HUD Secretary will quit

Reuters Staff
Mar 31, 2008 02:44 UTC

GWB’s embattled Secretary for Housing and Urban Development is expected to resign tomorrow according to the Journal.

HUD, usually a backwater federal agency, has been at the heart of the administration’s attempts to ease problems for homeowners. Although Treasury Secretary Henry Paulson has taken the lead on many initiatives, Mr. Jackson has been a partner on many, including programs such as Hope Now, an administration-backed industry plan to loosen the terms on hundreds of thousands of subprime mortgages.

HUD also runs the Federal Housing Administration, a big government division that insures mortgages for low-income homeowners and first-time home buyers. Many Democrats and Republicans have envisioned expanding the power of FHA to play a bigger role in stabilizing the mortgage market.

Mr. Jackson’s problems stem from his refusal to answer questions about his role in a Philadelphia redevelopment deal. The city’s housing authority has filed a lawsuit charging that Mr. Jackson tried to punish the agency for nixing a deal involving music-producer-turned-developer Kenny Gamble, a friend of Jackson.

Separately, a report from the department’s inspector general found what it called “some problematic instances” involving HUD contracts and grants, including Mr. Jackson’s opposition to money for a contractor whose executives donated exclusively to Democratic candidates.

Could this be good news? I think Jackson is one of Bushie’s original team of advisers, the one driven by loyalty more than competence–Rumsfeld, Tenet, Brown (at FEMA), Gonzales, Miers (who he nominated for the supreme court before it was learned she couldn’t complete an English sentence). The others didn’t survive so long, perhaps because they had higher profile jobs. I’m guessing it’s easier to hide incompetence or cronyism at HUD.

I say this could be good news because it could be an opportunity for Bush to get a ringer to do the job. The present economic crisis has been described by even the most sober observers as the worst economic disaster in generations. We’ll need steady, smart hands to get us through it.

We are VERY fortunate, I think, to have Bernanke and Paulson leading the charge here. Bernanke may be America’s greatest living scholar of the Great Depression. Particularly at this moment, when we face the largest banking crisis since the Great Depression, it’s good to have an expert at the helm.

The same is true of Hank Paulson. If the American housing crash is the underlying catalyst causing the earthquake in the world financial system, it could be argued that Wall Street is at its epicenter. Before going to Treasury, Paulson was the CEO of Goldman Sachs. He knows Wall Street. We know this because Goldman under his leadership always outperformed it…

Indeed Bernanke’s and Paulson’s actions have so far proven very prudent. They’re taking appropriately aggressive action while doing a good job to avert overt government bailouts. Some of their solutions have been totally original and almost ingenious. The “bailout” of Bear Stearns wasn’t much of a bailout, what with equity holders getting completely wiped out. And the Fed’s various lines of credit to Wall Street and Main Street are only that: credit lines. The Fed is NOT “printing” money in a misguided attempt to recklessly inflate our way out of this crisis.

HUD is more important than ever. Hopefully Bush finds another accomplished technocrat to fill the job….and quickly.

[If you didn't follow the Harriet Miers link above, here's another opportunity. It's hilarious.]

COMMENT

The factual error occurs in the mortgage model Mr. McCulley displays in his article. It is not a big issue, but when someone uses a specific example, then the example has to be factually accurate.If you turn the microsope to the other end of the mortgage system, away from Main street, to Wall Street and, for our purposes here, Washington Street, the example might look like this:In the post dot com/twin towers era, the Money Men looked for new worlds to develop, and they found the mortgage and housing markets. So them fed the beast that was thirsty with pentup demand for housing and cheap, easy mortgage money, and Wall Street tasted success, and Washington Street was happy too. So encouraged, they fed more of their intoxicating products into the system and THEY (Wall and Washington Streets) reaped more and more benefit…with little regard to any reasonable risk managment consideration. Values went up, paychecks and bonuses were huge, constituants were becoming happy homeowners, and life was great on Wall Street and on Washington Street. To paraphrase/write over the article, and this is not easy, but it makes a point: “Minsky’s hypothesis explains why the downturnoccurred. MORTGAGE PROFITS AND PROPERTY prices had been rising at a steady and stable pace , for a long period, so WALL STREET & WASHINGTON STREET walked the path from hedge units to speculative units and, finally, to Ponzi units. In the midst of the exuberance, the rising PROFITS were a self-fulfilling prophecy. As WALL STREET & WASHINGTON STREET walked, THEN RAN down the Minskypath, they drove up the value of the collateral AND THEIR HOLDINGS. Very few defaults were occurring because ACTUAL borrowers do not default when they are making EARNING PAYCHECKS and WALL STREET & WASHINGTON STREET WERE THRILLED BECASUE THEY WERE MAKING HUGE moneyOne should realize that what was happening, in effect, was that by 2006, WALL STREET & WASHINGTON STREET WERE GRANTING THEMSELVES, THROUGH marginal borrowers, a free at-the-money call option on the value of THE BORROWERS property AS IT RELATED TO THE VALUES OF THEIR MORTGAGE PROFITS. As the BORROWERS property market continued to go up, the default rate on the mortgages was low , SO WALL STREET WAS ABLE TO LEVERAGE MORE PROFITS THROUGH THEIR CREATIVITY, HEDGED BY because borrowers’ PAYMENT STREAMS AND PROPERTY VALUES, AND WASHINGTON STREET BASKED IN THE GLORIOUS LIFE THEIR CONSTITUANTS WERE LIVING.If BORROWERS defaulted on their mortgage, they gave upthe in-the-money portion, AND WALL STREET & WASHINGTON STREET WERE STILL IN GOOD SHAPE. UNFORTUNATELY FOR ALL, 2006 BECAME 2007, AND BY MID YEAR THE MORTGAGE LENDING AND LEVERAGE SYSTEM, DEVELOPED BY WALL STREET & SO APPRECIATED BY WASHINGTON STREET, WAS BEGINNING TO UNRAVEL…SO WALL STREET ABANDONED THE HOUSING MARKET AND THE EVER TRUSTING (BY IN LARGE) BORROWERS TO ITS OWN DEMISE, & WASHINGTON STREET BEGAN TO NEAGTIVELY CATEGORIZE AND CRITICIZE, AND THE SYSTEM DEVELOPED BY WALL STREET & EMBRACED BY WASHINGTON STREET TRANSITIONED INTO THE last stage of the Minsky journey from speculative to Ponzi. I really believe that the market makers and managers bear the brunt of the responsibility for market dislocations such as we are now experiencing, and they are found on WALL STREET & WASHINGTON STREET.

Posted by JohnP | Report as abusive

Thriftville vs. Squanderville

Reuters Staff
Mar 30, 2008 17:51 UTC

An oldie but a goodie (via Andrew Abraham). Warren Buffett explains in allegory why the trade deficit is bad news for the dollar over the long-run. [He wrote this piece in 2003, by the way. Since then, America's current account balance has worsened significantly.] And it’s not just the dollar that will suffer, it will be America’s standard of living relative to the rest of the world……this is what people mean when they say the baby boom and Gen X are literally mortgaging their children’s future. For those with time, I recommend reading Buffett’s whole article.

….our trade deficit has greatly worsened, to the point that our country’s “net worth,” so to speak, is now being transferred abroad at an alarming rate.

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that’s how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there’s a quid pro quo — but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off — or simply service — the debt they’re piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat — they have nothing left to trade — but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are — in economist talk — some pretty dramatic “intergenerational inequities.”

Let’s think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).

Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies — that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island’s fiscal pain.

That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island’s government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force.

