Opinion

Felix Salmon

Fannie Mae demonizes the victims of the housing bust

Felix Salmon
Jun 24, 2010 14:45 UTC

When Fannie Mae got taken over by the US government, it became even more of an instrument of state policy than it was before. Today, Fannie Mae and its state-owned brethren (foremost among them Freddie Mac and the FHA) are responsible for funding the overwhelming majority of mortgages in the US: they essentially are the housing market, for most of us. So when it comes to the problems of default and foreclosure, it’s crucial that Fannie Mae be part of the solution rather than part of the problem. Instead, it’s decided to get onto a self-defeating moralistic high horse.

The headline of Fannie’s latest press release says it all. “Fannie Mae Increases Penalties for Borrowers Who Walk Away”:

Defaulting borrowers who walk-away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure…

Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.

This is going to do significant harm, and it’s going to do no substantial good at all. Mike Konczal has an excellent response, as you’d expect: the key thing to note is that Fannie is not proposing the kind of modifications that minimize the probability of redefault — ie modifications which reduce the principal amount outstanding. By encouraging homeowners to modify their loans without reducing the amount they owe or having any chance of having any equity in their homes in the foreseeable future, Fannie is kicking the can not very far down the road, and ensuring that default and foreclosure will be a nationwide problem for years to come.

Meanwhile, when Fannie is presented with innovative ways of keeping homeowners in their homes and saving on substantial foreclosure costs at the same time, it refuses to do so. I make no apologies for the long hyperlink there — this is an important an under-reported story. Rather than do something concrete and positive-sum and helpful, Fannie Mae is happier putting out press releases which talk airily and moralistically about people who walk away from their loans without any visible attempt to define what they mean by that.

Ultimately, of course, this new policy is something of an empty threat in most situations. Is Fannie really going to spend huge amounts of time and money and effort going for deficiency judgments against borrowers who clearly are victims of the housing bust, especially when it’s certain that the money they collect will fail to cover their legal costs? I doubt it. And the refusal to issue a new mortgage to these people for seven years is something of a blessing in disguise, since substantially all of these jingle-mailers will be better off renting anyway.

In fact, it would be quite wonderful if the new Fannie Mae policy created a new class of people who thought that they needed to own their home but who, after renting for seven years, finally work out that it’s a lot less unpleasant than owning, and that maybe they should just continue to do so in perpetuity. It’s not exactly the intent of the Fannie Mae policy, but let’s hope that this misguided idea has some kind of silver lining.

COMMENT

I shake my head too. There are still people who enjoy their homes even more, knowing paying for it isn’t money with wings. (like monthly rental versus monthly payments)

I think Felix, you are feeling for those who can’t afford to make monthly payments but wish to keep their homes? Well in that case, if Fannie is not doing what they can, then you are right … they will make more problems.

But being they were referring to “Defaulting borrowers who walk-away and had the capacity to pay or did not complete a workout alternative in good faith”, dang straight there should be something done to deter walking away/being able to get future loans it will be en masse zombie land once word gets round they can “do” that!

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Counterparties

Felix Salmon
Jun 24, 2010 03:04 UTC

Germany’s finance minister defends its spending cuts — FT

Xan Brooks liveblogs Mahut-Isner — Guardian

Good idea: rating wines on how quickly they’re drunk — Dr Vino

BP: Now more evil than Goldman Sachs

Felix Salmon
Jun 23, 2010 20:55 UTC

There will be rejoicing in the corridors of Goldman Sachs tonight: BP has finally overtaken it in the most-loathed company stakes! Yes, Goldman is still plumbing depths rarely seen in the modern era. But BP, even after putting aside $20 billion and grovelling to the president, continues to implode: it’s now hit a level of -47.6 in the latest BrandIndex poll. That’s not far from Toyota’s low point, which was -52.7 at the end of March, but it’s going to be a much harder fight back for BP than it was for Toyota.

It’s amusing to remember that earlier this year BrandZ put out a piece of glossy research saying that the BP brand was the 34th most valuable brand in the world, worth $17.283 billion. (Love the specificity there.) Is it possible for a brand to have negative value? If so, BP has probably achieved that distinction at this point.

Meanwhile, for those of you keeping count, BrandZ put the value of the Toyota brand at $21.769 billion, post-recall, while the Goldman Sachs brand was worth $9.283 billion, up a whopping 25% from 2009. How quickly these things can change.

