Are the low US home mortgage rates for real?

Oct 11, 2011 17:33 UTC

We hear on almost a weekly basis that mortgage interest rates in the US are at all-time lows. The annual percentage rates in mortgage advertisements seem near an historic nadir. The Fed has even begun to purchase long-dated mortgage backed securities (MBS) in an effort to push rates even lower and, hopefully, spur more refinancing activity.

But are these rates real? Are all American consumers, especially low-income borrowers, able to borrow at those low teaser rates? The answer in both cases is no. This is a crucial question, as we have discussed on this blog before. Home mortgage refinancing is the primary conduit for the Fed to provide liquidity to the US economy. In August of last year, I noted:

‘In every Fed easing event during my career in finance (1986, 1992, 1998, 2002), it was the wave of refinancing of debt after the Fed eased interest rates that put permanent disposable income into the hands of households,’ notes a former Fed official who worked in the banking industry for decades. ‘In this last easing, however, FNM, FRE and the TBTF banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.’

Since last year, little has changed. On Friday, Housing Wire reported that “Prepayments, mostly through refinancing, on mortgages backing Fannie Mae and Freddie Mac securities increased substantially in September, higher than what some analysts expected.” In fact, prepayment on FNM 4s surged over 100%, but the real story was the fact that prepayments on higher coupon FNM paper actually fell as shown in the table below.

Fannie Mae 30-Year Prepayments (September):

Coupon (vintage) Change in prepayment rate (%) Amount outstanding (B$)
4s (2009) + 130 102
4s (2010) +157 112
4.5 (2009) + 80 227
4.5 (2010) + 100 124
5 (2009) + 29 69
5 (2005) + 5 51
5.5 (2008) - 8 65
5.5 (2005) 0 45
6 (2007) - 4 62
6 (2006) - 8 43
6.5 (2007) - 13 16
6.5 (2006) - 9 17

Source: Fannie Mae/Absalon

While most of the business currently being written by banks and the GSEs is related to refinancing, the vast bulk of the loans are being written against relatively low coupon loans. Home owners with older, high coupon loans are largely excluded from the refinancing activity.

More, two of every three mortgage refinancings done by banks and guaranteed by the GSEs since 2008 have gone to higher income households. Low income families who need the benefit of lower rates are mostly locked out. One key telltale in the Fannie data about the discrimination against low income borrowers: The average loan size of the older, high-coupon loans is almost half that of new loans.

Notice that virtually all of the increases in prepayments were recorded in FNM 4s and 5s, while prepayment speeds actually fell for the older, higher coupon loans. The higher income households who held high coupon loans from the 2008 and earlier time frames have largely refinanced, leaving only the low income borrowers trapped by the GSEs and investors in MBS who do not want these needy American families to refinance.

Remember that the Fed is already diverting more than half a trillion dollars a year from savers to the banks through low interest rates. The behavior of the GSEs and the top four banks – JP Morgan, Bank of America, Citigroup and Wells Fargo – which prevent lower income Americans with performing loans to exercise their contractual right to refinance borders on the criminal. But in terms of public policy, the blockade by the GSEs and the zombie banks is blocking the Fed’s efforts to reflate the consumer sector and help the US economy.

Treasury Secretary Tim Geithner has stated that the Obama administration is moving forward with plans to help more homeowners refinance out of higher rates. But Congress and members of the media should ask Secretary Geithner why he has been dragging his feet with respect to forcing the GSEs to refinance all of these older, high coupon loans to help the most needy Americans. The fact that Geithner and Federal Housing Finance Administration chief Ed Demarco are responsible for blocking more than 30 million American families from refinancing their mortgages is an outrage.

What should be done? In a presentation to the Mortgage Bankers Association in Chicago the other day, Alan Boyce of the Absalon Project listed a number of steps that Geithner and the White House need to embrace. Obama should require FHFA to direct GSEs to use all tools available to stimulate more home refinancings. Specifically:

•Eliminate loan level pricing adjustments for the refinancing of ALL loans currently guaranteed by the GSEs

•Eliminate the 25bp “Adverse Market Fee” imposed after the government takeover of Fannie and Freddie.

•Eliminate appraisals and paperwork as part of a new “Super-Streamlined” refinance program

The key requirement is that the borrower be current on the existing mortgage that is guaranteed by the taxpayers. Boyce believes that following this approach will have big benefits. Some 25 million new refinancings from 32 million tax payer backed loans will reduce mortgage payments of about $51 billion. Lower income borrowers will get over half of these savings.

And there are big benefits for the banks. Underwater borrowers at greatest risk of default will get some financial breathing room. Improved labor mobility provided by refinancing will reduce unemployment and also help to lessen the chance of a second wave of loan defaults. And, most importantly, the single biggest obstacle to the Fed’s efforts to add liquidity to the consumer sector will be removed. The hour is late, but prompt action now can make a big difference to the economy in 2012 and beyond. Does President Obama have the courage to act?


