11% unemployment coming to the US?

Economists Kenneth Rogoff of Harvard and Carmen Reinhart of the University of Maryland have a particularly grim view of the economic outlook.

In a fascinating new paper that Mr. Rogoff presented this weekend at the annual meeting of the American Economic Association, they offered some sobering details on what has happened to other countries in the aftermath of severe financial panics like the one the U.S. is now experiencing.

Their bottom line: If history is any guide, the housing market might not bottom until 2010, a stock market rebound isn’t in sight, the unemployment rate could exceed 11% and government debt is about to soar.

The work is an extension of long-running research by the two professors on the history of financial crises. In past work, they compared the U.S. situation to financial crises in developed countries. This time, they are adding in the experiences of developing after concluding that severe emerging-market crises aren’t all that different from crises in developed markets.

They also expect the stock market to stay down for a few years.

Thoughts?

Thread drift on Megan McArdle's blog led me to post this as a logical response to what other posters were saying: The Rapture is a profit opportunity for those left behind.

To profit from the Rapture make sure you are not a believer. Otherwise you'll go up with the Rapture and your inheritors will reap all the profit.

I see some Rapture investment angles:

1) Do not own homes in fundamentalist neighborhoods because housing prices will drop when all those believer homes come on the market in estate sales.

2) Believer mortgages are similarly a bad investment bet.

3) Get into cash before the Rapture so you can buy up businesses and housing of departed believers that will sell for cheap in estate sales.

As for how to profit from societal collapse: I think the people who are focusing in guns and canned food are not thinking sustainably. Look, if utilities are going to collapse you ought to be thinking about a country home with solar panels and near a creek with a dam for hydroelectric power.

Think about how to sustain flows when the flows have stopped for everyone else. Now, I'm not saying pairs of 50 cals and lots of ammo aren't useful. You've got to be ready to repel direct assaults on the greenhouses you are going to sustainably grow food once TSHTF. But dogs are more sustainable for routine guard duty since you can trap rabbits and other small game to feed them and the dogs can reproduce.

Dogs are more sustainable. Dogs, solar panels, and small scale hydroelectric are what you need.

This is practical advice. If you want more disaster fare then also read Jason Bradford on survival in Mendocino County once nuclear war cuts off Middle Eastern oil. Mind you, his premise is flawed since a cut-off of Middle Eastern oil will not stop the flow of trucks to refill grocery stores in Ukiah or Willets. The amount of energy cut needed to strangle US agriculture and food distribution would need to be a lot larger than that. Precisely because we waste so much we have a large buffer of cuttable energy usage before we'd see collapse of essential infrastructure.

But disasters are good fun as numerous disaster movies demonstrate.

The Taliban have brought their educational policies with them from Afghanistan.

Taliban militants in a former tourist region of Pakistan have banned girls from school beginning this month, claiming female education is contrary to Islam.

"From January 15, girls will not be allowed to attend schools," Mullah Shah Doran, the Taliban second in command in the scenic Swat Valley, announced in a recent radio address. Mullah Doran said educating girls is "un-Islamic."

120,000 girls were in school but the violence (including destruction of schools) has already cut the number to 40,000. Barack Obama wants to take on the Taliban. But is he going to send US troops into Pakistan to do it? The Pakistani government would object to large scale US operations inside of Pakistan.

Can anyone point to a good analysis of US military prospects for stomping down the Taliban in Pakistan? The Taliban are making headway in tribal areas of Pakistan according to some reports.

Militants have launched six such attacks in Peshawar since the beginning of December, destroying some 300 Humvees and other military vehicles as well as supplies worth millions of dollars. While these raids have obvious consequences for international troops in Afghanistan, they also mark a new level of insecurity for Peshawar, a city of universities, kebab stands, and carpet dealers that has always had an edgy border-town vibe but that now seems increasingly vulnerable to a Taliban takeover. Mahmood Shah, a retired army brigadier who lives in Peshawar, estimated that, based on the scale of the attacks on NATO supplies, it would take the Taliban as little as 20 minutes to gain control of the city's key administrative offices and essentially conquer it.

