Bruce Krasting

Counter Trade Dubai

2009-11-27T07:35:00.000-08:00

I wrote a piece on Wednesday evening that discussed my own experiences with market volatility over Thanksgiving. It ended with:

The rates on your screen Friday morning will be meaningfully different than the ones you are looking at today.

I got the Vol. right. But I had no clue that the source of the hiccup would be Dubai. The reason is, as many have pointed out, this is “old news”. To be sure, there have been some new and important developments. But I doubt that Dubai is the issue that sinks the ship.

The talk is of $80-90 b of exposure. Say half of that is lost money. Of that, 70% is deep pockets in Abu Dhabi. That gets to an ‘outside the Gulf’ loss of only $15 b. A few European Banks will get hit. There is very little US exposure to this mess. The numbers do not look that big to me.

How big of a surprise was this? I suspect not so big for those who have big stakes in Dubai. These were WSJ headlines from 11/23. Three days before before the Tday blowup.

If you are a big bondholder you keep an eye on whether the contractors are getting paid. If there is no money for the vendors then it is just a matter of time before the creditors get stuck. This comment from a gulf paper Six months ago:

Nakheel, for example, has asked its suppliers to take discounts of between 25 per cent and 35 per cent.

There are dozens of examples of press reports that Dubai was in arrears for a long time. So I do not buy that this is a nexus for the market.

I think that by next week market focus will again return to those of Wednesday. A weak dollar, strong gold and busted monetary policy. Dubai is a side show that was aggravated by our holiday and an overreaction in Asian markets. We will revert back to the main event.

Note: In looking at this I saw these comments. Someone has to say things like this. It still strikes me funny:

November 24, 2009 US Consul General Justin Siberell to “Emirates Business”.

"We are certainly bullish on Dubai.”

Micro and Macro Economics – “It Stinks”

2009-11-26T07:00:00.000-08:00

I was talking to a friend who is a contractor. He’s been in business for a long time and has a good reputation. Renovations, additions, a custom built house now and then were his specialty. In the good times he had three crews working full time and a payroll of $20 grand a week. The good times are over. I asked him how is business was going. His response, “It stinks.”

I asked him, “What changed?”

He said something that rang a bell:

“90% of my business came from homeowners who re-fi’ed to pay for the work that I did. That is over now. No one has equity in their homes anymore and if they do have equity, the banks won’t lend against it .”

Jump from the micro to the macro economic impact of this. The following is a graph of total mortgages outstanding. Mortgages debt grew at a 10% pace up to 2008. Since then the total has declined.

This chart looks at the trajectory of mortgage growth based on prior years and compares it to the actual.

The gap is very significant. Of course the trend line of mortgage growth pre 2007 was unsustainable. Assume that instead of a crash we had a soft landing in 2008. This graph looks at a mortgage growth rate half of what we were experiencing. There is still a big ‘debt gap’.

These gaps are what hurt my contractor friend. His business (and a lot of others) lost the grist that made it all work. Money. The home equity ‘piggy bank’ is empty and busted. He has only one crew now. He is not buying any new equipment anytime soon. His business at the lumberyard is down 60%. The bank cut his line. His subs and suppliers want cash. The jobs that are out there are bid low because there are a lot of guys scrambling for work. A business that once paid payroll and income tax is now costing us. There are 15 people getting nine months of unemployment. As far as GDP impact goes, this company went from third gear to reverse.

I don’t know the relationship to mortgage debt creation and GDP. I would guess around 20%. Based on that, the gap I described above would translate into a $300b contribution to GDP. About 2%. We desperately need that 2% right now. We aren't going to get it. We are at least three years away from achieving growth in total mortgage debt.

Total residential mortgages outstanding today are at levels last seen in the 1st Q of 2007. By way of comparison the current GDP level is about where it was at the end of 2006. For me, this means that the economic recovery for the next few years will be anemic at best.

Note: The FRB data is from June 30, 2009, so it is stale. The monthly numbers from both Fannie Mae and Freddie Mac through October confirm that there is still no growth in mortgages. F/F’s combined books are in decline. FHA has picked up the slack, but I doubt that there is any net growth. FHA will have to reduce its lending in the near future. They can’t keep lending 96.5%, they will go broke. There is no soft landing for this segment of the economy.

Bernanke Vs. Gold - Getting Hostile

2009-11-23T14:15:00.000-08:00

I was struck with Bernanke’s comment last week at the Economics Club regarding bubbles. He said:

”It is not obvious to me that there are any misalignments in the US financial system”.

This comment has already gotten the attention of the media. Two years from now the blogs will be quoting it along with other notable words from the Chairman. Remember the following? Mr. Bernanke regrets having said this:

“We (the Fed) do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

When Mr. Bernanke made those comments back in May of 2007 he was either misrepresenting the facts or he simply could not see the implications of the facts that were in front of him. I don’t think he was fibbing to us then. He called it as he saw it. He simply had no clue what the pieces meant. I am concerned that he is equally out of touch today.

How could Mr. Bernanke not see that zero interest rates are a misalignment?

Mr. Bernanke is a student of economic history. He knows that during the 30’s T Bill rates went negative. I am sure that he remembers the panic of 2008 when again Bill yields fell below zero. But those were panic situations. There is no panic today. But bill rates are at zero.

I am sure that Mr. Bernanke is smiling ear to ear as he sees the evidence that his plans are working. Zero interest rates were his objective. He has succeeded and even exceeded his goals.

What Mr. Bernanke has accomplished is making fiat money useless. It now costs you to own the stuff unless you want to gamble with it. Our whole system is based on the notion that money has value. The Fed has established that it has none.

I assume that Mr. Bernanke is acutely aware of day-to-day market movements. He knows that the comments by St. Louis Fed Governor James Bullard that “Maybe we should extend the Agency POMO buys” quickly resulted in a $20 pop in the gold price. You can’t ask for a better example of the market’s attitude towards America’s monetary stance. It is starting to get downright hostile.

It would be a kick in the pants to the entire financial system if the price of gold started to have a meaningful impact on monetary policy. I think that is exactly what is going to happen. It is just going to take a while. Bernanke continues to believe that nothing is misaligned. We are going to wake up and find out that things are horribly misaligned.

FDIC on REO Sales: Keep'em in the Dark!

2009-11-22T07:00:00.000-08:00

In October the FDIC held a large auction of properties it had acquired as a result of failed banks in Georgia. I thought this was an interesting story and wrote about it before the auction took place. It was my intention to write about it again after the results of the auction were released. No such luck. The FDIC has decided to keep us in the dark on this one. The following is an email I got from JP King, the auction house who ran the Georgia auction:

“Unfortunately, FDIC has prohibited us from releasing any information regarding the auction. We've been trying to get them to let us release the results, but they have denied our requests. We aren't allowed to release any details.”

I would have thought that the results of a pubic auction of properties owned by FDIC would have to be publicly disclosed. So why is the FDIC trying to cover this up?

The answer is that the REO problem for the D.C. lenders and the FDIC is reaching a crisis level. In spite of every effort to avoid foreclosures the fact is that the number of properties owned by the Feds is rising on a daily basis.

There are approximately 55 million mortgages outstanding today. At least 10% will/have gone into default before this is over. Of those half will result in foreclosure. These numbers create an estimate of the Federal share of REO at about 1.5 mm homes. Depending on unemployment and the economy going forward that number could be much higher. Before this is over the Feds could own up to 5% of all residential RE.

D.C. is struggling with this. The Treasury Department has created HAMP and HARP, two programs designed to restructure bad mortgages and keep homeowners in the house at all costs. So far the results from these programs have been terrible. More than half of the restructured loans re-default within nine months.

Fannie and Freddie are going into the rental business with their REO. They are charging “market rates” of rent to defaulted owners who are willing to stay in the home. Given that market rents today are equal to the costs of ownership I doubt that the new ‘Renters’ are going to be able to make the payments. So this program is just delaying the recognition of the REO problem. At best they have pushed the problem forward by one year.

The FDIC, FHA, Fannie and Freddie all have their own web sites for the properties they own. I think they are doing a good job of advertising what they have to offer, but of course they can’t find buyers. Unless a property is being offered up in an auction or at a very distressed price it just does not sell. Ask anyone trying to sell a house in any section of the country. If you sell today you have to leave a lot of money on the table. What is clear is that when properties are marked down to distressed levels, or there is an auction, the demand is there. The buyers are vultures. You can’t blame them for that.

We are in a vicious cycle. Lower properties values create more underwater borrowers. Underwater borrowers have no incentive to pay so they don’t. Defaults/foreclosures follow. The liquidation of the resulting REO creates more downward pressure on property values. The drop in values just leads to more underwater borrowers and more defaults.

D.C. is well aware of these facts. A recent letter from the American Bankers Association (ABA) to the FDIC had the following to say on the topic. Read these words to say, “Stop the liquidations! You are killing us!”

“The prompt post-closing sale (auction) of real estate in depressed markets, while understandable from the perspective of wanting to conclude a resolution quickly, results in a lower price paid to the FDIC for the assets. This further depresses the market prices obtained by other banks trying to work through problem assets of their own.”