Please remember that an unknown percentage of the high coupon loans have seconds which will need to be resubordinated. What do your numbers look like when you screen out the loans with seconds (and thirds)?

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Geithner and the delicacy of Euro-Dollar diplomacy

Sep 16, 2011 15:57 UTC

The departure of US Treasury Secretary Timothy Geithner to Europe to rescue our allies from themselves marks a change in the economic relations among the NATO countries that bears scrutiny. In the past, the loosely-connected federation we call the European Union has managed to muddle along. But now we see overt funding subsidies for the EU via the Fed and the active involvement of Geithner in what ought to be a purely domestic fiscal discussion.

I suppose that kudos are in order for Geithner and Fed Chairman Ben Bernanke for finally responding to the EU funding crisis. Bernanke has been sound asleep at the liquidity nipple, not realizing it seems that the Fed supervisory personnel were instructing US institutions to sever credit lines with their EU counterparts. Since most of these banks are now effectively nationalized, the behavior of US regulators in New York seems especially self-injurious. Now we have replaced private funding for EU banks with central bank swap lines. Hoo-rah. This is not so much a rescue as it is a temporary subsidy.

Geithner has his work cut out for him. Having worked in the Federal Reserve Bank of New York in the currency area during the Plaza Accord, this author has some ideas on the financial and psychological efficacy of central bank intervention. The key thing for any central bank trading desk is not to pretend that you are the market, but instead to support market activity and to slowly help restore the flow of private credit in the markets. Unfortunately this lesson still seems lost on central bankers on both sides of the Atlantic.

My friend Achim Dübel of Finpolconsult in Berlin, is critical of the handling of the intervention by the European Central Bank. Referring to a recent research note by Goldman Sachs on the outlook for the EU, he asks:

Does GS have on its radar how distortive and damaging are the ECB interventions into periphery debt at 80 or 90 cents? The ECB bought Greek debt at those levels a year ago – average portfolio cost is estimated at 70-80 cents, where market prices are now 30 cents. Why are market prices now at 30 cents? Because the ECB had to stop buying. After looking into the abyss of Greek default, the ECB simply ran away.

In the case of Greece and now Italy, Dübel notes very aptly, the ECB has been buying bonds well above the true market. “Now they are doing the same with Italian debt as they did with Greece, and of course the ECB will run away again,” Dübel adds. “With the banks the intervention levels were far too high (haircuts too low), with the worst example of all being Ireland. In all these cases, ECB became an obstructionist force against restructuring, i.e. solving the problem.”

Now, it seems, we know why Axel Weber, the ECB’s German board member, resigned from the board in protest last year. Geithner needs to quickly figure out whether the core EU nations can begin to act in a more rational and purposeful way when attacking issues of solvency, both of banks and nations.

Lagarde recently warned that the egos of world leaders are putting the global economy at risk. This is a nice way of saying that none of the leaders of the G-20, elected or not, are in the mood to take the risk themselves of publicly confessing to the true scale of the problem of excess debt and shrinking demand facing each nation. But as Geithner goes to the EU to preach tough love to his European counterparts, he leaves a lot of unfinished business at home.

Geithner ignored President Barack Obama’s order to consider dissolving Citigroup, a new book by Pulitzer Prize-winning author Ron Suskind claims. The top four banks in the US remain on the critical list, even with bulging deposits and capital levels. So when Geithner lectures his EU peers on the need for prompt and purposeful action, he will need to season his advice with humility and an appreciation that the war against global deflation is far from won.


Astuga, I beg to differ. The way the EU has behaved over the last 2 years as each crisis comes and goes shows that member states are a very loose federation indeed. Given that they cannot agree amongst themselves or with the ECB or with Geithner shows that too.

Given the lack of any suitable solution on the table at the EU ministers meeting last week, Geithner merely put forward an idea that might cover middle ground. It seems that Geithner realises the gravity of the situation unlike our fellow Europeans. It does look like the EU is not going to listen to the markets (quote from Manual Barroso) until it is too late.

Merkel and Sarkozy pushed Europe into the Euro and now they have it they do not know what to do. They are responsible for 500m people in Europe and they all deserve better leadership than all of the EU bureaucrats have shown so far. Whilst the US has trouble too, at least they have a plan which is one thing that we sadly do not have.

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Can Barack Obama channel Teddy Roosevelt?

Sep 9, 2011 14:50 UTC

My copy of the new book “Feynman”, written by Jim Ottaviani and illustrated by Leland Myrick, arrived last week and does not disappoint. I discussed it earlier on, “Steady state or dream state?” On the second page of this comic narrative led by one of the most remarkable personalities of the 20th century, Feynman asks:

Different theories of physics are very similar. Maybe that’s just because of our limited imagination … We try fitting every new phenomenon in the framework we already have! … Maybe it’s because we physicists have only been able to think of the same damn thing over and over again. Of course another possibility is that it is the same damn thing over and over again.