Emacs.jpg

COMMENT

Also interesting is how the brand value of Toyota is steadily recovering. 6 months later and $30bn higher. BP needs to plug that hole and just have patience.

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When the SEC subpoenas journalists’ sources

Felix Salmon
Jun 23, 2010 18:28 UTC

Henry Blodget, like all other right-thinking individuals, is appalled at the SEC recapitulating its David Einhorn let’s-shoot-the-messenger errors with its subpoena of 37,000 documents from Sam Antar. But at the same time, Blodget doesn’t seem concerned about the way in which the SEC has included emails to journalists among the documents it’s asking for:

Importantly, however — and to the SEC’s credit — the SEC is NOT trying to obtain those emails by subpoenaing the reporters themselves. The SEC is instead attempting to retrieve the emails to journalists from the targets of the investigation themselves.

As Weiss points out, setting a precedent that communications with the press can be used as evidence in an investigation could have a “chilling effect” on people’s willingness to talk to the media. But the fact that the SEC is not asking the journalists themselves to give up their sources is an important and welcome factor here.

Anonymous sources certainly rely on journalists to protect their identities. Therefore, if it became established precedent for the SEC and other regulators to immediately subpoena journalists and get a full list of their sources and notes at the beginning of an investigation, communications with the press would go into a deep freeze (to society’s detriment).

But when the point of the investigation is to determine if someone has been spreading lies about a company, asking the target of an investigation to fork over any emails that he or she sent to journalists seems perfectly reasonable. The journalists have not been asked to give up any sources in this case. And if one IS trying to spread lies about a company, sending emails to journalists is probably a good place to start — so it’s hard to argue that these communications should be granted some sort of privilege.

Blodget seems to think that the only good reason to keep journalistic communications from the SEC is to prevent journalists from having to give up their anonymous sources. But in fact there are lots of other good reasons to keep journalistic communications some kind of privileged status, as the SEC itself recognizes:

Freedom of the press is of vital importance to the mission of the Securities and Exchange Commission. Effective journalism complements the Commission’s efforts to ensure that investors receive the full and fair disclosure that the law requires, and that they deserve. Diligent reporting is an essential means of bringing securities law violations to light and ultimately helps to deter illegal conduct…

Subpoenas should be negotiated with counsel for the member of the news media to narrowly tailor the request for only essential information. In negotiations with counsel, the staff should attempt to accommodate the interests of the Commission in the information with the interests of the media.

Subpoenas should, wherever possible, be directed at material information regarding a limited subject matter, should cover a reasonably limited period of time, and should avoid requiring production of a large volume of unpublished material. They should give reasonable and timely notice of their demand for documents.

In the absence of special circumstances, subpoenas to members of the news media should be limited to the verification of published information and to surrounding circumstances relating to the accuracy of published information.

Sam Antar, responding to Blodget, says (in an on-the-record email which the SEC is welcome to subpoena) that “the SEC’s subpoenaing of sources for their communications with journalists is no different than the government subpoenaing client communications with their attorneys as a way to breach the attorney-client privilege.” And he has a good point.

If the SEC were to ask Antar for emails he sent to his lawyer, he could simply refuse, on the grounds that such communications are protected. And the SEC itself is happy to admit that communications with journalists deserve some measure of protection, and that the SEC shouldn’t simply go on massive fishing expeditions in such circumstances: instead, it should be very specific about exactly what information it wants.

The Sam Antar subpoena, however, is obviously a fishing expedition: it even includes documents from Antar’s recent divorce. And it nullifies a huge amount of the welcome sentiment behind the SEC’s policy on asking for information from journalists, if the SEC can ignore all those guidelines when asking for information from journalists’ sources.

The SEC should encourage communication between sources and the press, using the press as a kind of adjunct enforcement mechanism. Instead, this kind of activity is prone to making sources even quieter. And that doesn’t serve the SEC at all.

COMMENT

I suppose if ones definition of acceptable casualty amidst the debilitating real estate bubble were to include the Fourth Estate, a case for imperial cancellation of source confidentiality in journalism might be made.

Otherwise, no matter how loathsome Judith Miller, I think not.

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Income tax loophole of the day

Felix Salmon
Jun 23, 2010 17:52 UTC

Why would the government force consumers to pay someone else’s taxes — even when that person might not pay any taxes at all? The answer, of course, as it usually is in such cases, is regulatory capture, and in this case the regulator in question is the Federal Energy Regulatory Commission.