We have already spent trillions shoring up the banking system. They have a big REO problem too. Policies that hurt the banks and force them to compete with the likes of the FDIC are not constructive. We are shooting ourselves in the foot. So just this one time I have to agree with the ABA position.

In my prior post on the JP King/FDIC auction the comments were all in support of the FDIC. People wanted price discovery and a rapid wind down of the government’s ownership of residential RE. It’s hard to argue with that logic, except for the fact that if we go down that road RE is going to fall another 25% and we will be talking about the D word again.

With this as a backdrop it is easy to understand the thinking at the FDIC in withholding the results of the Georgia auction. They would be damned if it was determined that the liquidations resulted in drops in RE values in the communities where the auctioned homes were. (Trust me, that is what happened)

But they should be equally damned for not letting the public know what the results were. This policy is not in keeping with the, ‘new spirit of openness in government’ that we keep hearing about.

Secrecy is not going to work. The fact is we have four major Washington based entities that combined have over $8 Trillion in financial assets secured by real estate. There has to be a coordinated plan to deal with the individual Agency’s REO problem. Uncle Sam is already the largest property owner in the US; the holdings will double in the next twelve months. That is too big a problem to keep secret.

Oct. SSTF Report - We Are Now Living Off Of The Interest

2009-11-17T19:04:00.001-08:00

The Social Security Trust Fund wracked up another monthly deficit for October. The shortfall was $4.2 billion. This is the 5th consecutive month of red ink for the Fund. The total for the period comes to $15bil. Blame the economy and the boomers for this problem. Some basic measures of the Fund's performance are rapidly deteriorating.

A critical measure is the ratio of Payroll Tax receipts to Benefits paid. The following chart looks at that ratio over time. That ratio will fall below 1.0 for the full year 2009. As of today we are living off of the interest.

In November the SSTF will pay out $56.9 billion. They will be lucky to take in $47 billion in tax income. The deficit will be near to $10 billion. Interest income, and other income add another $140b annually to the Fund’s top line. But with monthly deficits of $10b on an operating basis, the Fund is running very close to break even for 2010. That possibility is not on anyone’s radar screen.

My estimate for benefits in 2010 is $756 b. If we assume total GDP growth of 2% the resulting ratio is 5.75%. That is up from 4% just a few years ago. It is rising fast. The following is from a CBO report on the Fund from August 2009. These guys think it going to 6% in 2030? This train will arrive 18 years early.

“Both CBOE and SSTF project that Social Security’s outlays will rise from 4.8 percent of gross domestic product (GDP) this year to about 6 percent in 2030 and will stabilize thereafter.”

The US is struggling with health care legislation. Inside of this debate is a cost of about $1 Trillion. We can’t agree on this because of the question, “Who will pay?”

Health care is small beer compared to SS. My estimate on the current imbalance of the fund is close to $7 trillion on a NPV basis. We are on a ship traveling at high speed toward a rocky shoal. And it is foggy and no one has a clue.

SS is too hot a potato to come up for a resolution prior to next year’s elections. That would imply it comes up for discussion sometime in 2011. The Fund can’t wait that long. I just keep wondering when the MSM will wake up to this.

FDIC Decision Due Out Soon

2009-11-11T15:47:00.000-08:00

On September 29th the FDIC announced a plan to bolster its reserves. There were three basic choices. A) Borrow from the Federal Financing Bank, B) Charge a large special assessment on the banks and C) Have the banks pre-pay three years of insurance premiums up front.

At the time, the FDIC gave the public a thirty-day comment period before the final determination. That time period is up. The letters are in. I would expect an announcement on this by Ms. Bair before the end of the week.

This is the link to the letters. There are a lot of them. The FDIC may choose to ignore all of the comments, but I think they will address some core issues raised in their final ruling.

The FDIC went after this with a carrot and a stick. They said to the banks,” If you pay up front we will make the accounting work for you”. “If you don’t, we will charge you a ‘Special Assessment’. That would go through your income statement”.

Bankers being bankers it is understandable why they would not want to recognize an expense up front if there was another way around it. Therefore almost all of the letters were in support of the pre-pay deferred recognition approach.

There was some support for the FDIC to tap its credit lines at the Federal Financing Bank. They have a blank check at the FFB for $100 billion. So the pre-pay option isn’t really necessary. But the easier FFB option had a significant cost. Ms. Bair is acutely aware of the ‘anti bailout’ mentality. Her words on the subject:

“It's clear that the American people would prefer to see an end to policies that look to the federal balance sheet as a remedy for every problem.”

This is why the FDIC made it easy for the banks to choose door (C). It’s cosmetics.

Not surprisingly the Banks all wanted a bone thrown to them. They made a good case. If they did not prepay they would have earned a spread on the cash. So in effect the proposal has a negative impact on income. We wouldn’t want that. A few examples:

Some thought of what may come:

-The $45 b prepay is a done deal.

-There will be exceptions in a number of cases and categories of banks. These banks will get a drawing from the FFB. That drawing will be guaranteed by the FDIC. This is small beer. Maybe $5b. It will look like the FDIC will have no borrowings however.

-There will be no special assessments.

-There will be a discount on the pre-payment. The banks will be allowed to take that as income. Top line benefit that has no substance.

-The assumption that deposits will grow by 5% will be reduced. This will have the impact of reducing the net amount that the FDIC takes in. (by just a few billion)

-The statement will reaffirm that deposits are safe and that the FFB (and this cash) is backstopping that promise.

-This will be made to look like a great success. A true private sector solution.

-The ‘system’ will have created another $45 billion of off balance/income statement funding. This will not show up anywhere.

-If a discount is awarded to the banks then that percentage should be compared to the cost of tapping the FFB for the shortfall. Any excess would be a measure of the Government's willingness to avoid the perception of a bailout.

Congressman Latta was very supportive of the proposal in his letter. I thought his side comments were interesting:

Also of interest was this comment by the ABA.

Fannie and Freddie Own Stuy Town?

2009-11-10T14:14:00.000-08:00

Stuyvestant Town in NYC looks like a default about to happen. This was a $5.4 billion mega RE deal from November of 2006. There is a $3 billion 1st mortgage. I think that Fannie and Freddie own close to half of that.

The following is from a 2007 Wachovia prospectus. This shows that of the $3b mortgage $1.5 bil was taken down by ‘Watchoveryou” (AKA Wells Fargo) and later put into this $7 billion CDO. (garbage) The balance was structured as a bond that ranked par passu with this mortgage. Those bonds made it to the government mortgage agencies.

Bloomberg quoted a Freddie Mac spokesperson as saying, “Freddie Mac doesn’t expect to lose money on the bonds backed by the property.” Let’s hope so, but the following doesn’t make me feel good that a $3b mortgage is money good:Link

Two questions come to mind. The first is, “How is it that the GSE’s bought this paper in the first place? The second, more important issue, “How much more of this kind of stuff do they have?”

Stuyvestant Town does provide rent controlled housing, but the 2006 transaction had nothing to do with achieving the Country’s housing objectives. The business plan from the new owners (Speyer/Blackrock) was to get the old rent controlled tenants out as fast as possible and then raise the rents and condo-ize units to pay down the loans. There is no justification for Fannie and Freddie to have financed that process. The motive was to leverage up their balance sheets and generate fee-based revenue. There was never sufficient income to service the mortgage debt. A $400 mm reserve was set up to cover the shortfall. That account is now empty. This was a bad loan from the get-go.

On the issue of how much else is there? We don’t know. The following from F/F just raise questions.

The Administration will address the GSE’s in the coming months. The path for the mortgage agencies and the government’s future role in the mortgage market is up for discussion. Possibly the process should start with a list of what the GSE’s did that was not in the interest’s of the taxpayers.

Fannie’s Tax Sale to Goldman – No Deal! Bad Optics the Reason?

2009-11-07T07:58:00.001-08:00

This is an odd ending to this saga. Some very big names were involved. Fannie Mae clearly wanted to do a deal; the regulator for Fannie (FHFA) was strongly supporting it. Goldman Sachs was looking to make a buck putting the transaction together and selling it to Warren Buffett. So why didn’t it happen?

Based on the information provided in Fannie's 10-Q the terms and conditions for the transaction were agreed to and a nonbinding contract was entered into prior to September 30th. The condition for a go ahead was subject to Treasury’s approval. Today we learned that Treasury has said no.

Treasury’s basis for nixing the transaction was pretty clear. In their view it would have resulted in a net loss to the taxpayer, from the WSJ:

Treasury Department officials blocked the deal after concluding that it would have resulted in a loss of tax revenues greater than the savings to the federal government had it allowed the sale. "In short, withholding approval of the proposed sale affords more protection of the taxpayers than does providing approval".

That conclusion is at odds with Goldman Sachs. Mr. Michael DuVally a GS spokesman said of the deal:

"The only basis on which approval for any transaction would be given would be if it was clearly in the taxpayers' best interest."