I read the words of the great American physicist last night as President Barack Obama was proposing yet another fiscal stimulus plan to a joint session of Congress. Basically Obama gave the same speech as last time and, again, largely avoided discussion of housing or banks. Indeed, the Obama Administration has been fighting against change since the President took the baton from George W. Bush. Witness Dodd-Frank, TARP, HARP, HAMP and various other deliberately ineffective policy initiatives from Washington supposedly focused on the banking and housing sectors.

A decade after the 9/11 attacks and the subsequent boom and bust in the housing sector, Americans remain unwilling and unable to embrace economic change – or to respond affirmatively to this change. Perhaps the biggest change facing us is the ongoing deflation of the bubble economy, which is manifested in stark terms by the reduction in both demand for and the supply of credit. Until we break the cycle of deflation, employment and economic activity will not rebound.

Both Washington and Wall Street remain defiant in their refusal to accept that there are probably still as many losses to be taken on housing and related securities as have already been recognized to date. And there is no concession among America’s political oligarchy that existing banks must be restructured in order to fix housing, restart credit creation and avoid economic catastrophe.

Pollock’s first law, named after American Enterprise Institute resident scholar Alex Pollock, states that debts which cannot be paid must default. In an upcoming article in Mortgage Banking Magazine, he notes that the political class resists real change in existing structures and debt:

Because this iron law and its implications are highly unpleasant, financial actors and politicians strive mightily to escape them, in spite of the fact that they cannot, with scheme after scheme. All to no avail, of course. The massive losses must ultimately be taken. So the questions are not: Will the loans default? They will. Or: Will the losses be huge? They will be. The only real questions are: What form will the defaults take? Who will take the losses? And when will the losses be recognized by those who are going to take them?

Notice that there was barely any mention of broad mortgage refinancing in President Obama’s speech last night, merely a comment about more emphasis on helping profoundly under-water borrowers via the HARP program. But without relief for the millions of home owners that cannot refinance their homes, the economy will not recover and many of these borrowers are likely to turn into future defaults. More defaults mean more deflation, fewer jobs and social instability.

The real world impact of the studied inaction by President Obama can be seen in the increasingly desperate situation at Bank of America. The bank has been selling assets willy-nilly and now has threatened to start closing branches and laying off 42,000 people, Reuters reports. Yet as I discussed in a previous post on, “Housing, debt ceilings & zombie banks,” Bank of America’s parent company needs to be restructured. See my discussion with Aaron Task and Henry Blodget on The Daily Ticker about how a BAC restructuring ought to proceed.

If President Obama was really concerned about jobs, he would pick up the phone and order Treasury Secretary Tim Geithner to start discussions with BAC about a voluntary restructuring with government and industry support. With Geithner, Fed Chairman Ben Bernanke and FDIC Chairman Martin Gruenberg standing around, the President would tell the American people that the bank subsidiaries of BAC are sound, that there will be no layoffs, and that the White House and Congress are directing Fannie Mae and Freddie Mac to move aggressively to refinance every performing American borrower who wishes to do so.

But of course this would require Barack Obama to get some new advisers, grow a set of cojones and start channeling President Teddy Roosevelt — and that is probably not going to happen. Just remember, Mr. President, that inaction does have a cost.






I just read an article about Obama channeling Franklin Delano Roosevelt. If I am not mistaken, and I am only going by the information provided to me in school, both Franklin Roosevelt and Teddy Roosevelt are dead and channeling is described as : the practice of professedly entering a meditative or trancelike state in order to convey messages from a spiritual guide. This article confuses me more than enlightens me.

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Barack Obama and the cost of doing nothing

Aug 23, 2011 21:31 UTC

The German philosopher and political theorist Georg Wilhelm Friedrich Hegel (1770-1831) said that “All that is real is reasonable, and all that is reasonable is real.” Frederick Engels, the collaborator and supporter of Karl Marx, took this to imply that “the value of a social or political phenomenon is its transitoriness,” as Austin Lewis wrote in the introduction to “Feuerbach: the Roots of Socialist Philosophy” (1919) by Engels.

Wind the clock forward a century, closer to the early days of the Obama Administration — days of financial crisis and fear when Wall Street was “melting, melting” a la the wicked witch in the Wizard of Oz. Economist Larry Summers reportedly advised President Obama that time will heal the wounds of the financial markets and that no further action to restructure the big banks or the housing market is needed. The view of leaving the big banks alone is consistent with the line taken by Summers’ political sponsor, former Citigroup Chairman and Treasury Secretary Robert Rubin, who has served as the political protector of Wall Street in Washington for a quarter century.

Writing in The International Economy, “Angela’s Amateur Hour,” Klaus Engelen notes that Summers has criticized German chancellor Angela Merkel’s actions in the euro crisis by supporting the central bankers in Frankfurt, an explicit censure of the EU debate over whether to impose losses on bond holders of insolvent EU banks.

Said Summers: “The European Central Bank is right in its concern that punishing creditors for the sake of teaching lessons or building political support is reckless in a system that depends on confidence.” But can we build or maintain public confidence in markets or governments upon castles made of sand?