So what does all this island hopping have to do with the U.S.? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment — that is, our holdings of foreign assets less foreign holdings of U.S. assets — increased (under methodology, since revised, that the government was then using) from $37 billion in 1950 to $68 billion in 1970. In those days, to sum up, our country’s “net worth,” viewed in totality, consisted of all the wealth within our borders plus a modest portion of the wealth in the rest of the world.

Additionally, because the U.S. was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg.

In the late 1970s the trade situation reversed, producing deficits that initially ran about 1 percent of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion.

Since then, however, it’s been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4 percent of GDP. Equally ominous, the rest of the world owns a staggering $2.5 trillion more of the U.S. than we own of other countries. Some of this $2.5 trillion is invested in claim checks — U.S. bonds, both governmental and private — and some in such assets as property and equity securities.

In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce — that’s the trade deficit — we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.

To put the $2.5 trillion of net foreign ownership in perspective, contrast it with the $12 trillion value of publicly owned U.S. stocks or the equal amount of U.S. residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what’s already been transferred abroad is meaningful — in the area, for example, of 5 percent of our national wealth.

More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level, which means that the deficit will be adding about one percentage point annually to foreigners’ net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding — goodbye pleasure, hello pain.


Treasury Dept. proposes new power for Fed

Reuters Staff
Mar 29, 2008 01:28 UTC

This is good news and big news. I’m not a fan of regulation in general. This is a good first step

WASHINGTON — The Treasury Department will propose on Monday that Congress give the Federal Reserve broad authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system.

The proposal is part of a sweeping blueprint to overhaul the country’s hodge-podge of regulatory agencies, which many specialists say failed to recognize rampant excesses in mortgage lending until after they triggered what is now the worst financial calamity in decades.

According to a summary provided by the administration, the plan would consolidate what is now an alphabet soup of banking and securities regulators into a trio of overseers responsible for everything from banks and brokerage firms to hedge funds and private equity firms.

—–

Under the Treasury proposal, the Federal Reserve would become the government’s “market stability regulator” and would be allowed to gather information from virtually any financial institution. Fed officials would be allowed to examine the practices and even the bookkeeping of brokerage firms, hedge funds, commodity-trading exchanges and any other institution that might pose a risk to the financial system.

“The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability,” Mr. Paulson said in the advance text of Monday’s speech. “To do this effectively, it will collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity pool operators.”

———

Mr. Paulson’s proposal, however, would fall short of the kind of regulation that Democrats have been proposing. Mr. Frank and other senior Democrats have argued that investment banks and other lightly regulated institutions now compete directly with commercial banks and should be subject to the same kind of regulation — including examiners who regularly pore over their books and quietly demand changes in their practices.

The Dems could have a point here. Wish they had similar insight regarding Fan and Fred. Unfortunately, they’ve blocked the Bush administration’s efforts to impose tighter capital requirements on them.

More NAR B.S.

Reuters Staff
Mar 26, 2008 12:01 UTC

House prices continue to slide nationwide, according to the latest Case-Shiller data.

But the National Association of Realtors can’t help itself, trying their best to put a smiley face on the implosion of the housing market:

The headline read, “Existing Home Sales Rise in February”, but the real story in yesterday’s existing home sales report from the National Association of Realtors was four short paragraphs in:

The national median existing-home price for all housing types was $195,900 in February, down 8.2 percent from a year earlier when the median was $213,500.

For more on the NAR’s release, that article is here. Comparisons are best made against the same month a year ago. Sure sales were up a bit Jan to Feb, but take a look at this Feb vs. last Feb:

Inventory is still sky high. If more people are selling than buying, prices have to fall for the market to return to equilibrium. This is bad for lenders and buyers who got involved at the top, but good for first-time homeowners who’ve been priced out of the market.

Continuing on my theme NAR Propaganda, I thought I’d post some highlights of an exchange that happened in the comments section of my post two days ago. A gentleman “in the mortgage and real estate industry” said, among other things, this:

JR…future appreciation is not an opinion…the fact is that over the past 40+ years housing has appreciated around 6.5% according to OFHEO….

In our area, according to OFHEO stats, we gainded 78% in value on the past 5 years, and gave back 3.8% last year…these are facts…not guesses.

Next fact is the rule of 7′s … 7 years on a job….7 years in a marriage…7 years in a home….these are norms.

Those who bought a home in the 2001-2002 recession did very well…their 7 years is up this year or next. Those who bought on 2006, their 7 years is up in 2013.

There is no evidence that they will not achieve a positive yield on their home onwership experience.

As for the mortgage credit stranglehold currently exacerbating the housing market, this same knee-jeck reaction took place the late 80′s-early 90′s problems, when lending abandoned the market place. Had we maintained a more stable attitude towards lending, our problems would be greatly reduced.

I have a client on the phone right now. His income is about to be cut by his employer…he works in a stone quarry and has had this job for 10+ years. His hours are getting cut 25%….next month..

Is this a housing problem or an income problem?

I felt compelled to answer this gentleman, “johnp”, b/c as a real estate professional he seems to be following the NAR’s lead: trying to figure out ways to convince people to buy homes in a market that clearly says it would be prudent to wait.

An income problem? Sure it is: house prices grew far faster than median income over the last eight years, which is why those prices are too high and have to fall. Thanks for making my point for me johnp! ;)

But I have a bigger beef with realtors conveniently obfuscating the present and asking people to look at the “long-term.” Here was my reply (with a few edits):

johnp continues to rely on “long-term” results. And his argument that 40 years of data prove his point is specious because, as I said in my comment above, we are in the midst of a housing decline of unprecedented proportion. Many reasonable observers are saying we haven’t faced a housing collapse of these proportions since the Great Depression. By definition, I think an “unprecedented” event is hard to fit into a box using “historical” data.

Again, let me reiterate the core of my argument. Buying a home isn’t necessarily a bad idea. Buying a home NOW is a bad idea–unless you can get a big discount on the market price.

Johnp notes in his first post above that he works “in the mortgage and RE industries.”

It’s funny, the similarities between real estate professionals and investment professionals. Having spent a few years in the investment profession, I can speak for that one. People listen to investment pros when they say you have to “stay invested for the long-term” because you “can’t beat the market.” These folks are often proponents of the “buy and hold” strategy…..for two reasons:

1. unfortunately, they don’t do a lot of real work to determine which stocks are actually a good value. Like johnp’s rule on housing, a stock probably will go up if you hold onto it long enough…..that doesn’t mean you bought it at a good price.

But perhaps more importanly,

2. they ONLY GET PAID if you “stay in the market.” Investment pros typically get paid fees based on the level of assets under their management. Therefore they have an incentive to keep you invested at all times.

Because the bottom line is that investment “pros” are actually SALESMAN. They get paid to sell you something, a stock or a mutual fund….making you money is also important, but SECONDARY.

I suspect things are similar with real estate and mortgage professionals like johnp, who only get paid when house sales and loans actually close. These people are salesman. They’re out to make THEMSELVES money, not you. So when common sense says now is CLEARLY NOT a good time to buy, they have to fall back on sophistries like relying on the “long-term.”

I would certainly grant you that you CAN make money in the stock market or in housing if you hold on for the long-term. But to MAXIMIZE your gains and to AVOID losses, first you have to buy assets (a stock or a house) at a good price.

Look at two investors who have been ridiculously successful, Warren Buffett in stocks and Sam Zell in real estate. Sam Zell (aka Saltator Sepulcri, Latin for “grave dancer”) has made billions largely by buying AT THE RIGHT TIME. Same story with Warren Buffett, he would be the first to tell you that you only buy assets you’re comfortable owning over the long-term. But before that, he would say you have to buy that asset at a discount to its true value.

Most of you would say, well you have to have some kind of special brilliance to be a Warren Buffett or a Sam Zell. Yes and no.