This sounds like the kind of situation that will get worse before it gets better. Can the US entice the government of Pakistan to assert full control of the tribal areas? Can the government of Pakistan competently do this?

Neil Howe and Richard Jackson argue that the demographics of aging populations will cause political conflicts as the young and old battle over how much hte young will fork over to support the old.

For the world's wealthy nations, the 2020s are set to be a decade of hyperaging and population decline. Many countries will experience fiscal crisis, economic stagnation and ugly political battles over entitlements and immigration. Meanwhile, poor countries will be buffeted by their own demographic storms. Some will be overwhelmed by massive age waves that they can't afford, while others will be whipsawed by new explosions of youth whose aspirations they cannot satisfy. The risk of social and political upheaval and military aggression will grow throughout the developing world -- even as the developed world's capacity to deal with these threats weakens.

High taxes to pay for huge increases in old age entitlements will cut living standards for younger workers. They do not mention this but those taxes will also cut economic growth by reducing investment and in some cases by reducing labor force participation.

Graying means paying -- more for pensions, more for health care, more for nursing homes for the frail elderly. Yet the old-age benefit systems of most developed countries are already pushing the limits of fiscal and economic affordability. By the 2020s, political warfare over brutal benefit cuts seems unavoidable. On one side will be young adults who face declining after-tax earnings, including many who often have no choice but to live with their parents (and are known, pejoratively, as twixters in the United States, kippers in Britain, mammoni in Italy, nesthocker in Germany and freeters in Japan). On the other side will be retirees, who are often wholly dependent on pay-as-you-go public plans. In 2030, young people will have the future on their side. Elders will have the votes on theirs. Bold new investments in education, the environment or foreign assistance will be highly unlikely.

At first glance the US looks in better condition than the European countries because the US has a higher overall fertility rate. But immigration of low wage earning and low education achieving ethnic groups is setting up the US for a substantial decline in average per capita income and greater demand for social services for poorer ethnics. But Howe and Jackson do not recognize our second demographic problem and claim we are in much better shape.

America's economic problem due to immigration will become too noticeable to miss in the 2010s. US states with declining per capita income will be hard to explain away any other way. California per capita GDP will decline 11% by 2020. Texas will decline as well. The US entitlements financial crisis will be much larger than the 2008 crisis. While many libertarians like open borders America will become less libertarian as a result of immigration. The libertarians are wrong on immigration.

As regular readers know, I take a dim view of what has become of higher education. The old brick-and-mortar schools cost too much and are antiquated in their approach to education. But it is worse. Some universities make money by helping to get their students deep into credit card debt.

Bank of America’s relationship with the university extends well beyond marketing at sports events. The bank has an $8.4 million, seven-year contract with Michigan State giving it access to students’ names and addresses and use of the university’s logo. The more students who take the banks’ credit cards, the more money the university gets. Under certain circumstances, Michigan State even stands to receive more money if students carry a balance on these cards.

Hundreds of colleges have contracts with lenders. But at a time of rising concern about student debt — and overall consumer debt — the arrangements have sounded alarm bells, and some student groups are starting to push back.

Whatever happened to the paternalistic view that colleges should treat their students as wards to protect? I really do not think universities should exist to put people into bondage.

Too many people go to college. Too many drop out or graduate burdened with debts. Charles Murray thinks we should stop pushing students to try to learn college level material that is beyond their intellectual capability.

For most of the nation’s youths, making the bachelor’s degree a job qualification means demanding a credential that is beyond their reach. It is a truth that politicians and educators cannot bring themselves to say out loud: A large majority of young people do not have the intellectual ability to do genuine college-level work.

If you doubt it, go back and look through your old college textbooks, and then do a little homework on the reading ability of high school seniors. About 10 percent to 20 percent of all 18-year-olds can absorb the material in your old liberal arts textbooks. For engineering and the hard sciences, the percentage is probably not as high as 10.

