests that was just perfect: He mentioned that Repos (aka Repurchase Agreements) are basically like the Fed acting as a pawn broker for the banks. And he’s exactly right. Here’s how it works…

Bubba Has A Liquidity Crisis

When one of my redneck buddies blows too much of his pay on beer and fried chicken, he sometimes runs a little short on cash for the routine stuff. You know, like rent and electricity. So he takes an asset, say the wife’s wedding ring, down to the pawn shop on Texas street, and the guy behind the counter gives him a few hundred bucks.

Bubba’s a good guy at heart, so he uses that cash to pay the rent or buy the groceries. Then when he gets his paycheck on Friday, he heads back down to the pawn shop and pays the broker the cash back, plus a little interest, of course, and brings honey’s ring back home. All is well, at least for the moment.

Banks Are Bubbas Too

What has been happening the last few weeks is that banks (redneck beer-bellies that they are) have been having trouble meeting their own financial obligations because no one wanted to pay the asking price on some assets they were trying to sell. What assets? Subprime mortgage paper- the notes that amount to I.O.U.’s from millions of our irresponsible neighbors who got into houses they couldn’t afford.

Well, if the Fed just stood by and let the banks look at their creditors (ironically enough, often that’s each other) with a big blank stare and a hangover, things would get really ugly really fast. Banks would begin to default on their obligations and the domino effect would crash the entire economy, possibly in a matter of days.

So, Uncle Ben Bernanke straightens his “Cat Diesel Power” cap, spits some Skoal juice into his ever-present styrofoam cup, and steps up to the pawnshop counter to save the day.

So far, what we’ve described is your normal, everyday overnight repo operation. “Repo” is the nickname for Repurchase Agreements, which simply means the Fed maintains liquidity by loaning the banks cash with some asset as collateral, and the banks then repurchase those assets in the designated time (hence the name- overnight repo, 3-day repo, 14-day repo, etc). This is how Repos differ from other Open Market Operations where the Fed purchases treasuries to permanently add cash to the system… repos add cash temporarily, then take it back, just “keeping the wheels greased,” so to speak, no net long-term change in the overall money supply.

Sounds familiar, no? That’s exactly what the pawn broker does for Bubba. He enters into a repurchase agreement with him for the wife’s ring.

Good Money for Questionable Collateral

But here’s the crucial difference with the Fed’s recent actions: they have agreed to take the unwanted subprime paper as collateral on the repo loans. Typically they would be getting Treasury notes as collateral. Imagine the pawn broker giving Bubba the cash loan and taking as collateral Bubba’s used wristwatch, which was valuable once upon a time, but no one wants it now because Bubba’s been wearing it while he replaced timing chains and camshafts, and it’s all banged up.

The pawn broker would have to be pretty worried about Bubba’s financial state to take a risk like that, wouldn’t he?

The Federal Reserve is providing tens of billions of dollars in liquidity to keep the banking system functioning, and is accepting moldy subprime paper (aka Mortgage Backed Securities) as collateral without significantly discounting those securities (it wouldn’t be as big a deal if the Fed were loaning, say, 40 cents on the dollar for the value of these notes).

That tells you how worried Uncle Ben is about the banks and their liquidity problem. And that’s the real news.