Both Marx and  Engels, as well as free market theorists, suggest that all things in politics and life change. The US economy in the post WWII period is certainly an example of this, with the demographic bulge we call the Baby Boom acting as a deterministic wave in terms of economic policy and financial market performance.

Yet somehow both Rubin, Summers and their minions, such as Treasury Secretary Timothy Geithner, seem to think that we can ignore these changes and simply continue along without making any fundamental fiscal and financial decisions — especially changes that will inconvenience them or their associates and clients on Wall Street.

But confidence based on mere rhetoric is an illusion. Confidence in the financial markets starts and ends with getting paid, with the ability of counterparties to perform on their obligations, of investors to value financial assets and consumers to purchase or sell homes. So while the arguments of Summers and others — that we should not reduce debt and compel the bond holders of the largest US banks to contribute to solving the problems in the banking and housing sectors may seem attractive today — they ultimately lead us down the road to long-term economic malaise and political instability.

The reason that Chancellor Merkel and her counterparts in the other EU nations have argued for requiring pain from at least some of the holders of bank debt is that there is no longer any choice. Most of the large banks in the EU are book insolvent as we define it in the US. With the ECB already purchasing the debt of member states in the open market and the EU’s ability to fund these operations limited to the printing press, Western European states are confronted with the grim task of restoring solvency to their banks and nation states by reducing debt.

“There isn’t any bailout big enough to rescue the third largest economy in the eurozone the way there was with Greece, Ireland, and Portugal,” notes Engelen with respect to the prospect of an Italian default. “Italy can only rescue itself.” Thus, with the endgame for Greece seemingly at hand, the next countries in question are Italy and Spain.

Both in the US and in the EU, politicians such as Barack Obama and Angela Merkel have been struggling to manage an economic problem that is problematic in political terms. The path of least resistance politically has been to temporize and talk. But by following the advice of Rubin and Summers, and avoiding tough decisions about banks and solvency, President Obama has only made the crisis more serious and steadily eroded public confidence. In political terms, Obama is morphing into Herbert Hoover, as I wrote in one of my first posts for, “In a new period of instability, Obama becomes Hoover.”

Whereas two or three years ago, a public-private approach to restructuring insolvent banks could have turned around the economic picture in relatively short order, today the cost to clean up the mess facing Merkel, Obama and other leaders of western European nations is far higher and the degree of unease among the public is growing. You may thank Larry Summers, Robert Rubin and the other members of the “do nothing” chorus around President Obama for this unfortunate outcome.

It is still not too late for our leaders to get ahead of the accumulating fear that eats away daily at public confidence in currencies and markets from Los Angeles to Berlin. But the first step to turning things around is to understand that doing nothing, as has been the strategy in both the US and EU since 2008, is no longer a viable strategy. When the public sees government and private institutions acting with purpose to address the core issue of solvency, then confidence will start to recover.


Warren Buffett is a parasite for this reason – he has based his being on his insurance business. His insurance business is secondary and parasitic. His main source of income is sucking the life out of people who make money. If he tells you any different he is lying to you.

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Housing, debt ceilings & zombie banks

Aug 17, 2011 15:08 UTC

In a Washington Post report this week, the Obama Administration was said to have decided to adopt a proposal to continue a major government presence in financing mortgages.  The Treasury subsequently denied this report in a statement posted by Deputy Secretary Neal S. Wolin:

“The Obama Administration believes that the private sector – subject to strong oversight and consumer protection – should be the dominant provider of mortgage credit.  That’s why, in each of the three options we outlined in our report to Congress, the government’s footprint in the housing finance market will shrink substantially.  That’s why, in each of the options, any government support for housing finance will be targeted and limited. This will help ensure that taxpayers are protected and the private sector bears the burden for losses.”

Would that any of this were really true.  Let’s go through this statement and pick out some of the more notable canards and omissions of fact.  First and foremost is the idea that the private sector is willing to take a leading role in housing finance in the U.S.

Since the 1930s, the U.S. has used a full-faith-and-credit guarantee for housing finance to turn disparate home mortgage notes into commodities attractive to investors.  The private mortgage market prior to the Great Depression and the New Deal is not comparable to the government-sponsored market for agency securities today, investment paper that is a close surrogate for Treasury debt itself.

The largest portion of the market for residential mortgage backed securities or RMBS has been government sponsored for 80 years.  By extending guarantees to private mortgage paper, banks were able to package the notes from each home mortgage and sell securities to investors backed by these notes.  This virtuous cycle provided liquidity for the banks, which recovered their principal and then were able to make additional home loans.  That cycle is now broken.

The role of the private sector in the RMBS market has been limited at best with private investors buying significant quantities of non-guaranteed paper only during times of market exuberance in the past decade.  Today banks are avoiding “first loss” risk on U.S. real estate and instead write almost all of their loan production to be guaranteed by one of the three housing agencies — the FHA, Fannie Mae or Freddie Mac.  Almost all of this flow of “new” loan business is refinancing for better borrowers.