Murray advocates for more certification tests for specific capabilities that employers need. Let people get demonstrable job skills. I think that's a good idea. I also think we need tests of college-level material that can be taken to demonstrate knowledge without enrolling in a college and physically attending classes.

Universities funded by taxpayers should put course lectures on the web for download. People should be able to watch lectures from home, study textbooks, and then take online tests to check their knowledge levels. Once they know they can pass tests for a topic they should be able to go to a testing center to take the tests with witnesses to verify they took each test. Passing grades should earn credits toward degrees or toward job skill certifications.

Women initiate most divorces. Due to the housing downturn they've got to think twice because with so many houses which have mortgages which exceed their market value many marriages no longer have net positive assets to divvy up.

With nearly one in six homes worth less than the mortgage owed on it, according to Moody’s Economy.com, divorce lawyers and financial advisers around the country say the logistics of divorce have been turned around. “We used to fight about who gets to keep the house,” said Gary Nickelson, president of the American Academy of Matrimonial Lawyers. “Now we fight about who gets stuck with the dead cow.”

As a result, divorce has become more complicated and often more expensive, with lower prospects for money on the other side. Some divorce lawyers say that business has slowed or that clients are deciding to stay together because there are no assets left to help them start over.

“There’s an old joke,” said Randall M. Kessler, Ms. Needle’s lawyer. “Why is a divorce so expensive? Because it’s worth it. Now it better really be worth it.”

I'd like to see some figures on month-by-month changes in divorce filing rates. Maybe the people who lose their homes in foreclosure are more likely to divorce while those still underwater are less likely.

The more I think about it the more I think guys are crazy to get married without a prenuptial agreement that lays out how joint property will get divvied up should the marriage end up in divorce court. Guys should negotiate rules about debt, child support, alimony, retirement funds, child custody, pet custody for pets that already exist at the start of marriage, and numerous other details.

Dexter Filkins of the New York Times reports on the depth and breadth of corruption in Afghanistan.

KABUL — When it comes to governing this violent, fractious land, everything, it seems, has its price.

Want to be a provincial police chief? It will cost you $100,000.

Want to drive a convoy of trucks loaded with fuel across the country? Be prepared to pay $6,000 per truck, so the police will not tip off the Taliban.

Need to settle a lawsuit over the ownership of your house? About $25,000, depending on the judge.

No doubt we fund those police. Given Afghanistan's fertility rate of 6.58 we are funding the development of a much larger corrupt state.

Hey, look at it on the libertarian free market bright side: Afghanistan has privatized everything, even the airport.

People pay bribes for large things, and for small things, too: to get electricity for their homes, to get out of jail, even to enter the airport.

A high rate of consanguineous (cousin) marriage with tribal loyalties over loyalties to the state, a high fertility rate, and an estimated average IQ of 84 all tell us that Afghanistan isn't on the road toward modern industrial society.

The US under the Obama Administration is going to get more involved with Afghanistan and Pakistan. We have a few advantages. First off, we can afford to bribe to rent loyalty. Though verifying performance will be difficult. Also, not too many countries care what happens in Afghanistan. So we probably won't be playing a Great Game for influence over Afghanistan. But our policy makers will continue to be blinded by politically correct ideology. Plus, the Pakistani government exercises limited control over Pakistan's Federally Administered Tribal Areas and some substantial portion of Pakistan's intelligence service is sympathetic to the Taliban on both tribal and religious grounds.

US policy makers are in way over their heads in the Middle East, Pakistan, and Afghanistan. We can't expect much from their performance.

Update Obama team adviser and former CIA analyst Bruce Riedel says Pakistan's government played us for suckers. Geez, are we really such Rubes? After all we've got foreign policy experts calling the shots in Washington DC. Surely experts know what they are doing? (okay, I'm being sarcastic)

Mr. Riedel is one of a chorus of terrorism experts who see the terrorist network’s base in the mountains of Pakistan as America’s greatest threat, and perhaps the biggest problem facing Mr. Obama’s new team.