These guys are famous for relying on simple common sense to make many of their investment decisions. Indeed common sense, combined with a measure of fortitude to ignore the stampeding masses, is often enough to keep people from buying at the wrong moment.

Who among you didn’t KNOW deep down that real estate was starting to get ridiculously overvalued back as early as 2004? You just have to stick to your conviction for the (seemingly interminable) period before which prices finally return to common sense levels.

Same story with tech/telecom stocks circa 1997-1998. Wasn’t it hard to stay on the sidelines while fortunes were being made in 1999 and 2000, before the crash that y
ou KNEW would come finally did?

The people that lost fortunes were the ones that kept drinking the kool-aid.

Buying and holding CAN BE a good strategy. But first you have to mix a little common sense into the buying part of the equation.

So, dear reader, I say to you ignore real estate/mortgage “professionals” who say you have to buy now. Your common sense is a better guide to smart investing, whether in the stock market or real estate.

………………
Read other posts on OptionARMageddon:

YouTube! John Stewart & Hillary Clinton
NAR Propaganda
Lowering Capital Requirements for Fan and Fred
Interest Rates and the Dollar
Capital Raising, Merrill trickery
A Great Society No Longer? Interview with GAO chief David Walker
Walking Away……
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

COMMENT

wow. I this represents USA, where does that leave Mexico?

Posted by gary | Report as abusive

Are we in Recession?

Reuters Staff
Mar 25, 2008 15:37 UTC

“Does someone around here have an MBA” to explain all this stuff to us? W has one……

(via CR.)

And a bonus video. I imagine plenty of my readers might be interested in this piece on Clinton and her “experience.” I’ve noted before that her economic proposals are pretty foolish.

COMMENT

If the people responsible for this mess are given more Authority;the mess will probably get worse.Better to let the financial entities fall without further involving the taxpayers.
Let the Bankruptcy laws function and let’s get through this quickly instead of a long drawn out World-wide Depression.

Posted by Frank Hayes | Report as abusive

NAR Propaganda

Reuters Staff
Mar 23, 2008 12:45 UTC

The National Associate of Realtors wants you to know that “buying a house this year” would be a “good move, both for your family and [for] building your long-term wealth.” To spread this message, they’re running commercials on CBS during the NCAA Final Four Tournament. They’re pushing people to their new website: housingmarketfacts.com. You can see the new commercials there….just follow the “watch TV commercials” link on the lower right side of the page.

I’ll assume my readers are smart enough to know that the National Association of Realtors is a biased source. Their constituent realtors only get paid when real estate transactions close. But to give you some color on these guys, here are a couple of books written by their former Chief Propagandist, er, Economist David Lereah.

From 2005:

The whole title reads: “Are you Missing the Real Estate Boom? Why home values and other real estate investments will climb through the end of the decade, and how to profit from them.”

From 2006 (published even as the housing bubble started to burst):

The sequel’s title reads: Why the Real Estate Boom will not Bust–And How You Can Profit From It. How to build wealth in today’s expanding real estate market.”

Lereah is no longer with the NAR.

With this in mind, let’s consider the claims in their commercials and on their website. [Fair warning: there's a creepy spokeswoman that hovers to the left on the home page. You can mute her, but she'll keep smiling at you on an endless loop. Anyone remember the hologram of Princess Leah in the first Star Wars movie?]

  • “Buyer opportunities have NEVER been better.” I wonder if the NAR has considered the excess inventory of new and existing homes on the market. With housing supply still FAR outweighing housing demand, prices will continue to fall. Even the CEOs of Fannie and Freddie said house prices still have farther to fall. So if you’re planning to buy a house, it makes sense to wait a year, when you’ll be able to get another 10, 20 or 30% off the asking price.
  • “Family conditions often outweigh market conditions.” I don’t doubt that owning property can be good for a family, but with house prices falling fast, I think market conditions BECOME family conditions. To the extent that you risk losing a big chunk of your savings, it makes sense for your family if you wait for prices to return to normal relative to median income.
  • Speaking of the family savings, the NAR flashes a statistic in their commercial claiming “60% of the average homeowner’s wealth comes from home equity.” The fine print below shows where they got that stat: from a HUD report. Published in 1995.
  • But let’s consider the wealth argument, as I don’t doubt that the majority of American’s “wealth” is in the form of home equity. I’ve always wondered about the way we define wealth in American society. Consumption being the root of the American Dream, I think we confuse having STUFF with having WEALTH. After all, to afford that McMansion and the second/third family cars in the driveway, Daddy often has to extract the wealth in his home through a home equity loan. IMHO, true wealth is literally “liquid net worth.” Net worth is assets minus liabilities. Cash good, debt bad. “Liquid” net worth is the ease with which your assets can be turned into cash.As the employees/shareholders of Bear Stearns can tell you, there’s a difference between wealth on paper and cash in the bank. Housing wealth, that is equity in a home’s value, is wealth on paper.
  • The website is full of real estate piffle from a “2006 NAR Study.” My favorite: “Homeowners are more likely to vote and they volunteer time for political and charitable causes more frequently than renters.” Hmmmm.
  • And then there’s this:
    • “Homeowners benefit from the power of leverage. Over 10 years, a $10,000 investment in the stock market at a normal 10% market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5% would return nearly 5 times the stock market return, at $110,300.”

Wow. You’d think it would be responsible for them to explain the downside risks of leverage while they’re at it. The leverage argument relies on the real estate myth that “prices never go down.”

But what if prices DO decline? Let’s use their example. You take your $20,000 of life savings and make a 10% down payment on $200k house today, which means you have a mortgage of $180,000. Even after house prices have declined significantly nationwide, many experts still claim house prices have much further to fall, perhaps another 20%. What happens to you if the value of your house falls 20% by next year? At that point it’s worth $160,000. First of all, your equity is wiped out, and you still owe close to $180,000 on the house.

The truth of the matter is that leverage is very dangerous. It magnifies returns, to the upside AND downside. To use their analogy, if you’d put that $20,000 in the stock market and watched it decline 20%, you’d still have $16,000. With the house, your $20,000 is wiped out entirely AND you owe an additional $20,000 on a mortgage over and above the continuing value of the home. Essentially, you’ve lost $40,000.

This isn’t just a hypothetical. Thousands of people are walking away from their homes because they owe more on their house than it’s worth. Leverage has wiped out whatever “wealth” was invested in their home.

Still think there’s “never been a better time to buy a home?”

[for those interested: a buy vs. rent calculator and a closer look at the math of renting vs. buying]