This brings us to the second fallacy in the debate over the future of the government role in housing, namely that the current policy is meant to protect the taxpayer and the public generally.  You may have noticed that the Obama Administration has started to talk about creating opportunities to turn foreclosed properties into rental housing, a common-sense initiative that is born of necessity.  Hold that thought.

Empty homes represent tens of billions in future losses to the Treasury.  When the house is sold, the government takes the loss.  Thus the last thing either the Treasury or the White House wants to see is any effort to move the restructuring of the housing sector or the largest banks before the 2012 election.  Delay means higher cost to the taxpayer.

We talked about the need to restructure Bank of America as a precursor to clearing the U.S. housing market in an earlier post on, “Uncertainty and indecision threaten Bank America and global markets.” But given the recent debate over the debt ceiling, President Obama does not want to tell Congress that he needs at least a $1 trillion in borrowing authority to fix the GSEs and the largest banks.  Politics is the chief obstacle to fixing the housing mess.

Attorney Fred Feldkamp reminds us that “we knew virtually all the Texas S&Ls and banks were broke by 1984, but we could not get Congress to permit enough coverage in the federal debt limits and restructuring costs to close the vast bulk of them until FIRREA was passed in August of 1989,” he recalls.  “Even then, Congress tried to renege on the 1988 deals that kept the S&L problem from becoming twice as large.  It wasn’t until 1996-2004 that the people who were promised the 1988 deals received what they bargained for.”

One of the reasons that I have pushed for an FDIC resolution of some of the huge housing exposures facing the largest banks is that the cost can be kept off the federal budget.  FDIC is an industry funded mutual insurance scheme with powerful receivership and debt issuing authority, especially with the Dodd-Frank legislation.  The U.S. banking industry, not the taxpayer, has always paid to clean up the mess in previous crises via the FDIC.  The present housing crisis demands a similar response.

If the banking industry were to use the FDIC to restructure BAC and other large lenders, then immediately spin the smaller, better capitalized banks back into private hands, this would not only help Washington to focus scarce public resources on the losses inside the major housing agencies but would also greatly rehabilitate the industry’s public image.

Americans need to see some good examples of civic action, instances of private people and companies moving with purpose to solve our national problems.  A private sector approach to the housing problem, using the industry funded vehicle at the FDIC to restructure some of the largest banks and breath life into moribund housing assets, could be a powerful tool to that end.  But do we have the courage and the vision to make it happen?


For the record, I’m with Lambertstrether, too. I’ve been advocating widespread RICO prosecutions since 2008, but that is a side issue.

Regarding Chris Whalen’s article, I would like to see some data regarding his assertion that almost all of the “new” real estate loan business is refinancing for better borrowers. I suspect that his claim is true, but are we talking about a 75/25 split or a 95/5 split?

I also agree that the FDIC should now be used to clean up this banking mess. In 2008, the magnitude of the problems would have overwhelmed the FDIC, but there should be no more harm done to taxpayers at this point.

The banking industry needs to quickly expand the size of the FDIC and be start restructuring. BAC has a huge exposure to the tottering Eurozone.

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Uncertainty and indecision threaten Bank America and global markets

Aug 9, 2011 13:41 UTC

For the past several years, my firm has been arguing that restructuring is the only way to solve the problems facing the largest US banks — the top four institutions that exercise a de facto cartel over the US housing market. After years of earning what seemed to be supra normal returns from the “gain on sale” world of US mortgage originations, the large service banks are now drowning in the same sea of risk that once made them seem so profitable.

As investors have slowly become aware of the concentration of housing risk that surrounds these large banks, they have increasingly shunned them. First with Bear Stearns, then Lehman Brothers, and then the housing GSEs Fannie Mae and Freddie Mac, markets stopped facing these names in the interbank credit markets, then accelerated into a crisis which compelled government intervention.

Now the Obama Administration faces the same threat with Bank of America (“BAC”), an institution that is one of the largest lenders and also servicer of loans in the US.  Millions of payroll deductions, property tax payments and remittances flow through BAC daily. But losses from acquisitions such as Countrywide, Merrill Lynch, as well as hundreds of other operating entities, threaten to bring the bank down. Yet herein is an opportunity for national salvation.

BAC is a too big to fail zombie created by the Obama Administration and the Fed to protect US financial markets, but is now so vast and unstable that it threatens the global economy. But more corrosive and dangerous than the torrents of red ink inside BAC is the steady erosion of public confidence. Uncertainty is the enemy now, both with respect to BAC and to its large bank peers.

The only way to end the uncertainty and also accelerate the economic recovery is to put BAC through a restructuring using the powers under the Dodd-Frank legislation. While a restructuring by the FDIC may seem to be a horrible prospect, in fact it offers the first real hope of definiteness in the housing crisis, the multi-trillion dollar millstone around our collective necks. Indeed, the BAC situation illustrates why the Founders of the US embedded bankruptcy in the Constitution, namely the need for finality.