So who is right, GS or Treasury? Just this one time I am going with Goldman. They would not have made the statement to Bloomberg unless they had the numbers to back it up.

This was not a simple matter of Buffett writing a check and getting a specified tax benefit. It involved an asset transfer, presumably funding would have been required. The tax benefits would have been realized over a period of time. At some point in the future the assets would have reverted back to Fannie. This was a rental of tax benefits.

Given the complexity, it is possible that the parties had different measuring matrix's when assessing the merits of the deal. But I doubt that. Clearly Fannie’s management and regulator were happy with the numbers. They must have considered the taxpayer side of this before signing the deal. Same for Goldman and Buffett. They understand the necessity of passing the “Smell Test” these days.

My guess is that this deal did not crater because of bad economics. It bombed because of bad optics. The Administration did not want to be seen as facilitating a transaction that would have been perceived as benefiting the ‘Fat Cats’.

This is a sign that D.C. is well aware of the fact that a significant percentage of the populations hates our public and private financial institutions. They understand that this issue is the “Mother of all Systemic Risks”. In that light, the Administration’ decision to nix the deal makes a great deal of sense.

I fear that net net; the taxpayer will pay a price for this choice. I, for one, would like to see the actual economics of the transaction. Possibly Treasury could provide the details. My guess is that over the next five years this will cost us a few billion. That would be a cheap price if it placated an angry population. I doubt it will.

NOTE:
There is nothing new in the proposed transaction. Fannie did this in 1999 with Citicorp:

WASHINGTON, March 16 /PRNewswire-FirstCall/ -- Citibank, N.A. and Fannie Mae today announced that Citibank purchased from Fannie Mae a portfolio of investments representing approximately $676 million in federal Low Income Housing Tax Credits (LIHTC) for cash plus the assumption of Fannie Mae's capital obligations relating to the investments.

In it’s November 5, 2009 10-Q Fannie Mae discusses the proposal. The cost to them of not disposing of the tax assets? $5.2 billion.

“As of September 30, 2009, the carrying value of our LIHTC investments was $5.2 billion.”

Goldman/Buffett/Fannie Tax Deal Inked a Month Ago

2009-11-05T14:34:00.000-08:00

If you were curious about the recent news regarding Goldman Sachs and Warren Buffett’s interest in acquiring the tax losses of Fannie Mae the details are in Fannies 10-Q.

This deal was agreed to and inked a month ago. It is still pending approval. So the information that was first reported by Bloomberg was a deliberate plant. A possible objective would have been to get a decision on the transaction before today's release. Note that the Q provides an update of the deal’s status as of November 5. Someone was waiting to edit this section right up to the last minute. A tad unusual.

From the Fannie Mae 10-Q , November 2009

Prior to September 30, 2009, we entered into a nonbinding letter of intent to transfer equity interests in our LIHTC investments. Under the terms of the transaction as currently contemplated, we would transfer to unrelated third-party investors approximately one-half of our LIHTC investments for a price that exceeds their current carrying value. Upon completion of the contemplated transfer, the unrelated third-party investors would be entitled to receive substantially all of the tax benefits from our LIHTC investments for a specified period of time. At a specified future date, the percentage of tax benefits the investors would receive would automatically be reduced and the percentage of tax benefits we would receive would be increased by the same amount. In addition, we could have the obligation to reacquire all or a portion of the transferred interests.

We have requested the approval of FHFA, as our conservator, to complete this transaction. FHFA has advised us that it has no objection to this transaction as it is consistent with the conservation of the assets of the corporation and that FHFA has requested Treasury’s approval under the senior preferred stock purchase agreement. As of November 5, 2009, FHFA has not yet received this approval. If in the future we determine we no longer have the intent and ability to sell or otherwise transfer our LIHTC investments for value, we would record additional other-than-temporary impairment to reduce the carrying value of our LIHTC investments to zero. As of September 30, 2009, the carrying value of our LIHTC investments was $5.2 billion.

So the number that Fannie puts on the value of these tax credits is $5.2 bil. It will be interesting to see what Goldie and Warren were willing to pay for them. The real question is, what are they worth?

A Move on Gold? Willy-Nilly Did It.

2009-11-03T19:13:00.000-08:00

Is it possible that gold could move up in value to say $1,400 and at the same time the relative values of the Dollar/Euro/Yen/ Sterling would remain stable (+/- 2%)?

One month ago I would have said that would not be possible. Today it looks like a wild card that could come in.

There is a biblical amount of liquidity available globally at a cost less than 1/2%. In that environment gold is an increasingly attractive asset class. Gold doesn’t pay interest, but neither do T Bills. India just said so. We will see more of this.

Would a move up in the price of gold against the major currencies precipitate policy responses by Central Banks?

I think it would. As much as they hate to admit it, every Central Banker for the past forty years has watched the price of gold. It is their ultimate barometer. The US would be the last to respond and reverse the emergency liquidity measures. But it will be increasingly difficult to defend QE when other reserve currencies have reversed their cheap money policies.

The markets have called all of the policy responses for the last two years. We might not be done with that cycle yet.

Some thoughts from Mr. Bernanke from 2002 that I thought were relevant:

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

“Of course, the U.S. government is not going to print money and distribute it willy-nilly.”

Note: These remarks were made in a speech titled Deflation: "Making sure “It” Doesn’t happen here”. November 21,2002. The full speech is here. The quote is from the fourth para. following the heading: Curing Deflation.

Richmond Fed on the GSE’s – “They Encourage Defaults”

2009-11-01T04:54:00.000-08:00

The Richmond Fed produced a report that provides some useful information on the issue of non-recourse mortgage loans and their default rates. The report includes a State-by-State breakdown of the rules for defaulting.

This report was over my head. For example, the following calculation describes the probability of a short sale in a Recourse State:

The conclusions are easier to read. I found this interesting:

“For homes appraised at $300,000 to $500,000, borrowers in non-recourse states are 59% more likely to default than borrowers in recourse states. For homes appraised at $500,000 to $750,000, borrowers in non-recourse states are almost twice as likely (100%) to default as borrowers in recourse states while for homes appraised at $750,000 to $1 million, borrowers in non- recourse states are 66% more likely to default.”

California is the largest State that is also a non recourse State. It is also a place where a significant amount of properties are worth >$300k. Given that the anticipated default rate is 70+% greater then in another State it tells you what is happening and what will continue to happen for Cali-jumbo mortgages. It is a black hole. Given this, why would anyone be willing to lend in California?

Also from the conclusion is the following. It took me a bit to understand the double negatives. When I see words like this I just assume that it is an effort to obfuscate something.

“We cannot reject the hypothesis that recourse does not have an effect on Loans held by the Government Sponsored Enterprises.”

In the body of the paper is a better explanation:

“Recourse does not have a significant impact on the probability of default for mortgages held by a GSE.”

I found that to be a startling observation. What this means is that people will more likely default on a GSE loan than a private lender regardless if they are in recourse or a non-recourse State. This can only be attributable to the following mindset:

“I owe this mortgage to the Feds. Even though they have the right to go after my bank account to pay this off I know they will not. So screw them, I‘m not paying. There is no downside”.

The confirmation for this comes from the Richmond Fed:

“The probability of default by foreclosure increases by 7% for mortgages held by a GSE as compared to the mortgages held by private lenders.”

This report was sent to Congress. I doubt they will read it. Barney Frank, one of the chief ‘deciders’ on all of this should read it. The conclusion is obvious. When the government makes mortgage loans they are encouraging defaults. As lenders they appear to have no teeth. This is a hell of a predicament given that the D.C. lenders are currently 95% of the new mortgage market. The total value of mortgages held by Uncle Sam is $7.5 Trillion.

The most significant contribution from this piece is a well-organized discussion of who can do what to whom and when can they do it on a State-by-State basis. That information can be downloaded at this site. The information on the individual State Laws starts on page 43 and ends on 54.

The following is a summary of that information. If you are thinking of defaulting on your mortgage you might take a look at these sources. Who says the government doesn’t provide useful information?

Hampton Georgia (Pop. 5,300) Attacked by FDIC, FHA, Fannie and Freddie

2009-10-30T15:00:00.000-07:00

The FDIC held a big auction this week of properties they own outside of Atlanta Ga. JP King conducted the auction. The FDIC put up 187 properties for sale. The results have not been released yet. I suspect that it might be an interesting story when the numbers do come out. I reviewed some of the available information and came up with some observations.

-Of the 187 properties listed by the FDIC 18 were located in Hampton, Ga. Zip 30228.

-FHA (Federal Housing Administration/HUD) is currently listing 32 properties in zip 30228.

-Freddie Mac has only 2 listings in 30228.

-Fannie Mae has 25 properties for sale in 30228.

-The total number of homes that the government has foreclosed and has for sale in Hampton Ga. is 78.

-The FDIC is auctioning off the following home at 148 Makenna Drive; while at the same time FHA is trying to off-load the same model at 202 Makenna. Note that the FHA notice suggests a Sale Pending at $84,000. I will bet that the auction price for the FDIC is far less than the price FHA got for its house. Therefore the FHA deal is going to crater.