The FERC sets the rates that consumers pay for moving oil through pipelines. Because these pipelines are monopolies, the FERC controls the prices — and it takes into account the taxes that the pipeline owners have to pay when it sets those prices. “As a general proposition,” explained one judge, in a key decision, “a pipeline that pays income taxes is entitled to recover the costs of the taxes paid from its ratepayers”.

So far so good. The problem arises with a clever little loophole: the corporations which used to own the pipelines have all now transmogrified themselves into partnerships. And somehow, in the wake of this clever little restructuring, the owners of the pipelines have seen their post-tax income skyrocket by as much as 75%. Essentially, when the pipelines were owned by companies, the companies paid tax on their profits — which was accounted for in the federally-mandated revenue rates — and then the post-tax profits of the companies became taxable income for the companies’ owners, just like any other dividend income.

Now, however, the companies have become partnerships, which pay no corporate tax at all. And the tax rate taken into account by the FERC is the individual income tax rate, and it’s assumed that all the owners pay tax at the top marginal rate.

Here’s how David Cay Johnston puts it in his detailed explanation of what’s going on:

The regulatory rule, upheld by the court of appeals, is that you must pay the income taxes of the pipeline partners even if they are only “potential” taxes. No actual income tax need be paid.

What exactly can be just or reasonable about forcing you to pay the income tax of another person who may not even pay tax?

The effect is a massive increase in post-tax profits for owners — and a concomitant decrease in tax revenues for the state. Here’s the chart:

IIT_chart.jpg

In case it’s hard to follow what’s going on here, we’re looking at what happens to $175 in pre-tax pipeline profits. Under the old corporation rules, the company would pay 42.7% corporate income tax, leaving $100 for the owner, who would then pay 35% personal income tax, for a post-tax profit of $65. Under the new partnership rules, there’s no corporate income tax at all, leaving the full $175 for the owner, which is $114 after taxes. A 75% post-tax pay hike, essentially, for doing no extra work at all.

The US tax code is full of these loopholes, and it’s great that the likes of David Cay Johnstone are exposing them. Now to see whether the government is going to do anything about it.

COMMENT

@Napstuh, please calm down and talk like a grown up.

Since you appear to be in over your head a little bit, let’s go over things slowly.

The US has just about the highest corporate tax rate in the world, number two in the OECD, and 50% higher than the OECD average.
http://alhambrainvestments.com/blog/2009  /01/29/corporate-tax-rates-by-country-o ecd/

You wrote “corporations and citizens who own stock are not the same people” –

Um, hello?

Corporations are not people at all. The corporation is a legal stand-in for, wait for it… the shareholders.

The same income is being taxed twice (for some education, google ‘corporate double taxation’) and it is mostly an American problem. It is why most American companies don’t even bother with dividend: the tax treatment is so bad. Almost every country has solved this glaring double taxation problem but America.

Don’t believe me? Here’s a bit of reading:
http://www.cato.org/testimony/ct-ce0301. pdf

As for the low percentage of taxation per GDP? Yes, sir. That would be the majority of people in America who pay no income tax at all.

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Goldman presses the flesh

Felix Salmon
Jun 23, 2010 17:16 UTC

Goldman Sachs was historically a bit like Bernie Madoff: both of them were successful partly because they were very good at playing hard to get. They both had sterling reputations, and both of them were wrapped in a certain amount of mystery.

Things are different now, and as Matt Goldstein and Steve Eder report, Goldman is opening itself up to clients in an unprecedented manner, in the wake of the SEC suit against it. In equity underwriting the firm is taking deals which it would have formerly rejected for being two small — its three post-lawsuit IPOs have averaged just $189 million a piece. And the prime-brokerage operation is also showing more hustle:

Another hedge fund that a year ago turned down Goldman for a prime brokerage assignment was recently contacted again by the Wall Street firm to see if it would reconsider. A person close to the hedge fund, who declined to be identified, said the incident was surprising since Goldman rarely comes back begging for business.

Since the SEC announced its charges, Blankfein and Cohn also have participated in conference calls with wealthy clients, reassuring them about the direction of the firm. Cohn, for instance, took part in a June 16 call with Goldman’s wealth management customers.