In mechanical terms, here is how it works. Let’s start the narrative with a last, Hail Mary move by BAC CEO Brian Moynihan, who put the shell corporation that is the legal successor to the Countrywide business into bankruptcy after settlement efforts fail. This engraved message from Moynihan to BAC’s creditors, litigants and even Treasury Secretary Timothy Geithner — “foxtrot oscar” — begins the real endgame.

Hopefully Secretary Geithner will know about the BAC filing before it occurs and will have begun the process under Dodd-Frank to give regulators and especially the FDIC the power to move immediately to protect BAC and its subsidiary banks. In our narrative, FDIC enters the bankruptcy litigation for Countrywide and asserts control of the entire BAC group. BAC becomes effectively a subsidiary of the FDIC, with the full capital and assets of the entire industry behind it.

Once the FDIC is in control of BAC, the process will then proceed like a typical bankruptcy, with the operating units continuing to do business in the normal course. For consumers and business customers, the situation at BAC will be mostly the same. But for investors and especially creditors, the situation will be far from normal.

In a Dodd-Frank resolution, the creditors of BAC will have an opportunity to file claims, much as with any failed bank. Unlike a bankruptcy, however, the FDIC will make all depositors of the subsidiary banks whole before considering claims of creditors of the parent, a significant difference investors ought to consider. Most important, however, will be the process of converting debt to equity in the restructured BAC, providing the resources to absorb losses, fund continuing operations and restructure.

The beauty of a restructuring is that it forces all parties with a claim on the failed company to speak now or forever hold their peace. It also requires the conversion of debt to equity, which increases capital dramatically and also lowers the operating expenses of the enterprise. A super-capitalized BAC with 2-3% asset returns, 30% tangible equity and gobs of cash flow will then be ready to sell assets, modify mortgages and do whatever it takes to restore the ability of the bank to support new leverage. That is why restructuring is the key to US economic revival.

Economists from Irving Fisher to Henry Kaufman have noted that without credit expansion, the US economy cannot grow. In fact, credit is contracting with public confidence in America’s banks. The solution to the financial crisis affecting BAC and the US economic malaise are the same, namely an orderly, immediate public process of restructuring for the top banks and housing agencies. Think of a BAC restructuring as a working model for the rest of the US and EU to emulate.

The good news is that a growing number of observers see what needs to be done, much to the delight of this lonely herald of woe. The bad news is that the Obama White House is clueless, but such is life in a democracy. We can only hope that some of the Americans I now hear talking about the need for restructuring will speak to President Obama and Secretary Geithner sooner rather than later. And if they need help, they know where to find me.




Fabulous proposal Chris, but isn’t there an argument that the major reason why BAC is presently a too big to fail zombie is because it bought Merril Lynch in October 2008 at the behest of the Treasury and Fed? Moreover, in November 2008 when BAC discovered that ML was in far worse shape than they expected, BAC tried to back out, but was instead coaxed/coerced into staying the course by the Treasury and Fed (at the tail end of Henry Paulson’s term). Would it not be perverse if the Treasury and the Fed now turn around and restructure BAC wiping out equity holders and haircutting creditors? Could not the argument be made by many of the equity holders that they suffered this loss because of intervention of the Treasury and Fed in November 2008?

Restructuring BAC is problematic because of the Treasury and Fed actions. But instead of restructuring BAC, why not go after Citigroup? It too is a too big to fail zombie, but to the best of my knowledge, it did not receive the same commitments that BAC did in the fall of 2008.

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Paul Krugman and the neo-Keynesian myth of full employment

Jul 5, 2011 14:57 UTC

In the most recent issue of Housing Wire Magazine, economist Paul Krugman suggests more government spending as the means of dealing with the economic slump and the housing crisis.

“We will be seeing low interest rates for a very long time,” the Nobel laureate said. “The thing about housing … housing prices were stable for a long period of time, then they soared and came back down.”  So now we know that what goes up must come down.  Thank you Dr. Krugman.

Incredibly, neither Krugman nor his soul mates among the neo-Keynesian elite, a distinct group which exercises hegemony over American economic policy, seem to accept that government spending and more debt, enabled by double digit inflation, is not a solution.

“Government policies promoting consumer indebtedness with low interest rates and low down payments were partly responsible for the housing bubble,” notes Anthony Sanders of George Mason University in Housing Wire.  “It should be called the Keynesian bubble.”

Despite all of the academic fussing about the triumph of neo-liberal economic thinking in the 1980s and 1990s, the real underlying model of American political economy is entirely socialist in political terms and inflationist as to the core monetary model.  When the advocates of free market economic tenants have shown the temerity to challenge the control of the temple by the neo-Keynesian Sanhedrin, the result has been more government and ever mounting piles of public debt.