-It is fairly clear from this that one part of the government, FDIC, is killing the REO owned by other parts of the government. That is insane. No one appears to be looking at the Federal REO problem and attempting to make sense of it.

-The For Sale signs by the Feds are all over the poor town of Hampton, Ga. What does this do to the people who live there and own homes? For them Uncle Sam is driving down local RE prices. What are those folks going to do when the price of their home drops as a result of the liquidations by the Washington crowd? They are going to default on their mortgages too. We know that the biggest source of default in the current cycle is that borrowers are so far underwater they have no economic incentive to pay. So they don’t.

-Hampton Ga. is a troubled community. It was overbuilt with fast money. What is particularly troubling for me is that FHA has a 40% share of the government owned properties in this community. That is a very big number. At the time these bad loans were made the FHA had a 10% total US market share. Therefore the REO ownership is about 4X’s higher than one would expect. Possibly the FHA just got unlucky with it’s exposure to Hampton. But if one extrapolated from this it would be easy to conclude that FHA has a very troubled mortgage book.

HUD’s head Shaun Donovan has said that the FHA does not need a bailout. Their exposure in Hampton Ga. makes that a question mark.

.01% Or .1%? A Big Difference

2009-10-25T18:11:00.000-07:00

We will probably know if H1N1 will be a hit or a miss in the next 90 days. The range of possible outcomes is enormous. In an average year we would suffer 35,000 deaths to flu. This comes to .01% of the population. There is no indication that this year will be any different. There are some worrisome issues however.

-Swine flu has its highest mortality rates in the 5-25 age range. This is asymmetric to other flu results. Typically the very young and very old segments of the population would be most affected

-H1N1 ravages the lungs of those severely affected. It is the cause of death.

The vast majority of those who will be acutely impacted will require a ventilator. Without it they will die. The question is, “Is there enough of these machines?” The answer to that is dependant on the number people who become ill. If that number is high, then we do not appear to have the respirators that may be necessary.

To my knowledge there is no national public numbers on this topic. In 2007 New York State provided some information and analysis on this issue. I will use that data to extrapolate some estimates. From the report:

*15% of the admitted patients with pandemic influenza will require intensive care,
*7.5% of the admitted patients with pandemic influenza will require ventilators,
*There are currently 6,100 ventilators in acute care settings in New York State,
*At any given time, 85% of the ventilators in acute care settings are in use, and
*70% of deaths related to pandemic influenza are projected to occur in a hospital.

NY State has a population of 20 million. Prorate the NYS information across the total population of 330mm and you get:

-The total number of respirators is 100k.
-The number of respirators that are available net of other needs is only 15,000.

In a ‘normal’ flu season 200,000 patients require hospitalization. Using the NYS number of 7.5% needing ventilation you get to that 15,000 number very quickly. In the event of a severe outbreak, triage of ventilators will be required. If one was concerned about the, End of Life Counseling debate the discussion on how to handle a shortage of ventilators will ring a bigger bell. The first group to go will be those that are being vented and have one of the following:

Severe congestive heart failure; acute renal failure; severe chronic lung disease; AIDS with a low CD4 count; active malignancy with a poor potential for survival; cirrhosis; hepatic failure; and irreversible neurologic impairment, including persistent vegetative state.

This seems to be an easy choice. It is likely that teenagers will be competing for the equipment. But the questions arise if that is not enough. Some thoughts on that by Dr.s’ Hick and O’Loghlin, * they propose:

“the Extubation of any patient “who might be stable, or even improving, but whose objective assessment indicates a worse prognosis than other patients who require the same resource.” Thus, patient A’s continued use of the ventilator appears to depend not only on the estimated survival probability of patient A, but also upon that of newly arriving patient B, whose better health status leads to the extubation and probable death of A, and the intubation of B (at least until C arrives).”

That ‘logic’ is going to cause trouble if it comes down to it.

From the NYS report:

“Patient consent, the mainstay of ordinary medical care, will not be the determining factor in allocating ventilators. Threatened and actual legal actions are reasonable concerns in response to any emergency rationing scheme.”

At the end of the day what we are really worried about are the lawyers.

Tax Credit For Housing Now D.O.A.? What's this Mean?

2009-10-24T08:32:00.000-07:00

The $8,000 tax credit for first time homebuyers is turning into a disaster of major proportions. According to a WSJ (and other) report fraud has been rampant in this program. Some highlights:

-“The Treasury tax-oversight office said at least 19,000 filers who hadn't bought homes claimed $139 million in tax credits and were reimbursed.”

-“Treasury oversight officials said they have found an additional 74,000 tax-credit claims, valued at $500 million, where evidence of previous home ownership could make their claims invalid.”

-“More than 500 people under the age of 18, including a 4-year-old child, also had their names on applications for the credit, which has no minimum-age requirement.”

What does this mean? In all likelihood this means that the proposal to extend and expand the tax credit is D.O.A. A major sponsor of the bill that is up for a vote next week is Senator “Johnny” Isakson (R.GA). His comments on the fraud in the program:

Sen. Johnny Isakson (R., Ga.) said he is "cautiously optimistic" that an extension -- with procedural safeguards added -- can move in the Senate next week. "Just because someone used fraud [to claim the credit] doesn't mean the credit is a bad idea, it means there are some bad folks running around," he said.

Mr. Isakson does not get it. If the bill is passed it will double the size of this subsidy. It will also double the number of tax cheats who abuse the program. There is no way that this bill will pass given the cloud that has now been revealed.

I wrote about the Administrations plans to provide an alternative to the tax subsidy this past week. In that piece I said, “I am confused”. I am no longer confused. The Administration was no doubt aware of the tax fraud and failure of the existing subsidy. They knew that the story would break in the MSM this week. They desperately need a program to support housing, but they understood that the tax subsidy was not going to work. So they came up with Plan B, and implemented it in a short period of time.

The Administration plan uses the resources of the Treasury, Fannie, Freddie and FHA. If one is concerned about the fraud and losses that the taxpayers will incur in the existing program, wait until the results of the losses from the Administrations plans are revealed a year from now. They will be spectacular.

The following is a cut and paste of the program description. You tell me, does this make sense? Do you have any idea reading this who is doing what to whom? Keep in mind that this is all going to be managed by the same folks who failed miserably in the first place. The mortgage mess will cost us more than the wars in Iraq and Afghanistan before this is over. We can’t afford it.

The full description can be found in the 10/23 Freddie 8K.

NOTE: Assume: (A) the effort to extend/expand the housing tax credit dies as a result of the fraud and (B) The Administration plan to stimulate housing is all we will get. For me that means ‘Sayonara’ to the housing recovery. Without the tax credit sales will fall flat. Look at what happened post clunkers.

The Administration on the Agencies – Step One

2009-10-19T20:01:00.000-07:00

On a day when Keefe,Bruyette & Woods (KBW) pronounced the inevitable death of Fannie and Freddie the Administration announces a new initiative that insures that Fannie and Freddie will be around for a long time to come. I’m confused to say the least.

The plan revealed today by Treasury, HUD and FHFA is to provide assistance for first time home buyers and existing borrowers who are unable to afford their current mortgage. Some observations:

-I have not seen a joint announcement like this before. I read this to be a first step toward consolidating the very separate roles and standings of FHFA and HUD. This effort to stimulate housing is very much a team effort.

-The initiative will be directed through HFAs’. These are State and Local housing and finance agencies. Heretofore these HFA have not had a significant percentage of the total mortgage pie. It would appear that this is another example of “outsourcing.”

-Mr. Geithner said of the plan, “..it will help stabilize the housing market overall.”
Mr. Donovan the head of HUD said, “it will help in getting our housing market back on track.”

The Administration is directing its effort at the lower end of the housing market. For political and economic reasons this is the only segment of the market they can influence. That makes it the only right choice. The Administration has introduced the “Trickle Up’ theory.

-Senator Isakson (R. Ga) has been a strong sponsor of legislation that would expand the existing tax cut for first time buyers. That legislation may be trumped by the decision announced today. That remains to be seen. But if it turns out that way, it will be a window into just how political the Agencies are.

-Both Fannie Mae and Freddie Mac will play a critical role in this effort. They are both going to be bankers for the HFAs’, “F/F will provide credit and liquidity facilities (to the HFAs)”. In addition, “the HFAs will issue mortgage bonds that Fannie and Freddie will bundle and Treasury will purchase them”. That’s right. Treasury will purchase the paper that comes from this. There are some restrictions but be assured this is going to happen as described. This is intergovernmental debt. It will not show up on a budget.

I thought it was interesting that F/F are going to be providing these services. It is a perfect role for them. But, it does make it a bit more difficult to declare them bankrupt and toast the stock as KBW suggests. This does not mean that the equity has value; it just means that the road to zero will be bumpy.

Targeted Mortgage Lending - Who Pays?

