The recent era of easy lending was not confined to residential real estate.  Commercial real estate lending is the next big worry for a banking industry already beset by an avalanche of non performing loans.  The banking industry has $1.8 trillion dollars of commercial real estate loans and many analysts believe that banks have reserved for only a small fraction of current and future losses.  Recent examples of losses on commercial hotel loans  in major travel destinations such as Hawaii and Las Vegas indicate the severity of the problem.

Hawaii Hotel Industry Downturn Worse Than Great Depression

Hawaii Hotels Face Fewer Visitors - For the hotel industry in the continental U.S., this downturn is the worst since the Great Depression. But the Hawaiian resort industry is taking a beating that’s even more severe.

Meanwhile, revenue per available room has fallen nearly 25% in the past two years and now averages $150.75.

Major renovations of existing hotels are common in Hawaii because construction of new resorts has been limited since the 1980s because of steep land prices and local governments’ opposition to expansion. “So the name of the game is to buy, renovate and reposition,” says Joseph Toy, president and CEO of the hotel-consulting company Hospitality Advisors, based in Honolulu. Many of the resorts that changed hands in recent years were built by Japanese owners in the 1980s.

But practitioners of that pricey repositioning strategy now find themselves in a bind due to the recession, the capital crisis and Hawaii’s tourism downturn. “The operating numbers have cratered, the underlying fundamentals aren’t very good, and you have a whole bunch of problem loans,” says David Carey, president and chief executive of Outrigger Enterprises Group, which owns 30 Hawaiian hotels, none in foreclosure.

Las Vegas Hotel Worth 41% Of Construction Cost - Cheaper to Tear Down Than Finish

Doubts Are Cast On Value of Las Vegas’s  Fontainebleau - LAS VEGAS—The Fontainebleau the luxury hotel and casino development at the northern end of the Las Vegas Strip, sits more than half-finished after falling into bankruptcy in June.

But as potential suitors consider rescuing the project, they are facing a grim reality: It may not be worth the money it would cost to complete it. More than $2 billion has already been poured into construction.

“It is going to take $1.2 billion to $2 billion to finish Fontainebleau, and it’s not worth that much,” Penn National Gaming Chief Operating Officer Tim Wilmott said. Penn is currently negotiating to take it over from the project’s creditors.

When the 4,000-room Fontainebleau project was first mapped out four years ago, gambling revenues were soaring and Las Vegas barely had enough hotel rooms to accommodate a flood of visitors.

Now, Las Vegas has a surfeit of luxury rooms. Occupancy rates in August fell to 83% from 94.9% two years earlier, and room rates have fallen sharply.

An outside analysis contracted by some of the Fontainebleau lenders last spring found that Fontainebleau would be worth $1.76 billion if it were completed in May 2010, according to a court filing, far less than its $3 billion total cost.

Depression Pricing For Hotels

Overwhelming supply and weak demand have resulted in hotels slashing room rates to keep the cash flow going.  In many cases, the cost of lodging at major hotels and resorts has dropped as much as 50% from two years ago and vacancy rates still remain high.  For newer resorts that were built during the boom years, the picture is even bleaker, resulting in bargain rates that were previously unimaginable.  On a recent trip to Mexico in September, I had the occasion to visit the newly completed and mostly vacant multi billion dollar resort, La Amada Hotel, Playa Mujeres, Cancun.  The La Amada website describes the property, which opened in May 2009,  as follows:

La Amada Hotel is a 5-star luxury hotel. Here you’ll have a comfortable home base of contemporary luxury. Stylish hotel architecture and decor, generous suites, spotless service, deluxe facilities, and of course, our secluded beachfront setting, all enable you to let your days here happen naturally. Situated just 25 minutes from Cancun International Airport, Playa Mujeres is the newest luxury resort destination in greater Cancun.

This 922-acre (373 hectare) luxury development includes a boutique hotel, upscale residences, a golf, yacht, and beach club, and Cancun’s first marina situated on tranquil Playa Mujeres in the Mexican Caribbean. Envisioned as an exquisitely and carefully developed sustainable community, La Amada is a destination where culture, ecology, history and art are integrated in a stimulating style.

La Amada, located in the Marina section of the Playa Mujeres “master planned’ community, is a 552-unit project of one, two and three bedroom residences, a 110-room five star boutique hotel, and a top of the line spa. In addition, the developers have created a “marina village” with 150,000 square feet of commercial space for restaurants, bars, cafes and shops, creating an ambiance akin to top European resorts such as Puerto Banus and St Tropez. No expense was spared on this spectacular creation; residences can even fly in and land on the properties private helicopter pad.

La Amada is a spectacular luxury resort hotel.  Equally spectacular are the discounts  - luxury suites are being offered at $280 per night, marked down from $700.  Apparently, even at these discounted prices, income stressed consumers are saying no.  During three visits to the property, I saw only one couple on an otherwise deserted beach.  Finished units remain empty with no guests to be seen.   The planned bars, cafes and shops have not opened.   Virtually all of the 176 slips in the Marina remain empty.  La Amada was built during an era of easy money when it was assumed that prosperity, based on eternal asset appreciation, would never end.  There is little doubt that the investors in La Amada have created a truly fabulous resort - far less certain is whether or not they will ever see a return on their investment.