COMMENT

Rachel….you may not like the statistical facts, but they are what they are…facts are facts…deal with them, sad as they may be…Anyway, to all, I have come back to follow up on the thread. “More NAR BS” is really not an accurate lebel, as I beleive my knowldge-base and experience factor go well beyond NAR. Yes, I am a member of NAR. But I have also been a mortgage lender, a title S&L officer, an underwriter and a licnesed appraiser. And, I read a lot.The focus of my posts is two-fold: (1) To corrent the record with facts; and (2)To state my opinions to the group for reasonded consideration and comment. Basically, I want to help the discussion.First, imagine a large stadium setting, such as the Rose Bowl. Next, imaging the person sitting in the most distant seat is announcing on the game for one of the media companies covering the event, with his color analyst. Lastly, imaging they are all near sighted and suffering from myopia. Something tells me that “call” will be problematic.This is how I view much of the commentary on the current situation in mortgage lending and real estate. Many commentators, too far from the playing field, viewing the blur as it were, and making simplistic comments and rendering poorly supported criticisms about a very real situation…and missing much of the game. I do work on Main Street, in the mortgage and real estate industries. I sit with home buyer prospects, and have since the late 70’s, and discuss with them on the whys and wherefores of the transition from tenancy to home ownership. Or, I meet with existing homeowners and discuss refinance and debt restructuring choices. I hear the details of their situations, the realities of the lives and explain options currently available. Like the infamous Jim Cramer rant…”they just don’t get it” …he was right…THEY don’t get it! THEY being the folks in the cheap seats.It is my view that, if a homeowners income is at or above the level it was when they purchased their home, or last financed their home, then all is probably ok. It is my view that, of those who are in trouble, the vast majority (in the high 90% range) have suffered significant income discounts of 30% or more…and that is not a story I ever hear. This is not a subprime, ARM reset, 100% LTV problem…it’s not a housing problem. It’s really the economy, and about household income, and negative changes taking place. As I see it, housing is a victim, not the culprit. The real culprit is not the free market…it’s radical, poorly formulated , market manipulation. Were there some housing issues developing…assuredly, YES. Had the response been more measured and responsible, would the issues have developed to the point we are at today…most assuredly, NO.Case examples:Case #1: I had a Hispanic client who was working as a roofer. He was grossing about $7,000 per month is 2005, according to his paystubs. He did not possess a green card, but his sister did. So, she bought a house as a second home. She did not need th3e property…or want it…or intend to pay for it. It was the brothers plan to pay for the house, and to eventually correct his legal status. Today, with the construction downturn, his income is $3,000, and Arizona has its Employer Sanctions Law, which is making employment difficult. Is this a sub-prime problem or an income problem.Case # 2: Client and his wife buy a home in 2006 with a conforming, 100% LTV, fixed rate loan. He delivers rock and decorative stone. Today, with the construction downturn, he no longer has a job. They may leave their $1,100 payment, for a $900 rental, in part because they can save on fuel prices as their home is 20 miles (one way…80 mile per day for both) from their new jobs. Is this a 100% LTV problem or an income problem.Case #3: Retired teacher and his teacher wife build a new luxury home. They gross over $100,000 with his retirement, his income from a second teaching job with the University of Phoenix, his wife’s income and payment from the State of Arizona for children he adopted. After 12 years with the UoP, his $25,000 job was cut and now they are in trouble. Their current loan is a 5/1 ARM, with 2 years until reset…unfortunately he will lose the home before then…by sale or foreclosure. Is this a reset problem???I have more case studies from my closed files like these, but you can see the trend developing. In 2005, the FIDC did a study entitled “Boom Does Not Always Follow Bust. The conclusions of the study were that, after price run-ups, prices stagnate, rather than burst, unless there is a severe economic reversal (like in Detroit…like in the construction industry…like what may be developing right now) or an event like Katrina. In most case, the housing market stagnates until income growth regenerates…then housing prices take off again. The study was done in 2005, so none of the radical reversals in lending practices and guidelines were included in their model. Just like homebuyers and borrowers, they looked the current playing field, the “rules of the game” so to speak, and made a buying/borrowing decision. Would their decision be the same if they had the benefit of knowing “today’s playing field” …but that is hind sight.With proper management of the mortgage markets during this transition to stagnation by the highly paid, but myopic rulers of the GSE’s, Wall Street and the major lenders, we could have avoided all of this current mess. The mortgage industry spent 7 years, or so, developing guidelines and then spent 7 months, or so, undoing it all. Had we amortized our way back to a more reasoned approach to lending, we would have not have the “shock and awe” problem we are now faced with. How does housing impact the economy? Robert Shiller, he of index fame, did a paper in 2006 which compared the impact of increases in stock market prices and increase in housing prices on consumption in the general economy…this study was multi-national. It concluded that stock market increases had no correlated impact on the consumption in the economy. He did, however, conclude that housing had a strong correlation to consumption in the economy. Shiller concluded that a 10% growth in housing prices had a 1.1% increase in consumption patterns in the economies he studied. Which begs the question, ”What will a 10%-20%, or greater, downturn in housing values do to consumption and the general economy?” When housing works, it seems, the general economy works well. When you crush housing, and believe me, for some reason housing is being crushed…nothing in the economy will work. This snowball is out of control now, in part due to an artificially magnified downturn in the real estate and mortgage markets, which is the result of an inadequate understanding of the various dynamics involved by those highly paid individuals, and pundits in the cheap seats. The The old saying, “whether you rent or own, you pay for the space you occupy” really applies now…everyone will suffer, renters and homeowners alike, in some manner, in some degree. ALL homes will go down in value…all interest rates will be affected…all participants in the economy will suffer. ALL! So why all of the negative and angst driven posts regarding housing…we all should want housing to work and work well.Market timing…when to cross the line and make a buying decision, is really personal It is not necessarily math driven as far as prices go, or interest rates for that matter. The concept of low versus high counts to a degree. There are also intrinsic considerations. The need or desire to own a home, the capacity to actually accomplish the purchase , and confidence in the future . These considerations are as critical as is the math. Real estate is not a slide rule industry… the process is not that precise. Warren Buffet, referenced above, only has to be right once a
year, or so, he says, when describing his investment process. He has a long term vision, like homebuyers. Homebuyers have to be right once, too, and wait for seven years…the average term of ownership. But, being right is more than just about the price…

Posted by JohnP | Report as abusive

Lowering Capital Requirements for Fan and Fred….

Reuters Staff
Mar 20, 2008 12:12 UTC

Can’t say I support this move. Seems a bit short-sighted to add MORE debt to Fannie’s and Freddie’s balance sheets. We’re simply encouraging them to throw more good money after bad in a quixotic attempt to keep house prices from falling any farther. And taxpayers remain on the hook if either or both of these companies–levered 50:1–end up in bankruptcy.

Fan and Fred say they are going to raise additional capital as part of this move. But that shouldn’t inspire confidence. What’s happening here is the companies’ regulator, the Office of Federal Housing Enterprise Oversight, is allowing them to carry less capital RELATIVE to the mortgages they purchase or guarantee.

The plan involves a reduction in capital requirements for the companies and a promise by them that they will each raise several billion dollars of capital this year, likely through a sale of preferred shares, according to several people familiar with the situation. As a result, they are expected to be able to provide additional funding of as much as $200 billion for home mortgages and related securities.

…..

Ofheo for the past several years has required Fannie and Freddie to hold 30% more capital than their usual minimum while they have worked to resolve lapses in their accounting and internal-risk controls, a process now viewed as largely complete. Ofheo is expected to reduce that capital “surcharge” initially to 20%.

…..

The move should reduce Freddie’s capital requirement by about $2.6 billion and Fannie’s by $3.2 billion. The companies have indicated that they are prepared to raise similar amounts in new capital, though the timing and exact size of those transactions depend on market conditions, according to people familiar with the agreement.

Currently, the two have purchased or guaranteed well over $4 trillion of mortgages, including hundreds of billions of subprime/Alt A/high LTV. And they have approx. $80b of capital between them as a backstop against losses. A 15% fall in the value of mortgages in their “high-risk” portfolios would by itself be enough to wipe out their capital. Nevermind that in a world of falling house prices, even “prime” creditors often have an incentive to walk away.

So while we’re waiting for Fan and Fred to “raise new capital” the two behemoths will be allowed to back another $200 billion worth of mortgages, including jumbos up to a price of $729k in bubbly areas like California.

For the moment, this move isn’t costing taxpayers anything. But the more mortgages Fan and Fred are allowed to back, the larger the bill for taxpayers when they fail.

But say they don’t fail. Maybe we get through the present housing crisis without much more damage. My question is: at what cost? The various “emergency” moves meant to prop up house prices are bailouts that simply shift more risk TO taxpayers without any additional regulation to PROTECT taxpayers.

Frankly, I think Fan and Fred should be abolished. The government has no business subsidizing housing for those that can afford it.