2009-10-14T17:51:00.001-07:00

Edward DeMarco, the boss at FHFA made the following statement recently:

For many decades the federal government has sought to affect housing finance in ways that promoted the availability of credit for low-and moderate-income homeowners and renters. Under the current structure, the many subsidies granted the Enterprises were exchanged for various requirements, including housing goals, to ensure the Enterprises did not ignore these segments of the marketplace. Going forward, policymakers may consider alternative approaches to defining and targeting subsidies to achieve public policy objectives. For instance, subsidies intended to support the financing of affordable rental units or to assist first-time homebuyers could be more efficiently targeted through down payment assistance or other measures than by a general subsidy provided to all types of mortgage credit.

DeMarco has articulated something that I have not seen proposed before. It is important to analyze the implications of his words.

Administration after administration has used the Washington mortgage lenders as tools of social policy. The agency's respective charters confirm this. Part of their mission statements’ is to advance the nations housing objectives. This was a lovely marriage of interests for many years. It worked because RE value almost always went up. There weren’t significant losses until 2008 happened. Mixing high-octane credit with social objectives was a way of creating Federal off balance sheet financing. It was a contributor to the bubble in housing. We are paying a big price today for social policy choices that were made years ago.

Demarco has said that that policy has not worked and needs to be changed. That is a very significant acknowledgement of failure. That he goes on to propose that down payment assistance instead of 100% mortgage financing must be considered has potentially far reaching impacts.

For DeMarco to comment like this confirms that Fannie and Freddie have a lot of underwater mortgages that are tied to social housing goals. The question is, “How big is this problem?” There is no published information that breaks this out. A starting place for an estimate comes from a minor announcement from FHFA’s sister in law FHA. The announcement confirms that the “favored lending” status (Targeted Lending Initiative or ("TLI") for areas of Louisiana that were impacted by hurricane Katrina would be extended.

From that document comes the following graph. The FHA proudly points out that it has made 900,000 loans totaling $111 billion dollars that fall under their definition of a social objective mortgage. That comes to 15% of their total book.

If one uses that percentage as a proxy for all or the $7.3 trillion of D.C. mortgages it implies that the social side of this is approximately $1.1 Trillion. If this level of social lending is to be sustained and DeMarco’s suggestion that down payment assistance should replace bad lending standards then is would require an on budget expense of $50 billion a year forever.

That is not in the cards. Not by a long shot. The days where ‘social mortgages’ are made without equity are coming to an end. At some point in the future if you want a D.C. mortgage, you will have to put up 20% of the purchase price. You will have to get that from savings, friends or family. You might even get it from your Uncle Sam if you’re lucky, but don't count on it.

The long-term implications of this on the housing market will be significant. More important will be the social implications. We are not going to pay for the next Katrina with low-interest, no money down mortgages. We will have to pay up front.

It is good that DeMarco put this in front of the Senators. Now that it is out it will be difficult to withdraw. Something will have to change. The lending Agencies have been geese laying golden eggs for years. Then they morphed into a Black Swan. We are going to wish we had those geese back.

BofA/BONY Versus AIG – No Winners

2009-10-11T20:26:00.000-07:00

It would appear that an important court case may go in favor of BofA and Bank of NY in a suit brought by AIG’s wholly owned subsidiary United Guaranty Mortgage Indemnity Co. If that is the final outcome it will set a dangerous precedent for the Mortgage Insurance industry. It could destroy what is left of an already broken part of the mortgage market.

This fight is headed for a conclusion in the next few weeks. I think the MI industry has been a significant part of the collapse of the mortgage market, housing market and therefore the US economy. But, in this case I have to side with the MI industry. I have some insight on this that is apparently not in the court’s hands at this time. If and when this information becomes public it could change the outcome of this important case. Some background:

In March of 2009 United Guaranty (UG) sued Countrywide Financial (“CWF”) (BofA now owns CWF). The lawsuit accused CWF of misrepresenting underwriting standards on loans UG insured. Specifically, UG claimed that most mortgages covered by policies for asset-backed securities were either underwritten in violation of Countrywide’s own guidelines or contained defects, such as missing documents, misrepresented credit scores or false social security numbers. The mortgages in question were bundled into junk MBS. The Agent for these securities was Bank of NY. Investors who lost money are suing BONY/CWF-BofA. UG insured the mortgages and is now trying to walk on that promise.

A US District Court issued a ruling on 10/5/09 in favor CWF. While there is still some wiggle room it looks like UG is going to have to pay. If that is the case it will set a dangerous precedent.

Historically MI companies have paid claims in situations where there has been fraud committed by the borrower. However they do not pay claims where a loan officer, appraiser or real estate agent has committed the fraud. The critical issue is therefore who committed the fraud. If it is the borrower, then UG and the other MI companies are forced to pay. If the fraud is perpetrated by the lender (or their agents) UG can walk on its obligations.

The question that needs to be examined is how many of the defaulted mortgages in question were the result of fraud by the borrower or fraud by the lender. In this regard consider an (as of now) unrelated matter in Illinois. This concerns a Countrywide office in Chicago. That office under a program called Optimum originated approximately 1,000 loans. Substantial percentages of these loans have gone into default. An investigation has determined that 90% of the busted loans had the following ‘coincidences’:

-The same loan officer.
-Same RE agent.
-Same appraiser.

All of the loans had credit references from the same sources:

-A boot company.
-A linen shop.
-A restaurant.

The FBI is involved with this case. I will leave it to the reader to conclude if lender fraud was involved or not.

If the Court’s decision in California stands, the MI companies losses will explode. Their ability to survive this is already in doubt. Approximately 20% of the mortgages held by Fannie Mae and Freddie Mac are insured by the MI industry. Therefore the taxpayer will suffer the losses. If the California court reverses it’s decision (unlikely) then BofA and Bank of NY stand to lose. In this outcome the taxpayers will also suffer.

The President has proposed regulations that would protect consumers from predatory lending tactics. That is sorely needed. What is needed even more are some regulations that protect the taxpayers from footing the bill for everything that goes wrong. There is plenty of evidence that fraud has been committed by all involved. The lenders, the borrowers and Wall Street are all dirty. But it is our grandchildren that will get stuck with this bill.

FHFA's DeMarco Speaks - Ouch!

2009-10-08T14:58:00.000-07:00

FHFA’s Acting Director Edward DeMarco provided written testimony to the Senate today. I would give his presentation a B+. There is little room for optimism in this story. Mr. DeMarco did not gloss that fact over. A few snips from that speech:

-From July 2007 through the first half of 2009—combined losses at Fannie Mae and Freddie Mac totaled $165 billion. In the first half of 2009, Fannie Mae and Freddie Mac together reported net losses of $47 billion.

-Since the establishment of the conservatorships, the combined losses at the two Enterprises depleted all their capital and required them to draw $96 billion. The combined support from the federal government exceeds $1 trillion.

-The short-term outlook for the Enterprises remains troubled and likely will require additional draws under the Senior Preferred Stock Purchase Agreements.

That’s funny; I thought things were going so well. From the WSJ 8/8/2009:

Some random comments on credit conditions:

-Among subprime adjustable-rate mortgages, nearly 40 percent are seriously delinquent.

We really ought to string someone up over this number. A 40% default rate is not bad judgment. It is a crime. It is what kicked us over the top.

-We remain concerned and recognize the risk associated with increasing numbers of seriously delinquent loans and higher forecasted foreclosures. In particular, we are concerned with the continued increase in serious delinquency rates, even among prime mortgages.

Read this to mean, “The next shoe to drop will be prime mortgages.” It was always perceived that prime mortgages were money good. They are not.

On the issue of REO (real estate owned from repo/default)

- Currently the Enterprises are managing a real estate owned (REO) inventory of almost 100,000 properties, a number expected to grow.

The government can’t sell this crap. If they did, it would just tank the RE market and cause more Prime defaults. Uncle Sam is going into the rental business big time. But that does not look too promising either. Some sobering thoughts on that market:

-As of mid- year 2009, rental vacancy rates hit their highest level since the U.S. Census Bureau began tracking vacancy rates in the 1950s.

That does not sound like a plus for CRE either.

There are obvious problems at the FHLB’s. Do these words trouble you?

-The most important financial development among the FHLBanks in 2009 is the deterioration of the PLS portfolios held by the FHLBanks.

How big a problem is this? Big. I smell bailout. The question that must be asked and answered is, “Why were the FHLBs buying private label mortgages? What were the rules on that? Someone made out big on the sale of those securities.

-Total retained earnings were $6 billion, but negative accumulated other comprehensive income (AOCI) exceeded retained earnings at the six FHLBanks with the greatest PLS exposure.

A good number of people were paid a fair amount of money to come up with the term AOCI. What would be a better description of "Negative Accumulated Other Comprehensive Income"? The word "loss"comes to mind.

You have to give DeMarco some credit for the following. The accountants may be lying but he is not:

-The decline in the carrying value reflects impairment charges of almost $8.2 billion, however, a change in accounting rules resulted in only $953 million charged against income.

On the issue of interest rate risk management at Fannie and Freddie DeMarco gives a ‘tell’.