The roots of neo-Keynesian socialism of the Krugman variety go back to before WWI, to the creation of the Federal Reserve System in 1913.  I spent a good bit of time talking about the statist and ultimately socialist roots of the Fed in my book Inflated: How Money and Debt Built the American Dream, including a number of sources that deserve more attention. One of these is “The Role of Keynesians in Wartime Policy and Postwar Planning,” by Byrd L. Jones of the University of Massachusetts, who described how Harry Hopkins and the socialist brain trust around FDR plotted a course to “full employment” using deficit spending funded with debt.  Historians of this era lionize these socialists for “saving what even conservatives call capitalism,” to quote James Galbraith on Alvin Hansen, another of the authors of the Keynesian illusion of pretend economic growth via deficits and debt.

Hansen was one of the key architects of the idea of “full employment,” a concept he developed during a series of lectures at Harvard University, one of the great birthing grounds of American socialism.  James Tobin wrote of Hansen in 1976 that as the principal intellectual leader of the Keynesian conquest, Hansen deserves major credit for the “fiscal revolution in America.”

That revolution, sadly, put the US on the road to fiscal recklessness and a steady rate of debt accumulation and inflation that has robbed Americans of most of the value of a dollar of a century ago. FDR operatives such as Leon Henderson, Richard Gilbert and Lauchlin Currie based the recovery of the US economy in the 1930s on defense spending, arms exports and domestic subsidies — a tendency for an expanded government learned in WWI, expanded in WWII and continued happily ever since.

Currie, a Canadian socialist who like Hansen worked at the Fed and later at the White House for FDR, also focused on war as a means of economic stimulus — a policy still followed under President Barrack Obama.  Jones writes that in Currie’s analysis, defense spending and arms exports were means to be “temporary” aids to the economy, but that a long run solution not dependent upon “chronic fiscal deficits” required “a liberal program of progressive taxes, increases in social security benefits, more public works projects and encouragement of investment (especially in home building).”

If you think that the last sentence sounds an awful lot like what we hear coming from the mouth of Paul Krugman and other advocates of more public spending today, then you’re correct.  The basic program of the neo-Keynesian socialists has not changed in decades, namely to expand the role of the state in the US economy and use inflation to create the illusion of economic prosperity — what liberals call “full employment.”

During the years following WWII, America donned the clothing of free market capitalism, at least in a rhetorical sense, but the underlying model of political economy has remained true to the socialist roots of FDR.  Conservatives from Hayek and Henry Hazlitt on forward have warned that the end result of the neo-Keynesian path is an authoritarian state and we have one today.

Yet even with a government monopoly on the housing sector, professor Krugman still wants to spend and borrow more.  In a post on Zero Hedge yesterday, “Counter-Cyclical Follies,” my friend Dick Alford argues that economists are finally realizing that “counter-cyclical fiscal and monetary policies do not address the cause of the under-performance of the US economy and hence are not solutions.”

Maybe.  But it has taken educationally deprived Americans a century to figure out this key economic insight.  So long as people take their policy guidance from committed neo-Keynesian advocates like Paul Krugman, who continue to follow the same socialist line set down a century ago by the likes of Hansen and Currie, we shall make no progress on truly fixing the US economy.


This article makes grandiose use of creative labels but avoids some critical facts:

A third of the stimulus was comprised of tax cuts. Another third went to shore up state budgets which were being slashed and so did not add new spending to the economy. The actual amount of stimulus was just over 300 billion, spread out over two years. Krugman estimated that for the stimulus to reverse the effects of the recession, it would need to be 2 trillion. So there really was no stimulus.

Krugman, and Keynes, never advocated stimulus in good times. It is a tool to be used sparingly and wisely only when capital and labor are idle because of a vicious cycle. Once the markets recover and growth resumes, both economists say that stimulus spending should not be used. Whalen conflates the pre-recession government support of the housing market with “neo-Keynesian” (an absurd attempt at slur) stimulus, which it is not. Further, the housing bubble wasn’t an American phenomenon. Investors around the globe grew the housing bubble. Is Whalen saying the US government policies buttressing Fannie and Freddie are to blame for the housing bubble in Spain, Ireland, Italy, etc.? This is a ridiculous and dishonest claim. Does Whalen know better or is he simply blinded by ideology?

The only moment in history when stimulus spending of the scale proposed by Keynes was actually deployed was during WW2. And it worked. The economy of the US was put back on track and the growth it enabled lasted decades. This fact is well understood by all who are not blinded by fear and hatred of American hegemony. The very term is a dead giveaway.

Finally, we have plentiful examples of the effects of austerity and raising interest rates on a global recession. Britain has gained nothing by cutting its public spending. Revenues are down because growth is still nonexistent. Businesses have cash but won’t invest until the economy begins to grow again. In the absence of public spending, the economy will take perhaps decades to begin growing again on its own, thus the recession deepens and lengthens.

This is all so elementary, but like most facts it stands no chance of being recognized by those who cling to their irrational belief systems.

Whalen is not credible.

Posted by BajaArizona | Report as abusive

As Obama and Congress fiddle, America liquidates housing sector

Mar 29, 2011 13:28 UTC

Republicans in the House of Representatives are busily assembling several legislative proposals to reform the housing sector and reduce government support for the secondary market in home loans used by banks to manage their liquidity.