But since they do exist, since their quasi-public status means taxpayers share the risk of declining house prices along with Fan/Fred shareholders, then taxpayers should also share in the returns. But they don’t. To start with, Fan’s and Fred’s shareholders own 100% of the companies’ profits. And as AEI’s Peter Wallison points out on the WSJ op-ed page today, the two don’t even act as a stabilizing force for housing. In fact, they are procyclical: shoving more capital into housing when times are good and, because they exist to serve shareholders, withholding capital from housing when times are bad.

The solution here isn’t to lever up and pour more capital into housing. The solution is to reduce the size of their balance sheets as a prelude to outright privatization. Taxpayers have enough to pay for, they shouldn’t be providing insurance to buyers of mortgage-backed securities.

—————-

And while we’re on the subject of taxpayers bearing risk without receiving adequate protections, we have exhibit B….the Fed’s new “Term Securities Lending Facility.”

–In the wake of the Bear Stearns failure, which itself was NOT a bailout, the TSLF allows investment banks to put their toxic mortgage securities onto the Fed’s balance sheet in exchange for treasuries. This is yet another example of public resources protecting private balance sheets.

Some observers even see these loans as pseudo-equity. After all, if the investment banks encounter serious enough trouble that the loans are at risk, does anyone think the Fed will pull the plug by refusing to roll over the loans? Meanwhile, the investment banks haven’t been asked to submit to regulations that would protect the Fed (i.e. taxpayers). But don’t take my word for it:

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Read other posts on OptionARMageddon:

Interest Rates and the Dollar
How ’bout some good news!
Capital Raising, Merrill trickery
Fannie/Freddie may need to raise MUCH more capital
A Great Society No Longer? Interview with GAO chief David Walker
Walking Away……
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

Interest Rates and the Dollar

Reuters Staff
Mar 18, 2008 22:47 UTC

Why do lower interest rates depress the value of the dollar? And why should you care? Good questions worthy of a textbook-length response. I will try my best…..

First of all, it shouldn’t take much to convince you that you care about the value of the dollar. When its value declines that means, quite literally, that your dollars command less in terms of goods and services in the economy. Four years ago, one dollar purchased nearly a full gallon of regular unleaded gasoline. Today it buys only a quarter of a gallon…..

Now that you know you care about the dollar’s value, you may want to know some of the determining factors. One factor is interest rates. And the simple answer to the first question above–why lower interest rates depress the dollar’s value–is that lower interest rates for a currency reduce the incentive to save that currency.

Domestically-speaking, this rule means people have less incentive to park their money in a bank and more incentive to spend it. More spending means more dollars are floating around the economy. More dollars chasing a fixed number of goods will drive up the price of those goods (think Manhattan real estate: with so much Wall Street wealth floating around this island and only a fixed amount of land on it, real estate costs more here per square foot than anywhere else in the U.S.).

Internationally-speaking, the rule means investors have an incentive to move their money to countries where their savings will pay a higher rate of interest. So for instance, after today’s Fed rate cut, short-term U.S. savings will get an annualized rate of return between 2 and 3%. That’s down from over 5% less than 6 months ago. Compare that with the 4% rate of interest savers get in Europe right now. 4% interest vs. 2% interest. All else equal, investors with the option to save in dollars or in euros prefer to save in euros.

But how do those currently invested in dollars switch their savings to euros? How would you open a euro savings account if you only have dollars in your pocket? You simply exchange your dollars for euros, which you then put in a euro savings account. “Exchanging” dollars for euros is the same as “selling” your dollars for euros.

Remember that: SELLING dollars, BUYING euros. That’s the transaction that happens on foreign exchange markets when investors want to switch from “dollar-denominated” assets to “euro-denominated” assets.

Forgive me for repeating myself, but just so we’re clear:

If interest rates on dollar savings are going down, which they are, while interest rates on euro savings are staying the same, which they are, then it stands to reason that investors who have their savings in dollars would want to exchange them for savings in euros. To do that they have to sell dollars and buy euros. The demand for dollars is going down; the demand for euros is going up.

Here one need only recall the fundamental law of supply and demand: all else being equal, if demand for a commodity falls then so does the commodity’s price. The dollar is a commodity like any other and is subject to the same laws of supply and demand.

If investors increasingly demand euros instead of dollars for their savings accounts, then the value of the dollar will fall relative to the value of the euro. The chart below tracks the price of the dollar as quoted in euros since December 2005:

In December of 2005, one U.S. dollar purchased 0.86 euros, now it purchases 0.63 euros. The dollar buys 27% fewer euros today than it did just over two years ago.

Let’s add a complicating factor here: the trade deficit. What does the trade deficit have to do with the falling value of the dollar? Plenty. The most salient fact is that it turns America’s largest trading partners into some of the largest savers of dollars. Savers who have a larger incentive to shift their savings into higher-yielding euros each time the Fed cuts rates.

THE TRADE DEFICIT

Consider that every time an American imports a commodity from abroad he trades his dollars for it. For example, an American might trade $1 in exchange for a toy made in China. Or he could trade $109 for a barrel of oil dug from the ground in the Middle East. They get our dollars, we get their goods.

To help you, the individual consumer, appreciate exactly how YOU contribute to the trade deficit, it’s important to understand the middlemen who keep the process going. These middlemen buy goods from overseas, bring them back to the U.S. and then sell them to you. Walmart is a good example. To keep its prices so low, it searches out the lowest cost producers for all the stuff it stocks on its shelves, many of whom are located abroad. When you buy a toy at Walmart with a “made in China” label, the behemoth retailer is facilitating trade between you and a Chinese producer.

Again: you give the Chinese a dollar and get a toy in return.

Trade tends to be a two-way street. Most economies that sell goods to America also buy goods from America. And the mechanics are the same, just reversed. They give us currency, we give them American-made goods.

America has a trade “deficit” because we buy more foreign goods than foreigners buy American goods. $60 billion more per month to be exact. $2 billion more per day. That’s the net amount of cash we send abroad in exchange for goods and services. (Swedish massage anyone?)

Many foreign economies rely on trade with the U.S. in order to drive growth. It’s in their interest to keep the prices of their goods competitive in dollar terms so that American consumers keep buying them. To do so, foreign governments have to prevent their currencies from rising in value versus the dollar, which can be tough because the constant flow of dollars into their economies makes those dollars worth less.

To prevent their currencies from rising in value against the dollar, foreign central banks must mop up the flood of dollars flowing into their economies by purchasing them with their own currency.

In this and other ways, $2 billion a day finds its way into the savings accounts of foreigners and foreign governments.

And now we’re back to where we started: savings denominated in dollars….trillions of them in the vaults of foreign governments, which they turn around and invest in U.S. treasuries and mortgage-backed securities.

As the Fed cuts rates, it gives foreign governments an incentive to shift their savings into higher-yielding currencies.

Remember the basic relationship we specified above? As savers shift their savings into currencies other than the dollar, the value of the dollar falls relative to the currency into which they’ve converted their savings. This was because to effect the trade, the saver has to SELL dollars and BUY the other currency. Lower demand for dollars…..law of supply and demand….the dollar’s value falls. You’ve got it now.

But foreign countries that rely on trade with the U.S. to drive economic growth are loath to let the dollar fall since it would make their exports more expensive/less appealing to American consumers.

But at a certain point, some experts worry that the constant flood of dollars into their economies–combined with more Fed rate cuts that make those dollars less valuable savings vehicles–could cause certain foreign governments so much inflation at home that they have no choice but to let their currencies rise:

The inflation mechanics are as follows. The pegging central bank has to buy U.S. dollars in the foreign exchange market in order to prevent the dollar from falli
ng against its currency. The dollar-buying central bank purchases dollars with its own currency. The dollar-buying central bank gets its own currency the same way all central banks get their own currency – it figuratively “prints” it. The dollar-purchasing central bank therefore floods its economy with its own base money, resulting in inflation – inflation in the prices of goods/services and inflation in the prices of assets. [The above is often referred to in shorthand as the U.S. "exporting inflation."]