-The Enterprises’ investments in mortgage assets expose them to market risk. Given the uncertainties in the marketplace, managing market risk continues to be a challenge.

There was a spike in interest rates earlier this year. At that time someone did very big amounts of ‘duration’ trades. I believed then that it was the Agencies puking it out at the bottom of the market. I think Demarco confirmed it. Look for big derivative losses in the third and fourth Q’s for both F/F.

On the complicated issue of mortgage insurance (PMI) comes this from DeMarco:

-The Enterprises will refinance those mortgages (ones in default) without requiring additional private mortgage insurance. If there already is mortgage insurance on the existing mortgage, that coverage will carry forward to the new mortgage.

This is a flat out subsidy for the PMI providers. When a loan goes into default and a loss is realized the insurance that is there should cover a significant portion of the loss. By rolling the loans the loss is avoided, and so is the necessity to pay up on the claim. This is keeping the PMI folks alive and well. One of the larger players in this space is AIG. We wouldn’t want to do anything that would hurt them would we?

The following warmed my heart. Finally someone is owing up to how we got into this mess:

-The markets relied upon an implicit government guarantee of Enterprise securities.

Who created and sold the lie that the US Government was behind $5.3 trillion in dodgy MBS paper? It was a few dozen politicians, folks at Treasury, the entire mortgage industry, most of Wall Street and everyone at Fannie and Freddie.

Finally, a confirmation from DeMarco that there is a plan coming. Of interest is that the timetable seems to have been accelerated. This was supposed to be a March 2010 issue. The Director suggests it may be here in time for Santa. I can’t wait.

-I know the Administration has committed to addressing (the GSE’s) in the coming months.

September - Another Stinker for SSTF

2009-10-05T17:12:00.000-07:00

The Social Security Trust Fund ran another deficit in September. This time it was $4.13 billion. This is the third month in a row that the Fund has run a deficit. The July –September 2009 shortfall was $10.4 billion. This compares with a surplus for the same period in 08 of $6.8 billion and $12.0 billion in 2007.

The full year 2009 surplus is, as of 9/30, $85 billion. This compares with $128 billion and $132 billion in 2008 and 2007 respectively. So far this year we are running 40% below 2007.

I anticipate that October and November will also be deficit months. The total could be an additional $10 billion. December will be a surplus. Possibly $35 billion. If that pans out the surplus for the year will be $100-110 billion.

When everything else is in massive deficit why should we care about Social Security? After all, they are still running multi-billion dollar surpluses. The answer is that the rate and direction of these surpluses have significant implications for the Fund. This is going to dramatically foreshorten the day of reckoning when annual receipts are less than disbursements.

There is little hope of a turnaround. We have a surge of new beneficiaries that are driving up costs. Interest rates will remain low for a long time to come; this is a drag on the Funds earnings over time. But the most critical factor is employment. The Fund is suffering from the recession. They need more workers that contribute payroll taxes. The prevailing view from most economists is that unemployment will remain high for another year. There will be no significant job creation until 2011. That is too far off for the Fund. By then they will be running deficits, once that starts it is very difficult to turn around.

There are two significant implications to this. One is social, the other economic. They are interconnected.

-The only viable solution is significant cutbacks in benefits. There has to be a long lead-time for this process. There are many people who are approaching retirement on the assumption that they will receive specified benefits. We can’t let this process go to the 11th hour and then drop a bomb on 15 million retirees. It is not fair, and there will be hell to pay when it happens.

The end result will be that there will be less money and the age for benefits will be extended. The people who will be most effected deserve a few years of notice. We are getting near to the point where that might not be an option. A plan for SS needs to come on the table sooner versus later. The idea that, “SS comes after we fix health care,” is wrong. This is all a jumble of entitlements. Both of these problems are promises that simply can’t be paid for.

We will commit more riches to health care. That means the cupboard will be bare when SS sticks its hand out. About 20% of all our citizens will be 65+ when this happens in a few years. They are also 30% of the voters.

-Zero Hedge had a piece today that is relevant. There was a letter to investors from Kyle Bass of Haywood Advisors. The following is from the letter. The similarities of the US situation to Japan are striking. We are not far behind them on this time line. Between two and four years by my calculation.

"Interestingly, the Government Pension Fund ("GPIF") Japans public pension fund and historically the biggest individual net buyer of JGB's, said in June that it may become a net seller of securities this fiscal year (ending March 2010) in order to pay benefits."

The SSTF has wracked up surpluses totaling $2.5 trillion. They own the biggest chunk of America’s IOUs. They have funded the deficits in the past. Over the next ten years, when we most need them to buy more, they are going to turn into sellers.

Schumer and Cornyn - "We Agree on Tax Credit"

2009-10-04T15:39:00.000-07:00

There was a love fest on ABC’s This Week. The odd couple was Senators Schumer (D.NY) and Cornyn (R.TX).

When Schumer says, ”We have to extend the housing tax credit” Cornyn says, “Chuck and I agree”.

Cornyn went on to make a plug for Senator Isakson’s (R.GA.) bill. This would expand the $8,000 tax credit to $15,000. I t would also make it available to all comers. The existing bill is only for first time buyers.

While Cornyn is talking, Chuck is shaking his head, Yes, yes, yes.

The clip is here. The discussion on the tax credit is at -9.55.

Read this to mean that it is certain that the existing subsidy will be extended. In my view these two making nice on TV means that a form of the Isakson bill is what we are going to get. This is a very significant development.

For the sake of discussion assume we do get a $15k credit. Assume also that the FHA makes available 90% mortgages at low rates (they are currently doing 96.5% LTV, so this is a conservative assumption). The question is how many will take advantage of this and what might be the consequences.

On September 17th the IRS came out with this headline:

First-Time Homebuyer Credit Provides Tax Benefits to 1.4 Million Families to Date, More Claims Expected

There is a backlog on these deals today. It is reasonable to assume that the $8,000 credit could result in 2mm homes being sold in just nine months. Based on this what is an estimate for the number of homes sold with the $15k incentive that is open to all? I think 4 million is a good number. Let’s use 3 million to be conservative.

The average price of a home is $200,000 (also conservative). Using all of these assumptions you get some very big results.

-This translates into a total sale value of $600 billion.

-The direct cost to the government would be $45 billion.

-The total equity required by the private sector net of the subsidy would be $15 billion. The equivalent of only 2.5% down.

-FHA would guaranty an addition $540 billion in new mortgages.

Based on the assumptions the following positives may occur:

-This would be a back door bailout of the GSE’s. It would give them an opportunity to off load some of their REO. It would also reduce costs of short sales that will come in the next year. This only lessens the loss however.

-The FHA would have an explosion of new activity. This premium income would dramatically increase their cash cushion. It would temporarily avoid a bailout of FHA. It would insure that the ultimate bailout costs will be much higher.

-The economic activity related to the sale of 3mm homes will contribute to GDP. For example; the RE commissions will be $30 billion, the mortgage brokers will get $6 billion, The lawyers will collect another $6b in closing costs. This is how America makes money. This class of beneficiaries just takes commission as part of the creation of debt. There is zero residual value to this. It is just pumping up current consumption.

-You have to assume it would benefit the big, publicly traded, homebuilders. How much clout does this group have? Plenty. Senator Isakson’s family owns one of the largest private RE brokerages in the country.

-This could be beneficial for holders of busted MBS. Additional demand for the underlying collateral will create better exit opportunities. While this does not make any of the old crap money good, some smart folks are going to make some dough off of this. It might even benefit the zombies. You can be sure the GS’s of Wall Street will make a buck. More clout.

There are some negatives:

-There is an on budget cost of $45 billion. A very big number. There will be some who appose it. But I think it will pass. Congress is looking for a new stimulus package. This is going to be a part of that. The ‘Bear Hug’ on TV today convinced me.

-In my example 97.5% or about $585 billion will be debt issuance by either Treasury or Ginnie Mae. This would increase the 2010 funding requirement by about 30%. No one cares about this issue. Bernanke still has $500b of Agency buy back power. If they want to do more, there is nothing stopping them.

-This program will have the same effect as the Clunkers program. While the window is open that stimulus is powerful. The existing housing tax credit has been very successful. It is reasonable to assume that a larger, broader program would also bring results.

But as with Clunkers, when the music stops demand stops as well. Given the magnitude of this potential bill the impacts would be very substantial when the program is ended. There will be a great sucking noise in the months that follow the end of this and the other ‘fixes’. We will not QE ourselves out of that one. The sucking noise will be heard around the world.

My guess is that the Isakson bill will come out of the Senate. Congressman Barney Frank (D.NY) has a big say in this. He would do anything that would help the Agencies. He enabled them. So this will come down to the WH.

-Geither and Goolsbee will say yes.

-Summers will carefully describe the pros and cons. He will lean toward a more modest proposal.

-Volker will say no to this.

-Bernanke will end up supporting it. (He doesn’t have a say)

-The political advisors will say, “pedal to the metal”.