It’s worth noting here that wealth management doesn’t play the same role within Goldman as it does at other banks, which are content to invest their clients’ money and collect fees for doing so. Goldman does that, of course. But it also specializes in pairing off its wealth-management clients with its prime-brokerage clients: introducing hedge funds to the wealthy investors they need, and giving wealthy investors access to the hedge fund investments they desire.

When this system is working smoothly, it runs itself, in a virtuous cycle: more prime-brokerage clients mean the bank is that much more attractive to high net worth individuals, and vice versa. But clearly now the bank’s executives, up to and including Lloyd Blankfein, feel that the system needs a lot of personal attention on both sides to keep it chugging along as profitably as it has been in the past.

What’s certain is that Goldman Sachs has lost its mystique and aura, as Yankees fans would put it. And the problem with trying to make up for that with high-touch personal service is twofold. Firstly, it takes up a lot of executives’ time, and it doesn’t scale. Secondly, the more time that executives spend with clients, the less valued and valuable that time becomes. This is a tactic which can only work once: after that, Goldman’s clients are going to be fully aware that its executives are only human, and that face-time with them is not particularly valuable or reassuring. So Goldman is definitely going to want to get its mystique back. And it’s going to be sorely disappointed on that front.

COMMENT

Goldman only has a certain amount of capacity. If Goldman is asking the smaller fish for business, they must be hurting a bit.

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Ireland’s dastardly new savings product

Felix Salmon
Jun 23, 2010 13:54 UTC

A standard trick in the consumer-facing financial services industry is to appeal to people who are sure they’re going to have no liquidity or cashflow problems in the future, and then make lots of money off them when the inevitable crunches happen. Free checking, for instance, becomes extremely expensive checking when you overdraw your account; and people regularly buy items on their credit card intending to pay the statement off in full, but then fail to do so, incurring substantial interest payments not only on that one item but on everything else they bought that month as well.

In the U.S., some kind of consumer financial protection agency is going to be created to crack down on the worst excesses along these lines. In Ireland, however, the government seems to be interested in taking a leaf out of the predators’ book with its new savings product, the National Solidarity Bond. You can download the brochure for these things here, but the basic structure is quite simple and dastardly: the bonds pay a coupon of 1% per year, and then pay out a massive final tax-free coupon of 40% of the initial investment at maturity in 10 years’ time. And then there’s the clever twist: you can pull your money out at any time, with just 7 days’ notice.

It’s trivially true that this product makes very little sense as an investment product unless you’re going to hold it to maturity. And it’s also trivially true that the number of people who end up needing to get at their money at some point in the next ten years is going to be substantial. It’s a bit like the life insurance industry, which is profitable only because of the people who stop paying their premiums and therefore never get any payout at all.

So while this is a clever way for the Irish government to raise some much-needed long-term funding, I also think it’s a little bit evil. And it’s very hard indeed to recommend this product to anybody.

(Many thanks to Alex Rolfe for the tip.)

COMMENT

When we hear of anything, either a service or a product which would help us enjoy some savings, we usually go for it but just be very careful on what you go for. for some the best way to have their money on safe hands is through bonds. Now with Ireland’s new financial scheme, it still is something to find out whether it is something worth trying.

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Counterparties

Felix Salmon
Jun 23, 2010 05:43 UTC

New quantitatively rigorous analysis of KIPP shows positive results — MPR

Gourmet magazine is coming back, online — Gourmet

“It was never our intention to misguide American citizens regarding the differences between the pig and the unicorn” — ThinkGeek

Understanding German fiscal policy — MR

Target makes more money after offering a 5% discount on its store-brand credit card — Benzinga

Competition in payments

Felix Salmon
Jun 22, 2010 18:35 UTC

Adam Ozimek reckons that we need more competition in the payments space, and that interchange regulation is going to impede progress toward that goal:

I think we can all agree that more competition is, when feasible, the best way to deal with undesirable market power…

I think this issue deserves a much closer look, because some not so futuristic technologies like mobile payment seem to be potentially disruptive market entrants that could upset the Visa/Mastercard duopoly. Lawmakers need to be cautious with this, because if you’re going to start setting prices, then you’re messing with the profits for potential entrants, and thus possibly disrupting the future path of innovation. The welfare impacts of accidentally preventing a market entrant or technological innovation here would be huge, and would likely trump any welfare benefits of the proposed regulations.

I don’t see it this way at all, partly because we don’t all agree that more competition and innovation is necessarily the optimal way to go with respect to payments.