…in our opinion, what could turn a walk on the dollar into a sprint would be a decision by the Chinese and/or Saudi central banks to eliminate the pegs of their currencies to the greenback. Now, what would motivate these central banks to sever the peg? The desire to rein in their domestic inflation. In an environment in which the dollar is under downward pressure, the by-product of pegging one’s currency is higher inflation in the economy whose central bank is pegging.

It’s not exactly easy for a government with trillions of dollars in its bank to convert them quickly into other currency. So a “sprint” from the dollar by governments that hold them isn’t a high probability event. And yet it seems unwise for the Fed to tempt fate……

As we noted at the top, you care about a fall in the value of the dollar because that means you can’t buy as much stuff. A dollar is, after all, only worth what it will buy……

[Why in God's name would the Fed cut interest rates if it could cause a dollar stampede? Good question......but I'm tired so will save that one for another day.....]

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Read other posts on OptionARMageddon:

How ’bout some good news!

Capital Raising, Merrill trickery
Fannie/Freddie may need to raise MUCH more capital
A Great Society No Longer? Interview with GAO chief David Walker
Walking Away……
Sanity at last? Paulson rejects bailouts
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

COMMENT

Take a look at johnp’s argument, it continues to rely on “long-term” results. And his argument that 40 years of data prove his point is specious because, as I said in my comment above, we are in the midst of a housing decline of unprecedented proportion. By definition, I think an “unprecedented” event is hard to fit into a box using “historical” data.Again, let me reiterate the core of my argument. Buying a home isn’t necessarily a bad idea. Buying a home NOW is a bad idea–unless you can get a big discount on the market price.Johnp notes in his first post above that he works “in the mortgage and RE industries.” It’s funny, the similarities between real estate professionals and investment professionals. People listen to them when they say you have to “stay invested for the long-term” because you “can’t beat the market.” Having spent a few years in the investment profession, I can speak for that one and say the guys who always say “buy and hold” often do so for two reasons.1. unfortunately, they don’t do a lot of real work to determine which stocks are actually a good value.But perhaps more importanly,2. they ONLY GET PAID if you “stay in the market.” Investment pros typically get paid fees based on the level of assets under management. Therefore they have an incentive to keep you invested at all times.Because the bottom line is that investment “pros” are actually SALESMAN. They get paid to sell you something, a stock or a mutual fund….making you money is also important, but SECONDARY.I suspect things are similar with real estate and mortgage professionals like johnp, who only get paid when house sales and loans actually close. These people are salesman. They’re out to make THEMSELVES money, not you. So when common sense says now is CLEARLY NOT a good time to buy, they have to fall back on sophistries like relying on the “long-term.” I would certainly grant you that you CAN make money in the stock market or in housing if you hold on for the long-term. But to MAXIMIZE your gains and to AVOID losses, first you have to buy assets (a stock or a house) at a good price.Look at two investors who have been ridiculously successful, Warren Buffett in stocks and Sam Zell in real estate. Sam Zell (aka Saltator Sepulcir, Latin for “grave dancer”) has made billions largely by buying AT THE RIGHT TIME. Same story with Warren Buffett, he would be the first to tell you that you only buy assets your comfortable owning over the long-term. But before that, he would say you have to buy that asset at a discount to its true value.Most of you would say, well you have to have some kind of special brilliance to be a Warren Buffett or a Sam Zell. Yes of course you do. But common sense is often enough to keep people from buying at the wrong moment. Who among you didn’t KNOW deep down that real estate was starting to get ridiculously overvalued back as early as 2004? You just have to stick to your conviction for the (seemingly interminable) period before which prices finally return to common sense levels.Same story with tech/telecom stocks circa 1997-1998. Wasn’t it hard to stay on the sidelines while fortunes were being made in 1999 and 2000, before the crash that you KNEW would come finally did?The people that lost fortunes were the ones that kept drinking the kool-aid.Buying and holding CAN BE a good strategy. But you first you have to mix a little common sense into the buying part of the equation.So, dear reader, I say to you ignore real estate/mortgage “professionals” who say you have to buy now. Your common sense is a better guide to smart investing, whether in the stock market or real estate.

Posted by RW | Report as abusive

How ’bout some good news! Part 1

Reuters Staff
Mar 14, 2008 17:08 UTC

A dear friend e-mailed me yesterday and asked that I post some good news on my blog. It can be difficult these days as the credit markets implode and the realization sinks in that the worst is far from over. House prices have farther to fall, much farther. Banks will fail. The stock market will continue to crater as investors realize second half earnings will NOT rebound.

What’s the good news? I’d say that is the good news.

Yes credit markets are imploding and banks are failing. Why’s that good news? If you’ll permit me a moment of schadenfreude, I’d say it’s good news because the people who should be suffering ARE suffering. Banks made bad lending decisions, investors abdicated their due diligence responsibilities to credit rating agencies, both are suffering mightily. The whole structured finance business, whose function was to funnel cash from investors to home borrowers, regardless of risk, is more or less dead and tens of thousands of people will lose jobs as a result.

Real estate agents who helped inflate the housing bubble themselves with mindless marketing mischief (“house prices never go down”…..”there’s never been a better time to buy”….”renting is throwing your money away”) have seen business slow to a trickle. [By the way, if you still believe the canard that renting is throwing your money away, please do the math.]

Mortgage brokers and lenders–who, with the help of Wall Street’s securitization machine, shoveled credit to anyone with a pulse–are going out of business at an amazing clip.

Homeowners, especially those that bought recently, may be coming out quite well, relatively speaking. If you consider than many put in little or no equity to start, they basically lose little in foreclosure.

Those who did put money down and are suffering losses are doing so because they made a very poor decision to buy a house at the top of the market. That’s nobody’s fault but their own.

So part of the good news here is that those who should be suffering–irresponsible borrowers, foolish investors, enabler Wall Street banks, brain-dead real estate professionals, and predatory lenders–are indeed suffering.

Another piece of good news: house prices are falling. The beauty of market economies is that unsustainable market dynamics are, well, unsustainable……irrational prices don’t stay that way for long. After another couple years of renting, those of us who didn’t buy a house will be able to buy one at a reasonable price. In the meantime, we take comfort in knowing that renting IS better than buying. Here, once again, is why.

All of the above could be read as an endorsement of unfettered capitalism. It shouldn’t be. The rest of us may very well suffer from the bad decisions of others. Decisions that probably wouldn’t have been made had there been reasonable regulations for mortgage lender, for credit rating agencies and perhaps for capital levels and underwriting practices at Fannie, Freddie and other large financial institutions.

But we didn’t have reasonable regulation and the market was left to its own devices. I can see a few ways the rest of us will suffer as a result.

1. Banks are going to fail. When they do, deposits may be lost. Sure there’s FDIC insurance, but only for deposits up to $100k.
2. The implosion of credit markets means even good borrowers have no access to credit. If banks have no money to lend, well, they aren’t going to lend to anyone.
3. When the BIG financial institutions fail (Fannie/Freddie/Countrywide for sure…Bear Stearns, Citi, WaMu and dozens of regional banks potentially) the government will have to bail them out or risk depression. The government isn’t some big all-powerful entity, it’s taxpayers. Hundreds of billions of your tax dollars will have to be spent on bail outs.
4. The Fed is already trying to avoid that doomsday scenario by using interest rate cuts to take pressure off the economy. That’s spurring inflation and the dollar’s precipitous fall against other currencies. Who pays the price? Anyone with dollars in their wallet or a savings account since those dollars by less today than they did a year ago.