He speaks angrily about what he calls a savvy campaign by Pakistan’s government under President Pervez Musharraf to fleece Washington for billions of dollars even as it allowed Al Qaeda to regroup in Pakistan’s tribal lands.

“We had a partner that was double-dealing us,” he said during an interview in his house in a Washington suburb. “Anyone can be snookered and double-dealt. But after six years you have to start to figure it out.”

It takes 6 years to figure out that we are being snookered? Me thinks sufficiently talented people do not go into government service.

Secular Shia Lebanese immigrant academic Fouad Ajami, former unofficial adviser to George H. W. Bush, writes disapprovingly of the Obama Administration's plans to bail on Iraq while fighting the supposed good war in Afghanistan.

The new cause shall be a return to the struggle for Afghanistan. This is the liberal narrative: the bad, unilateral "war of choice" in Iraq, the good, multilateral "war of necessity" in Afghanistan. The doves on Iraq can thus be hawks on the Afghan-Pakistan frontier. The strategic gurus who preached that Iraq is a hopeless, artificial state put together by Gertrude Bell and Winston Churchill and T.E. Lawrence can try for victory and nation building in the unforgiving tribal lands of Afghanistan and Pakistan. If there is an artificial state in our world of nations, Afghanistan must be its closest approximation. If there is a false national boundary -- mocked by ethnicity and historical allegiance -- it is the Durand Line, drawn up by British power in the 1890s, between Afghanistan and Pakistan, through the lands of the Pashtuns. Afghanistan could yet thwart President Bush's successors, frustrate them in the way Iraq frustrated him.

Iraq still is an artificial state with the Kurds already ruling their area with de facto independence. Will the Arabs be able to entice or force them to stay in Iraq? Or will they reach some sort of agreement where the Kurds pretend to stay in Iraq while continuing to govern their area without Iraqi Arab involvement?

Ajami is right that Afghanistan has an even larger dose of tribalism than Iraq. Compare Afghanistan's fertility rate of 6.58 with Iraq's fertility rate of 3.9. The assorted Afghani tribal groups can afford to lose a lot of their young males at war. Plus, they do not have to listen to pacifist women since men dominate.

Note that Ajami doesn't call for splitting up Afghanistan. Would it make sense to shift the Pashtun part of Afghanistan into Pakistan? Or pull the Pashtun parts of Pakistan and Afghanistan together into a 3rd new nation? My guess is that the Pakistani central government would not take kindly to giving territory. But at the same time the Pakistanis might not want more Pashtuns added to the balance of Pakistani politics either.

By one measure the US in Afghanistan is more like the US in Vietnam than the US in Iraq. Pakistan serves as a sanctuary for Taliban fighters to a much greater extent than any neighbor of Iraqi provided sanctuary for militias in Iraq. The war in Vietnam had many differences as well. But achieving a state in Afghanistan that can be labeled "victory" seems hard to me.

I question the intellectual capacity of either of America's two political parties to think rationally about the Middle East. I wish we could wash our hands of it because I do not expect US policy in the region to be anything approaching wise.

What fraction of the US troops withdrawn from Iraq will get shifted to Afghanistan? Will Obama limit the scale of US involvement in Afghanistan in order to free up more money for domestic welfare programs?

Does ignoring the financial crisis make it less severe? In other words, is there any economic benefit from the censorship?

MOSCOW (Reuters) - When a Russian sociologist wrote a newspaper column last month suggesting the global financial crisis could cause social unrest, the state media watchdog advised the paper not to spread extremist sentiments.

"This is censorship," said Yevgeny Gontmakher, the author of the column and the head of the Academy of Science's Social Policy Center. "The situation in the country is changing; you can no longer utter the word 'crisis'."