Someone will say:

“Do a $12,000 cap deal. Sell the lower number as a measure of your fiscal conservatism. Low-ball the estimate of homes sold but leave the door open until 12/1/2010. The old $8k tax credit will be double over budget. Same with this credit. Worry about that later. This plugs some deep holes. It will look like progress is being made. The Dems will carry the mid terms in both Houses and you will have two years of grace.

This debt will be off of Treasuries balance sheet so no one will notice. Anyway, no one cares about that."

It’s a pretty compelling case. This is going to pass.

FHFA Makes a Big Bet

2009-10-03T18:50:00.000-07:00

There were several releases from the Federal Housing Finance Agency (FHFA) this past week including:

-A speech by acting FHFA Acting Director Edward DeMarco.
-A report on the efforts by Fannie and Freddie regarding restructuring exiting mortgages.

First consider this from the restructuring report:

Trial loan modifications under HAMP more than tripled from June to August, from 66,200 to 202,200.

In addition, the Agencies restructured 58,000 outside of HAMP. The average loan is close to $200,000. That means that the GSE’s have restructured $52 billion in loans. $39 billion of that was in the three months ending in August. Their rate for September must have been close to $20 billion. The total is north of $70 billion. As a percentage of their total book this comes to 1.25%, or 5+% annually.

From the speech this slide:

On numerous occasions the FHFA has used this type of graph to demonstrate how well they are doing. They point to the relatively low default rate they are experiencing compared to the private sector and other government lenders. DeMarco said in his speech:

Fannie Mae and Freddie Mac have a combined 57 percent share of mortgages Outstanding, that accounts for only 25 percent of serious delinquencies.

The FHFA is blowing smoke at us. Their default rate looks good by comparison because they are not recognizing losses. They are just rolling them forward. They have done $70billion already and now that they have it figured out they will continue the process. How much of the 5% annualized rate should go on top of their stated numbers? Over time, more than half . The Agency default rate is understated in the report as a result.

Most of the restructured loans are from seriously delinquent borrowers. Those in payment default by 90 days. When these loans are restructured they go off of the Delinquent list. Therefore the more the Agencies restructure, the lower their delinquency rate looks. Mr. DeMarco said this about his ability to restructure dead mortgages:

With HARP, these barriers have been addressed. Fannie Mae and Freddie Mac today will refinance mortgages they currently hold, even up to a current loan-to-value of 125 percent.

The ‘barriers’ he is referring to are prudent lending standards. Recent data shows that one half of these loans will re-default.If real estate prices do not make a significant recovery, the very high re-default rate will continue.

Also from the speech this slide on the balance sheets of the Agencies:

The funded portfolio at the Agencies has been static. This is because there are limits on the size of the portfolio. These were mandated as a result of the conservatorship. But there are no limits on the amount of MBS that is guaranteed. They are using that loophole to maximum advantage. Who owns this guaranteed MBS? Increasing it is the Federal Reserve through their non-stop POMO buys. The Fed is mixing its QE monetary policy objectives with support for bad credits. Agency MBS is not money good at par unless Treasury funds the losses. Agency MBS is still not full faith and credit paper. With the absence of a full guaranty the Fed would normally have to haircut this paper. The Fed typically requires ‘two ways out’. (1) The promise to pay by the borrower and (2) the collateral that backs up that promise. As of today there is only one certain way out of this MBS. And that is not worth par.

The Fed's POMO buys have facilitated HAMP. That is well outside of traditional monetary policy.

Finally, from the speech, a comment by Mr. DeMarco:

There is an opportunity today to help many more homeowners strengthen their own balance sheets by taking advantage of the HARP program.

How can lending someone 125% of the value of their home improve a balance sheet? At best it improves cash flow for the borrower for a short period of time. This is at the expense of a larger principal obligation. Underwater borrowers are bad credits. Rolling over bad loans is a bet on the come. The FHFA is playing at the big casino on the hope of a RE recovery. It isn't an even money bet.

H2SO4 – LEI?

2009-10-01T14:11:00.000-07:00

We use sulfuric acid in just about everything we consume. It is used in batteries, paint, fertilizer, ore processing, steel production and water treatment. It is a building block for a number of products like nylon, we pickle our food with it. By volume, it is the largest industrial chemical produced in the US.

There is no futures market that tracks this important commodity. This graph is of selling levels for bulk delivery at Gulf ports.

This is a boom and bust story. If you want evidence of how out of whack things got over the last year and a half this chart is a good place to look. Prices for sulfuric acid rose 700% in just 18 months. This was when oil was 180 and scrap steel was gold. Now it is 70% below the prices before the bubble. It has been a tough recession.

When the economy tanked the market value of this acid went with it. Prices through August 2009 have held their lows. It would appear that government economic intervention can impact GDP, but it does not seem to have much impact on demand in the industrial sector.

The Chicago PMI report caused a bit of a hiccup yesterday. The report showed a seasonally adjusted drop from 50 to 46.1. This lines up with the information on sulfuric. There is not much demand for ‘stuff’ that we use to make other ‘stuff’. This does not jive with the current notion that the economy is benefiting from a significant inventory correction.

Sulfuric acid looks like a high beta Nat Gas chart. Gas is a principal ingredient in production of this acid. So in this case gas is the dog and sulfuric is the tail that gets wagged around. But sulfuric is a very big tail and its demand (or lack thereof) may also cause the dog to shake a bit. For those who follow NG keeping an eye on sulfuric prices could be helpful.

There is another reason to follow this commodity price. One can be sure that the Fed watches it. This is one of many pipeline sources of inflation. Looking at it today you could say that there is little ‘cost push’ inflation from this. But if in four months this commodity price recovers it will be one of those data points that the Fed will have to consider. For what it is worth the price of Gulf sulfuric acid was back up to $30 at the end of the month. From the Chicago PMI:

Business Activity:
• Prices Paid continued to firm;
• New Orders, Production, and Order Backlogs suffered reverses;
• Employment index continued to retreat at the August rate;

While the overall report was negative, the Prices Paid component showed cost-push pressures. Sulfuric acid was just a part of that increase.

The data on sulfuric acid pricing comes from PentaSul Inc. Hat Tip Fiona.

Fed's Fisher Speaks - Geithner Cringes

2009-09-29T19:40:00.000-07:00

Dallas Fed President Richard Fisher spoke Tuesday. His words echoed those of Fed Governor Kevin Warsh who recently wrote an important Op-Ed in the WSJ. On the issue of withdrawing the monetary stimulus that is now in the system Fisher said:

"I have faith my colleagues on the Federal Open Market Committee will stand and deliver (monetary tightening) in a timely way."

Mr. Fisher and his colleagues recently voted to extend the Fed’s zero interest rate policy, “for the foreseeable future”. In his speech Mr. Fisher affirmed that the balance of the $1.25 trillion of Agency POMO intervention will continue through the end of March, 2010: As of 9/23 the Fed had purchased $700 b of MBS, they have another $550 billion to go.

(“T)he FOMC expects we will complete the execution of our $1.25 trillion intervention in the mortgage-backed securities market by the end of the first quarter of next year.” (Finally the word intervention, thanks Mr. Fisher)

Of interest to me was that Mr. Fisher had strong words to say regarding the Feds future tightening efforts:

“I expect that when it comes time to tightening monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity to that with which we pursued monetary accommodation.”

Really? Mr. Fisher has said he would ‘stand and deliver’ a reversal of monetary easing at a torrid pace. When the time is right. If it is needed. But not at anytime in the foreseeable future. If ever.

At this point I would assume that the term “foreseeable future” means “not until after January”. That dovetails with March as being the target for the ending of the Agency MBS POMO intervention. So ‘foreseeable future’ could be as far away as six months.

For me the idea that we are going to continue stepping on the gas for anther half year is scary. By that time there will bubbles all over the place. If you take Mr. Fisher at his word you would think that on April 1st the Funds rate would go to something crazy like 3%. Some April Fool joke that would be. That is not going to happen. This is a very big ship. It has go into neutral for some period before the engines can be reversed.

A more reasonable interpretation would be: Sometime after the first quarter 2010 the Fed will raise rates two times. The first will be in May, an increase of 1.5%. Later in the year it will be raised another big notch to 3%. The average for the full year will be less than 2%. There is no meaningful tightening in that scenario.

The tough talk by the Fed members is coordinated. Other Fed Governors have speaking engagements this week. Bernanke is talking as well. Look for all of them to pound the table on this issue. They know that the dollar has been getting dangerously weak of late. They know that the general distrust of the QE process is a part of that. It is no coincidence that the ‘market talk’ on the dollar has been more constructive over the past few days. Behind that recent thinking is the belief the Fed will, ‘do the right thing’.

However, if in three months the Fed is still buying $20b of long duration coupons each week and the bill rate is still at 9bp all this tough ‘Fed speak’ will be forgotten. It would be better for the Fed to act tough versus talk tough. They have a lousy reputation for backing talk with action.