What to do? That’s a tough one. I can tell you what I’ve done: a year ago I sold out of the stock market and put most of my savings in money market mutual funds. 5% of my assets went into exchange traded funds that track the Euro and the British Pound, not enough as it turns out. Recently I also bought some muni bonds. Lastly, I put some cash under my mattress. (Actually in a safe deposit box, but the idea is the same) Unfortunately, with the exception of the euros and pounds, I’m very vulnerable to inflation. And it’s probably too late to buy gold…..

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Read other posts on OptionARMageddon:

Capital Raising, Merrill trickery

Fannie/Freddie may need to raise MUCH more capital
A Great Society No Longer? Interview with GAO chief David Walker
Walking Away……
Sanity at last? Paulson rejects bailouts
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

COMMENT

Normally as a currency falls imports become expensive and exports become cheap to others, hence leading to improvements in the balance of payments.

Unfortunately in the case of the USA made in the “US of A” is not a thing globally associated with anything except Jets and weapons. So what would we sell to the world? movies? songs? I think most countries have their own. I do not think a cheaper Harry Potter will occur anyway.

Posted by JackoByte | Report as abusive

Where is all the oil money going?

Reuters Staff
Mar 14, 2008 04:13 UTC

Mish had a fascinating post of the same title. Hopefully he doesn’t mind me borrowing it. Take a look at these photos of the Sultan of Brunei’s plane. (Hat tip Clif). By the way, I can’t vouch for the factual accuracy of this info; I received it in an e-mail forward. But what the hell:

An Air Force Lt. General wrote: I toured this aircraft as it was being ‘remodeled’ in Texas. Yes, the sinks are solid gold and one of them is Lalique crystal. The Sultan bought the aircraft brand new for roughly $100 Million dollars. He had it flown to Texas from the Boeing factory and had the interior completely removed. Then, he had the folks at E-Systems install $120 Million worth of improvements inside and outside. I have gained entrance to nuclear weapons storage areas much easier than it was gaining entrance to see this airplane. While there it struck me. Maybe the rich really are different than the rest of us.









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Read other posts on OptionARMageddon:

Capital Raising, Merrill trickery

Fannie/Freddie may need to raise MUCH more capital
A Great Society No Longer? Interview with GAO chief David Walker
Walking Away……
Sanity at last? Paulson rejects bailouts
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

Capital Raising

Reuters Staff
Mar 13, 2008 02:59 UTC

Banks are strapped for cash. This much is obvious. Ways to shore up capital levels on a financial institution’s balance sheet fall into two categories that I can think of. Bring it in and don’t let it go. Ways to bring in new capital include infusions from sovereign wealth funds for example or making margin calls on stretched borrowers. Ways to keep existing capital on the balance sheet include not making new loans, cutting dividend payments to shareholders.

In his speech announcing the Bush administration’s new regulatory proposals for various financial institutions tomorrow, Treasury Secy Paulson is expected to encourage those institutions to take a fresh look at their “dividend policies.” He’d rather they conserve that capital so they can “continue to lend….”

The blog Financial Crookery recently noted that Merrill unilaterally sweetened the deal on one of its convertible issues in order to avoid a capital draining event. (Hat tip Laurito)

Give ‘em points for creativity:

NEW YORK, March 6, 2008 — Merrill Lynch & Co., Inc. (NYSE: MER) announced today that it has amended the terms of its Exchange Liquid Yield Option Notes due 2032…to increase the conversion rate from 14.0915 to 16.5000 [and] to add September 13, 2010, and March 13, 2014, as dates in addition to the existing dates on which holders may require Merrill Lynch to repurchase all or a portion of their LYONs….

To understand why this is a clever way to dodge a drain of capital on the balance sheet, you have to have a basic understanding of convertible bonds. In its most basic form, a bond is just an IOU. A borrower sells the IOU to a lender in exchange for interest payments on the amount lent.

A convertible bond has an added feature. It gives the lender an option to convert the bond into common stock at a certain price. This particular bond has a “conversion rate” of 14.0915. That means every $1000 worth of bonds is convertible into 14.0915 shares of Merrill stock. The “conversion price” of the stock is simply the price at which conversion takes place: $1000 divided by 14.0915 shares = $70.96 per share. If Merrill common stock is trading above $70.96, I can convert my bonds to stock and recognize an instant paper gain. If it’s trading below that level, then converting my shares to stock would result in an instant loss.

Essentially, a convertible issue is a bond packaged with a call option. It’s a safer way to play a stock because while the bond’s value will increase as the stock increases, it won’t necessarily decline as the stock declines. The stock can fall precipitously, but the convertible bond is still worth its par value at some date in the future…..assuming, of course, the borrower has the capital to pay back bondholders when the bond comes due…..

Here’s a handy chart that illustrates how a convertible bond’s value relates to the value of the stock it can be converted into:

You can see that as the “current stock price” increases (as we move along the X-axis from left to right), the value of the convertible bond converges with the value of the stock. But as the stock price decreases, the value of the convert converges with the value of the bond. Upside without the downside.

With a basic understanding of converts, it’s easier to appreciate Merrill’s trickery.

The only other thing to know is that the issue mentioned in the press release has another key feature: it is “putable,” which means bondholders can “put” the bond back to Merrill at par on particular dates. One of those dates is today, March 13. With Merrill stock at $44, the call option embedded in the bond has little value (I’m guessing the over-under on Merrill stock getting back to $70.96 is probably 2011…;). So bondholders have an incentive to “put” their bonds back to Merrill at par value in exchange for cash.

Merrill would prefer that cash NOT drain from its balance sheet right about now. It would rather bondholders hold onto their converts until which time they can be converted profitably into common stock. In that case Merrill wouldn’t have to shell out any cash….only more stock certificates.

So to give investors an incentive to hold onto their bonds, Merrill unilaterally increased the conversion ratio to 16.5 shares from 14.0915 shares per $1000. That means bondholders can now convert their bonds into equity at $60.61 per share on the common ($1000 / 16.5 shares = $60.61 per share). They’re also giving bondholders two more dates on which they can put their bonds back: 9.13.10 and 3.13.14.

Financial Crookery puts it well: “Merrill gets nothing in return for these new features, they are unilaterally value-enhancing for the bonds. The bonds’ fair value is now presumably sufficiently above [this] week’s put strike that bondholders will not exercise. Cash call avoided, at least for now.”

Cash is king.

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Read other posts on OptionARMageddon:

Fannie/Freddie may need to raise MUCH more capital
A Great Society No Longer? Interview with GAO chief David Walker
Great Deals after the Mortgage Meltdown…..on office equipment
Walking Away……
Sanity at last? Paulson rejects bailouts
Bailout Watch, keep Congress on speed-dial
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

Fannie/Freddie may need to raise MUCH more capital

Reuters Staff
Mar 12, 2008 14:05 UTC

Below a story from Housing Wire, which itself quoted some figures in the Journal. Bottom line is that Fan and Fred don’t have the capital to back the mortgages they’ve guaranteed and will need to hit the markets for more at some point. I’ve written that Fan has at least $400 billion of subprime and Alt A exposure (and you don’t have to take my word for it). Given the losses in the subprime, Alt A, and even prime mortgage markets–what with the huge growth of negative equity in a world of falling house prices–it seems inevitable that Fannie will need more than the $40 billion of capital it has on hand.

Part of the reason both Fannie Mae and Freddie Mac’s stock has been punished recently is because of general concern over whether both GSEs can successfully weather the housing storm using current capital; the Wall Street Journal reported Wednesday that some market participants have been pricing in the expectation that both Fannie and Freddie will likely need to issue new stock. And alot of it.