The control exercised by the authoritarian press-controlling regime in Russia would have been more justifiable if the Russians had managed to clamp down on the excesses of their own boom. They could have kept more money abroad to limit the size of the boom and make more money available after the popping of the bubble. Also, they could have shifted the ruble's value downward to boost the development of a manufacturing economy in spite of the oil boom. But they didn't. Not so impressive.

Police in European Union member Latvia jailed an academic for two days for saying in an online debate people should not trust the banks, and launched a case against a singer who made similar comments at a concert.

The European Union has a long way to go before it has press freedoms as strong as in America.

Reminds me of descriptions of penny stock brokerage firms selling misrepresented stocks in boiler room atmosphere. But this was a huge FDIC-insured bank.

On another occasion, Ms. Zaback asked a loan officer for verification of an applicant’s assets. The officer sent a letter from a bank showing a balance of about $150,000 in the borrower’s account, she recalled. But when Ms. Zaback called the bank to confirm, she was told the balance was only $5,000.

The loan officer yelled at her, Ms. Zaback recalled. “She said, ‘We don’t call the bank to verify.’ ” Ms. Zaback said she told Mr. Parsons that she no longer wanted to work with that loan officer, but he replied: “Too bad.”

Shortly thereafter, Mr. Parsons disappeared from the office. Ms. Zaback later learned of his arrest for burglary and drug possession.

The sheer workload at WaMu ensured that loan reviews were limited. Ms. Zaback’s office had 108 people, and several hundred new files a day. She was required to process at least 10 files daily.

“I’d typically spend a maximum of 35 minutes per file,” she said. “It was just disheartening. Just spit it out and get it done. That’s what they wanted us to do. Garbage in, and garbage out.”

Massive numbers of taxpayer-insured dollars got shoveled out the door. Many of the loans were packaged up and sold off. Washington Mutual just didn't package up enough of them to avoid holding the bag when the music stopped.

As housing prices went above the levels that buyers could afford WaMu responded by lowering standards and selling mortgages that the buyers wouldn't be able to afford once they reset.

WaMu’s boiler room culture flourished in Southern California, where housing prices rose so rapidly during the bubble that creative financing was needed to attract buyers.

To that end, WaMu embraced so-called option ARMs, adjustable rate mortgages that enticed borrowers with a selection of low initial rates and allowed them to decide how much to pay each month. But people who opted for minimum payments were underpaying the interest due and adding to their principal, eventually causing loan payments to balloon.

Customers were often left with the impression that low payments would continue long term, according to former WaMu sales agents.

For WaMu, variable-rate loans — option ARMs, in particular — were especially attractive because they carried higher fees than other loans, and allowed WaMu to book profits on interest payments that borrowers deferred. Because WaMu was selling many of its loans to investors, it did not worry about defaults: by the time loans went bad, they were often in other hands.

WaMu’s adjustable-rate mortgages expanded from about one-fourth of new home loans in 2003 to 70 percent by 2006. In 2005 and 2006 — when WaMu pushed option ARMs most aggressively — Mr. Killinger received pay of $19 million and $24 million respectively.

The FDIC ought to sue to recover some of that executive compensation. The financial executives of America should come to know some fear.

Private sources of educational financing charge crushing high interest rates.

Natalie Hickey left her small hometown in Ohio six years ago and aimed her beat-up Dodge Intrepid for the West Coast. Four years later, she realized a long-held dream and graduated with a bachelor's degree in photography from Brooks Institute in Santa Barbara.

Higher education does not always pay off. For some the odds of pay-off are slim. I doubt that Brooks graduates get a good return on their investment.

She also picked up $140,000 in student debt, some of it at interest rates as high as 18%. Her monthly payments are roughly $1,700, more than her rent and car payment combined.

I wonder how much this contributes to the birth dearth among smarter and more educated people. Miss Hickey isn't exactly a great catch for marriage and child-rearing. A guy would have to make big money to afford to let her make babies while still servicing her school debt.