According to Joe Engelhart at CapitalAlpha Partners: “House Republicans are considering an ambitious series of standalone legislative initiatives to reduce the role of Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) over the next five years.”

Meanwhile, President Barack Obama has started another war in the Middle East with his political soul mates in the EU.  The President has also embarked upon an ambitious schedule of foreign tourism and domestic campaign stops, but nothing of substance.

Obama is compared by some to Louis XIV XVI (and Mrs. Obama to Marie-Antoinette)  in terms of his detachment from the nation’s priorities, particularly the ongoing meltdown in the housing sector.

“Pres. Barak Hussein Obama has given new meaning to that epithet “imperial presidency,” my friend Sol Sanders opines.  “It was slung at Pres. Richard Nixon not only for his extravagant “palace guard” — some in kitschy uniforms — but his more serious unconstitutional overreach.  But if imperial in his style, Mr. Obama reigns; he does not rule.”

In many ways, the current national policy mix of more regulation, decreased government subsidies and, to add further urgency, a shrinking banking system, is the perfect storm for the housing, which is now down six months in a row.  Despite my long-held desire to see market-based reform in the US housing sector, I think all parties need to be aware of the precarious situation facing the American economy and banks as home prices collapse for lack of credit.

The slide in home prices and receding bank lending footprint is one of the reasons why at my firm we have begun to talk about putting aside structural reform of the housing sector this year and instead increasing the size of the loans guaranteed by the government, even while raising the cost of such “g fees” as they are called by housing market mavens.  Without credit, the real estate sector is left with a cash market liquidation with grave implications for financial intermediaries and investors.

We wrote this week in The Institutional Risk Analyst, “Wanted: Private Investors Seeking First Loss Exposure on RMBS, March 28, 2011,” about some of the details of the secondary mortgage market.  In simple terms, there is about $11 trillion in financing behind the real estate sector: $4.4 trillion in the portfolios of banks, $5.5 trillion in agency securitizations guaranteed by Uncle Sam, and $2 trillion or so in private label securities.

In order to believe the claims of my conservative friends about “reform” of government agencies like Fannie Mae and Freddie Mac you must believe that some of the $5.5 trillion in no-risk agency securities is going to be willing to migrate into the bucket of private label securities, where investors take actual credit risk.  It is unlikely that we are going to see any significant increase in the private market home loans unless interest rates rise significantly.

The net, net here is that the available pool of credit available for the housing sector is shrinking and thus prices must also decline to adjust for that supply of credit.  This fact of continued decline in home prices is going to have a chilling effect.

As we wrote in The IRA this week: “It is no accident that states such as Illinois, Nevada, Missouri, and Maryland are all considering legislation to ban appraisers from using involuntary foreclosure sales in home valuations. In a rational world where programs such as HAMP were really effective to restructure underwater loans and, of necessity, say 50% of all HELOCs were written down to zero, both the Too Big To Fail banks and the private mortgage insurers would be insolvent. ”

This week regulators are starting to work on the risk-retention rules of the Dodd-Frank legislation, yet another point of friction that is making it more difficult for Americans to obtain housing credit.  The political fight over what constitutes a “qualified residential mortgage,” which does not require banks to keep 5% of the risk, will only marginally effect the deflationary forces now working on the housing sector.

While the media will be fascinated by all of this insider play over the “QRM”, the real story is out in the housing market, where more than half of all home sales this year will be involuntary foreclosure liquidations.  The slow erosion of home prices is likewise eating away at the willingness of lenders to take risk in real estate, thus the 4% decline in loan balances YOY according to the FDIC.

I estimate that Fannie and Freddie alone are hiding $200 billion worth of bad loans on their books simply because there is no market for these foreclosed homes.  Ditto for the largest servicer banks such as Wells Fargo, Bank of America, JPMorgan Chase and Citigroup.  To clean up this mess with finality is going to cost $1 trillion or so in round numbers.  But nobody in Washington wants to go there.

The Obama Administration and the Congress need to put aside their respective fantasy world views and focus on the horrible economic reality ongoing in the housing and banking sectors.  It may be that the degree of self-delusion in Washington has reached the point that only another financial catastrophe can wake us from out collective distraction.  But if President Obama really believes he can win reelection with housing prices falling from now till November 2012, then perhaps those who liken him to Louis XIV XVI are right.

Editor’s Note: The piece has been updated with the correct regnal number for Louis.


The reason the housing bubble inflated is because there was a disconnect between borrowers and lenders. The disconnect was facilitated by Nationally Recognized Statistical Organizations (Fitch, Moody’s, S&P) and government guarantees and by government loan guarantees.

Twenty percent down and requiring originators to keep a large proportion of the loans they fund on their balance sheet would fix the problem. In fact it would have prevented the problem from occurring in the fist place.

Central planners always have such complicated solutions.

Posted by DiegoForever | Report as abusive