Being able to easily pay for things without worrying about the mechanism is a great public good. The U.S. had a disastrous experiment with privatized payments between 1836 and 1861, when thousands of local state-chartered, private banks issued their own paper money. There was a lot of confusion, and of course many of the notes traded at a discount, especially when they were carried out of state. (To this day, if you travel internationally and try to exchange pounds for dollars using Scottish banknotes, there’s a very good chance you’ll get a worse rate than if you’re exchanging the standard Bank of England notes.)

The introduction of Treasury notes in 1861 rationalized things wonderfully, and made commerce a lot easier: no longer was there a risk that the banknote in your wallet was issued by an insolvent bank.

When banks started issuing private checks to their customers, a lot of the problems associated with banknotes returned. Yes, there were the credit problems: the account the check was drawn on might not have any money in it, so there was a credit risk associated with accepting checks as payment. But there were also the boring old logistical clearing and settlement problems as well, and the Federal Reserve spent an enormous amount of effort and money putting together a complex nationwide system facilitating check clearing at par. This cost the Fed money, but again it helped smooth commerce more generally.

The system of checks and cash worked until the banks grouped together to create MasterCard and Visa in 1966. There were small-scale charge cards before then, most notably Diners Club, which was founded in 1949. But MasterCard and Visa (or the InterBank Card Association and BankAmericard, as they were originally known) signed up as many banks as they could to become truly formidable networks. Still, they weren’t direct-payment cards, at the beginning: the customer wasn’t paying for the goods with her own money, but rather borrowing the money to pay for the goods from her card issuer. It wasn’t until the 1980s that MasterCard and Visa started unifying their systems with ATM cards, to create PIN debit.

The logistics behind all of this were formidable, both in terms of clearing and settlement and in terms of getting the requisite approvals from banking regulators in the U.S. and around the world. But it was worth it, as a glance at the market capitalizations of MasterCard and Visa (they’re worth over $50 billion between them) indicates. And remember that it’s the card issuers, rather than MasterCard and Visa themselves, who make the real money, both from interest payments and from interchange fees.

Every so often, non-bank players like Diner’s Club or American Express would come up with a bright idea in the payments space, and some of them made good money for their owners. More recently, PayPal took advantage of the fact that, unlike Europe, the U.S. has a very antiquated and expensive system for moving money directly from one bank account to another. (In Europe, it’s as easy as a phone call, or hopping online; there’s no fee.) So PayPal set up shop in the U.S. to facilitate payments directly between individuals, taking a small cut for itself along the way. But PayPal wasn’t an improvement on the simple European system: it was merely an “innovation,” if you want to call it that, born of sclerosis and greed in the U.S. wire-transfer system.

Realistically, the best hope for real competition in the payments space comes from mobile payments: most of us, I’m sure, would love to be able to leave our wallets at home and just walk around with our phones. And in Kenya you can do just that, thanks to the M-Pesa system there. But note what’s necessary for M-Pesa’s success: you need a strong telephone monopoly, like Safaricom, which is at least as creditworthy as the local banks; and you need an unbanked population desperate for any kind of payment process at all.

In America, it’s pretty much unthinkable that someone like AT&T would get into the payments business. The technology of me going into a store and adding the cost of a candy bar to my monthly phone bill — that’s easy. But the security issues involved with giving all my spending history to AT&T are not, given its history of breaches. What’s more, AT&T doesn’t particularly want to get into the business of chasing me to pay for my candy bar, it’s hard enough trying to get me to pay my phone bill.

And finally, the Federal Reserve would never approve of a non-bank like AT&T performing so many banking functions: if Wal-Mart can’t get a banking license, you can be sure that AT&T can’t either. The Fed’s ultimately in charge of ensuring that big banks don’t fail and that deposits are safe: if a friend of mine transfers money into my AT&T account and then AT&T goes bust, I’m still going to want access to that money. And the Fed has neither the ability nor the inclination to police AT&T’s solvency.

The fact is that payments are a utility; they’re regulated like utilities; and utilities tend not to see much in the way of innovative new entrants. There are some problems that innovation can solve. For everything else, we’re going to have to make do with MasterCard.

COMMENT

Worth noting that one of the ways BankAmericard (later spun off into Visa by BofA) made inroads signing up merchants in the ’60s was to substantially undercut American Express on merchant discount fees.

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