Even worse in her case an LA Times photographer tells that demand for photographers and reporters is tanking due to the internet taking ad revenue away from newspapers. The editorial staff (which I think includes all reporters and photographers) has shrunk from 1500 to 600. The Tribune company that owns the LA Times just filed for bankruptcy. So the Brooks students graduating with piles of debt are entering a buyers' market for photographers.

If you are thinking about some career before you get yourself in debt up to your neck find out what the jobs in that occupation typically pay and how hard the jobs are to get. Kids need to be told that higher education doesn't automatically pave the road to your future with gold.

Chris Ayers, an Englishman stationed in Los Angeles for the Times of London, sees many advantages to loss of top position in rankings of nations.

Do Tehranis and Muscovites blame Britain for the culture of mindless self-gratification that brought down the global economy? Of course not. They blame America -- even though Britain is arguably the more guilty party, what with its foreign-debt-to-GDP ratio standing at an unconscionable (and, really, quite embarrassing) 490%, as opposed to the United States' puritanical 89% (according to the 2007 "purchasing power parity" GDP and external debt figures supplied by the CIA World Factbook).

The fact is that when you're No. 1, you always get blamed for everything. When you're No. 3, or No. 5 -- or No. 135 -- you can put your hands in your pockets and whistle tunelessly with a "Who, me?" look on your face, and no one ever asks any questions.

Take Slovakia. Five years ago, Slovakia invaded Iraq. Admittedly, it did this with the help of a few other countries. But still, does Slovakia ever get the blame for all the trouble that has gone down over there since then?

Nope.

I think the biggest relief will come when I do not have to worry so much about a future President of the United States making global mistakes. If only George W. Bush had gotten elected in, say, 2080 he couldn't have done much internationally with his position. But no. He had to have a powerful military at his disposal.

Ayers sees a booming business for any surviving US newspapers to sell condescending tripe to American readers eager to look down on peoples more powerful than them.

The beleaguered American newspaper industry, for example, might very well be able to profit immensely by simply dispatching its most snide and ironically detached correspondents to the new capitals of world power, from which they will be able to report with maximum condescension about the hilarious earnestness of the locals.

Well, if you are into condescension the future will seem culturally more enriching. Me, I think I'll shift to reading news written by the local writers of these future centers of power.

Enforced savings by the Chinese government causes a lack of savings in the US. It also causes financial distortions that lead to bubbles.

WASHINGTON — In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.

The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.

I've been complaining about this for years. Can the head of the US Federal Reserve get people to take this problem seriously?

Here's how it works: Americans buy something from Chinese exporters. The exporters get dollars and are required by the Chinese government to deposit them in a Chinese bank at a fixed exchange rate. Then the Chinese bank (which is really part of the Chinese government) takes those dollars and buys US Treasury bonds. One effect of doing this is to keep the US dollar strong against the Chinese currency. This cuts US sales to China by making US goods more expensive in China while simultaneously making Chinese goods cheaper in the US.

How does this cause a financial bubble in the US? Easy enough. The Fed sees that US companies aren't generating enough economic activity in the US (what with lots of factories shifted over to China and engineering as well). It expands the money supply to try to generate more economic activity here. Normally an over-expansionary money supply should cause inflation in the US. But the Chinese are keeping goods prices low with cheap imports.

The Chinese purchases of US Treasuries inject money into the US financial system and lower interest rates while also making imported goods cheap at the same time. Since consumer goods inflation is prevented by the cheap Chinese goods the monetary expansion causes inflation in the prices of real estate and financial assets instead. The inflation has to pop up somewhere.

The lower interest rates cause potential investments to look more attractive than a non-distorted money supply would cause them to look. The result was an excessive investment in the financial industry and in real estate. This caused excessive spending in industries that supply construction materials and in luxury goods as well. Eventually the bubble burst. We all see the results.

Other factors contributed to the real estate binge. Foolish deregulation of government-insured banks and really dumb policies aimed at boosting home ownership of non-Asian minorities (NAMs) both played roles in causing the unfolding financial disaster. But this one big monetary distortion caused by mostly East Asian countries played an important role in creating the mess we are in.