Consider this from the other side. Say Mr. Fisher and his colleagues do deliver on their words. Assume the Fed funds rate is 4% by 12/31/10. This creates a monster headache for Mr. Geithner. In a year from now the debt level will be +/-$13 Trillion. About 30% or $4t is short term. This scenario would increase the cost of just the short-term debt by $150b.

I don’t see that either of these possibilities adds up to a strong dollar medium term. In my view it is nearly certain that the Fed will go too far with the QE process. The fact that they want to continue for another six months at this juncture is proof enough for me. It will be interesting to watch the cat and mouse game evolve. At some point over the next three months words alone are not going to be sufficient.

Biz Booming at Geithner's Private Bank

2009-09-27T16:59:00.000-07:00

Tim Geithner hit the ground running in January when he took over as Treas. Sec. He had a lot on his plate. One of his smaller responsibilities was the Federal Financing Bank (FFB). Mr. Geithner has knocked the cover off with this one. So far this year the FFB has increased its portfolio by 50%. By asset size, FFB would have ranked 35th in the USA at the end of 2008. Today it would be ranked about 25th. Clearly a job well done.

The FFB is a child of the 70’s. It appears to have been a doghouse lender for years. The following looks at the FFB loan book. The numbers involved are peanuts compared to the big numbers that are being tossed around D.C. However there is a window into the thinking of Treasury in their lending activity.

The FFB business model is simple. They borrow money from Treasury and lend it to government Agencies. They take a small spread on the loans to cover administrative costs. Because all these loans are to ‘family’ members there is supposed to be no credit risk. On this issue FFB says:

The Bank has not incurred and does not expect to incur any credit-related losses on its loans.

Well, that sounds good. It is not clear to me that this is the case. The following is a description/discussion of the loan book at the end of July. You tell me if all this is money good.

-The $18+ billion outstanding to the National Credit Union Association jumps out. NCUA is the FDIC for America’s Credit Unions. They provide the insurance guarantee (up to $250,000) on the deposits of these entities. There are a total of 9,369 CUs. They have assets in excess of $600 billion. So this is a big deal.

The CUs bought big into “investment” grade MBS and got killed. Several of the big CUs have folded this year. An interesting discussion on this mess comes from a 5/15/09 statement to Congress, “The Credit Union Share Insurance Stabilization Act’.

This from the report:

"Both external and internal analyses have consistently shown that the projected MBS credit losses in the corporate system are real, highly likely, and relatively large."

That does not sound so good. The NCUA is a bailout to be. To assume that there is no potential for losses here is wrong.

Note: This may be a blueprint for a fix of the FDIC. Sheila Bair has said the problem with her Agency is “liquidity” not “solvency”. She could make use of the cheap money from FFB, as does NCUA. Note that there is already a line open on the report for the FDIC. Call this a blank check.

-I am reasonably sure that the Post Office will make good on its $6.5 billion of loans outstanding. The PO is an Agency of the US Government, but Uncle Sam does not guarantee their debts. This would appear to be outside of the scope of FFB. I assume there is a ‘carve out’ to allow this advance.

The folks at the PO must drive a hard bargain. Look at the rates that were set in July. Sweet deal!

-The FFB has a total of $20 billion outstanding to rural utilities. I am not sure that all of these borrowers are money good. The following is a description of the July 09 activity. Note that loans are being made for 32 years in a number of cases. The lending rates are at a fraction above Treasury’s cost to issue debt for similar maturities. This looks like cheap Preferred Stock pricing, not debt. This is a subsidy.

-The $492mm of HOPE bonds that the FFB purchased are being held at cost. That might be because very little of this money has been spent. The WSJ wrote on this recently. The HOPE money from Treasury was supposed to be used to help troubled borrowers restructure underwater mortgages. This is the grist for debt relief. When it is spent (it will be) it will be lost. The FFB is fooling itself and us by keeping this ‘investment’ on the books at par. Check out the reset rates. 18BP for three-month money. Thank Bernanke for that.

-The $2 billion to the GSA, the $600mm for Financing for Foreign Military Sales and the $600 mm of HUD notes are just a mystery. This is off balance sheet financing. That makes the FFB a SPIV for the government.

-The FFB will not lose money on its loan book, but future taxpayers will be obligated to fund the Agencies who are the borrowers so those loans can be repaid. Cheap money with no payback plan just creates bad borrowers. We have seen that. At a minimum, the FFB should revise its loan terms. Borrowers should be obligated to repay in a reasonable period of time. There should be a source of repayment defined in advance. The interest rates on these loans should be at market rates. The intent of this would be to make it more difficult for Government Agencys to finance themselves outside of budgets they are allotted. Exactly the opposite of the way it is has always been done.

Fed's Warsh on QE- Form Over Substance

2009-09-26T07:56:00.000-07:00

Fed Governor Kevin Warsh made a splash on Friday with an Op-Ed piece in the WSJ. The essence of this was that the Fed would have to move to eliminate the massive monetary stimulus quickly and aggressively at some point in the future when, “The timing is right”.

This sounded good to me at first. I hate the QE process. I think it will ruin us. Mr. Warsh’s comments were addressed to people like me. My thoughts after re-reading his words:

-Mr. Warsh is a ‘close confident’ of Mr. Bernanke according to the WSJ. Anyone who thinks that Mr. Bernanke did not have something to do with the Op-Ed piece and the follow on speech by Warsh is just wrong. While Warsh wrote this column, I will bet that Bernanke reviewed it before it was delivered to the WSJ. Fed Governors do not speak publicly unless there is a specific reason. Everything they do is orchestrated. Including articles in the WSJ.

-The timing of this writing is very suspect. It follows by just days the Fed’s announcement that they will keep rates at zero for, “the foreseeable future”. My guess is that after the last announcement Bernanke got phone calls from foreign central banks that said, “I am holding your paper and I do not like your actions. What you are doing is devaluing my holdings. Change your ways or I will change my holdings!”

-Why would any central bank willingly hold the vast quantities of Treasury IOUs when the return adjusted for inflation is negative? They have to account to their citizens as well. From China and now Japan and from many other traditional holders of our debt are coming words and actions that they have had enough. While they are not selling Treasury paper yet, there is little evidence that they are increasing their holdings net of Agency debt.

-Foreigners have expressed their concerns, but more significantly the American people are increasingly looking at the Fed's policies with disdain. People are aware that for the first time in our history the US is monetizing the debt. Large deficits have always been an issue. But we are in a new and dangerous place with the deficits in 2009. In prior years, holders of dollars purchased all of the debt. This time it is different. Now we are just printing the money. Depending on what is included in the calculation of QE that printing has/will reach a minimum of $1.75 trillion. Mr. Bernanke has to be aware at this point that many citizens are actively comparing our economic policies to that of post WWI Germany, Argentina and even comically Zimbabwe. There is nothing comical about this. We are doing what those countries did.

-Mr. Warsh suggests that at sometime in the future the Fed will react and remove the stimulus. These are empty words while the Fed buys $25 billion of Federal IOU’s each week. There is no substance behind Mr. Warsh’s comments when interest rates are negative 2% versus inflation. The Fed's credibility is not reestablished by an Op-Ed piece. It will be re-established by action.

-It is possible that the delay in reversing the QE program will have a negative effect in the short term. At this point everyone is thinking, “It is going to end soon and when it does there will be another big leg down in the economy, I am not going to plan an expansion based on that”.

-Do not assume that Mr. Bernanke is unaware that the dollar is at a low for the past year. He knows that this movement in capital is a function of the increased distrust in his policies outside of the USA. Mr. Bernake’s only job is to, “maintain price stability”. There is no confidence he will deliver on this promise.

-The words by Warsh coupled with the Fed’s unanimous vote to extend zero interest rates this week leads me to believe that the Fed will continue the QE process until the 1st quarter of 2010. Mr. Bernanke has said recently that the recession is over. The emergency monetary and fiscal steps that have been undertaken over the past year and a half have worked. The economy is now benefiting from a significant inventory correction. The real economy has some legs. They may be wobbly legs, but they are real. The inventory correction will be completed by the first quarter 2010, precisely the time that the Fed will be withdrawing its stimulus. The downturn in the 2nd quarter of 2010 will be significant as a result of these combined factors. It would be far wiser to reverse the monetary stimulus while the economy has legs of its own. Failure to do so will leave the Fed with no policy options nine months from now.

-In the Journal piece Mr. Warsh stated:

“If policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal–and the economy has returned to self-sustaining trend growth–they will almost certainly have waited too long.”

Mr. Warsh and Mr. Bernanke already know they have extended the emergency steps too far. They know that there is very little chance that the US will return to trend line growth of 3% on a sustained basis. Too much damage has been done to expect that to happen. It is more likely that we will have just a quarter or two of real economic expansion before the next slowdown.

This Op-Ed would not have appeared if that were not the case. The Fed is in a policy dilemma at this point. They know what they are doing is wrong, but they are afraid of the consequences of, “Doing the right thing”. So they are doing nothing. They write letters to leading newspapers saying they are aware of the problem, and will act in a timely manner. But they know that the longer the emergency steps are extended the harder the fall will be when they remove them.