The Journal estimated that both GSEs might need to pump out $20 billion in new issues this year, a number that could potentially double Freddie’s current float while diluting Fannie’s shares by as much as 50 percent.

From the story:

Equity issues of around $10 billion would have seemed outlandish just months ago, especially since Fannie and Freddie late last year raised new funds by selling $7 billion and $6 billion respectively in preferred stock. But the credit contagion has caused markets to question the ability of Fannie Mae and Freddie Mac to support the troubled housing market.

… In a recent research note, Friedman, Billings, Ramsey & Co. analyst Paul Miller suggests the companies should have capital equal to 3% of their direct mortgage holdings and 0.8% of those they guarantee. For Freddie, that would require $38 billion of capital, while Fannie would need $41 billion.

The rub is which capital measure an investor uses to see whether they meet that threshold. Fannie and Freddie publish several different ways of looking at this measure. There is capital defined by Ofheo, which excludes certain losses. On that basis, the companies are adequately capitalized, although markets don’t see it that way.

Then there is capital as measured under generally accepted accounting standards. At $44 billion, Fannie Mae would be all right on this measure, while Freddie Mac’s $26.7 billion in equity would be way under the $38 billion suggested by Mr. Miller’s approach.

Not that every investor is demanding this sort of massive dilution, of course, but there is enough speculation around that it is clearly pressuring both Fannie and Freddie’s share price. Freddie Mac has seen shares fall by more than 67 percent in the past six months, even including yesterday’s double digit rally; Fannie’s shares have fallen by more than 65 percent in the same time frame.

Both GSEs have said repeatedly that they feel they are adequately capitalized, after completing dueling stock issues late last year. Freddie Mac CFO Buddy Piszel on Wednesday said that the GSE is not planning on raising additional capital, Reuters reported.

“From a defensive position we feel okay,” Piszel is quoted as saying. “There is no dilutive capital raise planned.”

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Read other popular posts on OptionARMageddon:

A Great Society No Longer? Interview with GAO chief David Walker
Great Deals after the Mortgage Meltdown…..on office equipment
Walking Away……
Sanity at last? Paulson rejects bailouts
Bailout Watch, keep Congress on speed-dial
CDS, a hedge-funder’s view
Baltimore Sun Op-Ed: Ron Paul calls it on Fannie and Freddie

Spitzer admits involvement in "Prositution Ring"

Reuters Staff
Mar 10, 2008 18:19 UTC

This is completely unrelated to the subjects of this blog, unless you consider his time as Wall Street’s great nemesis as Manhattan AG. But what a great story. Somebody obviously caught him with evidence so he’s trying to pre-empt it. He’ll say something contrite in the appearance he’s planning to make any minute now. I wonder if his wife will be standing with him the way James McGreevey’s wife did…….

ALBANY – Gov. Eliot Spitzer has informed his most senior administration officials that he had been involved in a prostitution ring, an administration official said this morning.

Mr. Spitzer, who was huddled with his top aides inside his Fifth Avenue apartment early this afternoon, had hours earlier abruptly canceled his scheduled public events for the day. He scheduled an announcement for 2:15 after inquiries from the Times.

Mr. Spitzer, a first term Democrat who pledged to bring ethics reform an end the often seamy ways of Albany, is married with three children.

Just last week, federal prosecutors arrested four people in connection with an expensive prostitution operation. Administration officials would not say that this was the ring with which the governor had become involved.

But a person with knowledge of the governor’s role said that the person believes the governor is one of the men identified as clients in court papers.

The governor’s travel records show that he was in Washington in mid-February. One of the clients described in court papers arranged to meet with a prostitute who was part of the ring, the Emperors Club VIP on the night of Feb. 13.

Mr. Spitzer appeared on a CNBC television show at 7 a.m. the next morning. Later in the morning, he testified before a Congressional committee.

An affidavit filed in federal court in Manhattan in connection with that case lists six conversations between the man, identified as Client 9, and a booking agent for the Emperors Club.

He had a difficult first year in office, rocked by a mix of scandal and legislative setbacks. In recent weeks, however, Mr. Spitzer seemed to have rebounded, with his Democratic party poised to perhaps gain control of the state Senate for the first time in four decades.

Mr. Spitzer gained national attention when he served as attorney general with his relentless pursuit of Wall Street wrongdoing. As attorney general, he also had prosecuted at least two prostitution rings as head of the state’s organized crime task force.

In one such case in 2004, Mr. Spitzer spoke with revulsion and anger after announcing the arrest of 16 people for operating a high-end prostitution ring out of Staten Island.

“”This was a sophisticated and lucrative operation with a multitiered management structure,” Mr. Spitzer said at the time. ”It was, however, nothing more than a prostitution ring.”

Albany for months been roiled by bitter fighting and accusations of dirty tricks. The Albany County district attorney is set to issue in the coming days the results of his investigation into Mr. Spitzer’s first scandal, his aides’ involvement in an effort to tarnish Majority Leader Joseph L. Bruno, the state’s top Republican.

$107

Reuters Staff
Mar 10, 2008 16:03 UTC

The A.P. notes that oil has reached a new high of $107 in intraday trading today:

NEW YORK (AP) — Gasoline prices were poised Monday to set a new record at the pump, having surged to within half a cent of their record high of $3.227 a gallon. Oil prices, meanwhile, surged to $107, a new inflation-adjusted record and their fifth new high in the last six sessions on an upbeat report on wholesale inventories.The national average price of a gallon of gas rose 0.7 cent overnight to $3.222 a gallon, 69 cents higher than one year ago, according to AAA and the Oil Price Information Service. Last May, prices peaked at $3.227 as surging demand and a string of refinery outages raised concerns about supplies.

That record will likely be left in the dust soon as gas prices accelerate toward levels that could approach $4 a gallon, though most analysts believe prices will peak below that psychologically significant mark. In its last forecast, released last month, the Energy Department said prices will likely peak around $3.40 a gallon this spring; a new forecast is due Tuesday.

While Bernanke is busy trying to save the financial system from itself, the rest of us are, literally, paying the price. Inflation is rocketing northward as the Fed cuts rates and the U.S. economy slows. Why do those two factors influence inflation?

A weaker U.S. economy and lower U.S. interest rates discourage investors from holding dollar-denominated assets like American stocks and bonds. Selling a dollar asset in exchange for one denominated in another currency is tantamount to selling dollars. And the market for dollars responds to supply and demand like any other market. If there are more sellers than buyers, supply is higher than demand and prices drop. The price of the dollar is quoted in units of foreign currency. If the dollar is worth less, then it takes more of them to buy a unit of foreign currency.

For example, to buy one Euro an American has to pay about $1.54. A year ago, it was $1.28. That means that, relative to European currency, the value of American currency has fallen 17%(!) in one year.

Why does the foreign exchange market impact Joe Sixpack? Because as trade barriers fall, Joe now competes with foreign consumers for many of the same goods. To compete with foreign consumers, who have stronger currencies in their pockets, Joe has to offer more of his dollars.

This is a highly simplified look at things. It’s important to address the risk of deflation, which remains a very real threat. I will do so in a forthcoming post.

I should note that even though falling trade barriers mean that we’re increasingly competing with foreigners for many of the same goods, the answer is NOT to turn around and RAISE trade barriers. The flip side of foreign competition is that U.S. consumers gets to buy stuff that’s manufactured in cheap locales like China. Importing goods from countries with lower costs of production helps keep prices low.

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Indeed, that’s a key reason the U.S. economy has expanded so much over the last 20 years without igniting inflation. Costs haven’t been going up because producers have been able to shift production to countries like China and Mexico. Though SOME Americans suffer a job loss, ALL Americans benefit from lower prices.

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