Mortgage rates are about 2% higher in areas with expensive housing.

The average 30-year fixed jumbo loan rate was 7.32 percent on Dec. 22, compared with 5.38 percent for a conforming loan, according to BanxQuote of White Plains, New York.

Wide Spread

The difference between the two averaged 2.13 percentage points in December, 10 times the spread from 2000 to 2006 and above last month’s 1.95 percentage points that was the highest on record. If current rates reflected the historical difference of 0.2 percentage points, jumbo borrowers with an $800,000 mortgage would save $913 a month.

This provides a measure of how much Freddie Mac and Fannie Mae lower the cost of mortgages. Freddie and Fannie will only buy mortgages worth $417,000 or less (actually, there are exceptions that range as high as $729,750 depending on local housing costs). That higher cost for mortgages on more expensive houses is causing them to fall more in price than houses that qualify for cheaper mortgages. Note, however, that the more expensive market of California saw much more housing price inflation than most of the US. So these housing price declines are bringing houses down to a less distorted level.

The elite expert response continues to be that we should reflate the housing bubble.

“The real elephant in the room is falling house prices,” Glenn Hubbard, former chairman of the Council of Economic Advisers under President George W. Bush who is now dean of the Columbia University Graduate Business School, said in an interview Dec. 22. “We can fix this by lowering mortgage interest rates.”

Any dumb idea worth doing once is worth doing twice? Why is that? Let me bore you with repetition: The housing price-to-rent ratio and price-to-income ratio have to return to historical trends.

Some people took exception to a recent post about how alt-A and option ARM mortgages will be the next financial disaster. The argument in the comments of that post is that interest rates are so low that resetting of interest rates won't make the monthly payments higher but rather lower. But a lot of option ARM mortgage holders were not even paying enough per month to cover interest in the first place.

Known as an option ARM — and named “Pick-A-Pay” by World Savings — it is now seen by an array of housing analysts and regulators as the Typhoid Mary of the mortgage industry.

Pick-A-Pay allowed homeowners to make monthly mortgage payments that were so small they did not cover their interest charges. That meant the total principal owed would actually grow over time, not shrink as is normally the case.

Now held by an estimated two million homeowners, the option adjustable rate mortgage will be at the forefront of a further wave of homeowner distress that could greatly delay or even derail an economic recovery, mortgage industry analysts say.

Option ARM is yet another financial weapon of mass destruction.

“This product is the most destructive financial weapon ever deployed against the American middle class,” said William J. Purdy III, a housing lawyer in California who is representing elderly World Savings customers struggling to repay their loans. “People who have this loan are now trapped, and they can’t get another loan.”

People become less willing to make their suddenly higher payments as the price of their house drops and they find themselves financially under water - owing more than their house is worth. In some cases they never would have been able to make the higher monthly payments once the mortgage readjusted to cover interest costs. Some were probably counting on flipping and moving on to another home at that point. But in the game of housing musical chairs when the game stops it is those who are sitting in chairs who lose. These mortgage holders and their banks and the American taxpayers all became losers.

Once upon a time in a distant era regulators didn't think federally insured financial institutions should offer such risky loans.

When Reagan era deregulation arrived, the Sandlers and two other competitors were able to market option ARMs for the first time in 1981. Before that, lawmakers balked at the loan because of its potential peril to borrowers.

World Savings initially attracted borrowers whose incomes fluctuated, like professionals with big year-end bonuses. In the recent housing boom, when World Savings started calling the loan Pick-A-Pay, they began marketing it to a much broader audience, including people with financial troubles, like deeply indebted blue-collar workers.

The risky loans didn't just pull in people who had no business buying houses. These loans so boosted demand for housing that they had the macroeconomic effect of driving up the prices of houses. The rising prices pulled in more fools and so when the bubble inevitably popped it caused the deep long recession and big costs for the net taxpayers.