La Amada sign points to empty hotel

Deserted La Amada beach

Beachfront La Amada

Empty boat slips at marina

La Amada - where are the guests?

Discount prices fail to lure guests

The massive number of loan defaults that has put the entire banking industry on the brink on insolvency did not happen by accident.   Banks recklessly extended credit, even to low income borrowers who obviously had the least ability to service their debts.   What may have seemed like a virtuous circle of increased consumer consumption and  higher banking profits has turned into a debt disaster for both borrower and lender - consider the Democratization of Credit.

WSJ -The recession has forced a financial reckoning for Americans across the income spectrum. The pressure is especially acute for the low-income Americans who relied on borrowing for daily expenses or to gain the trappings of middle-class life. Shifting credit practices over several decades had enabled them to live beyond their means by borrowing nearly as readily as the more affluent.

But the financial crisis and recession have reversed what some economists dubbed the “democratization of credit,” forcing a tough adjustment on both low-income families and the businesses that serve them.

“We saw an extension of credit to a much deeper socioeconomic level, and they got access to the same credit instruments as middle-class and mainstream Americans,”…

The financial crisis has forced lenders to be especially cautious with the riskiest borrowers, a category that low-income families often fall into because their debt tends to be higher relative to income and assets.

Some are turning to wherever they can for credit. A publicly traded pawnshop chain, EZCorp., reported a 37% rise in revenue in the second quarter. “With credit limited and other options disappearing, there are people looking for somewhere they can get emergency cash,” said David Crume, president of the National Pawnbrokers Association.

Cash-strapped workers have long obtained advances through “payday loans,” available at storefront lenders for fees that equate to high annual interest rates. Even that move is not so easy now.

“More customers are walking in the door, but turndowns are up,” said Steven Schlein, a spokesman for the payday-loan industry’s trade group, the Community Financial Services Association of America.

The Journal article also includes a chart showing that the combined delinquency and default rate for lower income groups dramatically exceeds that of higher income groups.  Are lower income groups inherently a poorer credit risk or did lenders create the conditions for default by recklessly granting credit in excess of a borrower’s ability to repay?

The Journal article perhaps should have more appropriately been titled “the marginalization of risk”.   Banks failed miserably in executing their basic mission - lending prudently based on a borrower’s ability to service the debt.   Regulators failed miserably by allowing banks to make inherently unsound loans.  Did the bankers really believe the income numbers supplied by borrowers who “stated” their income?  What were the regulators thinking when they allowed banks to lend money without considering a borrower’s income, such as with “no doc” loans?

The long term adverse economic consequences of reckless lending are now obvious - the bigger tragedy is that it was allowed to happen in the first place.

Japan’s real estate and stock market bubbles burst in the early 1990’s.   Since then, twenty years of non stop Government stimulus programs have failed and left Japan with the highest debt to GDP ratio in the world and two decades of lost economic growth.   The costly attempt to have failed banks prop up failed companies has lead to a massive misallocation of capital and resulted in Zombie Firms and Zombie Banks.

Banks were not forced to recognize the condition of their balance sheets and were encouraged to continue lending to firms that were themselves unprofitable. Anil Kashyap labels these “zombie firms.”

Zombie banks continued to direct capital to zombie firms. This charade continued for more than a decade, with the result that the once-powerful Japanese economy was completely stagnant for that period. The government’s main response was to dramatically increase spending on infrastructure and frantically try to get Japanese households to save less and consume more. The resulting “lost decade” of economic growth cost Japan more than 20% of GDP.

Japan has now decided to exponentially expand policies that have not worked for two decades by forcing banks to agree to debt moratoriums.

Oct. 6 (Bloomberg) — Japanese banks’ bad loans won’t be driven higher by a proposed moratorium on debt payments by struggling small companies, said Financial Services Minister Shizuka Kamei.

Lenders won’t have to classify loans encompassed by the plan as non-performing, Kamei, 72, said in an interview yesterday at his office in Tokyo. That means they won’t be forced to boost provisions when borrowers postpone repayments of interest or principal, he said. At the same time, Kamei vowed to push banks to extend more credit to small businesses after bankruptcies hit a six-year high in Japan.

“We’re going to get financial institutions to provide these firms with more loans,” said Kamei. “Banks won’t have to treat debt on which they provide a moratorium as bad.”

Japan’s three largest banks, including Mitsubishi UFJ Financial Group Inc., posted combined losses of almost $14 billion last fiscal year as bad-debt charges surged.

“There is a potential for any proposal along the lines Kamei has made of debt moratoriums to backfire horribly,” said David Threadgold, a Tokyo-based analyst at Fox-Pitt Kelton. The plan could make banks more reluctant to lend to small firms, Threadgold said.

The moratorium, postponing repayment of principal and interest, will be extended to individuals as well as firms Kamei said. It will aim at giving relief to companies with about 100 million yen ($1.1 million) or less in capital.

“As long as I’m financial services minister, I’m not going to leave small companies in the lurch unable to get loans,” Kamei said. “If a bank takes that approach, I’ll hit them with a business improvement order.”

Japanese “salarymen” struggling to pay mortgages after bonus cuts may be eligible, he said. “We’re going to make it extremely easy for very small companies to get money,” Kamei said.

Let summarize the lunacy of this new plan: debtors pretend they will pay later; the banks pretend that the defaulted loans will be repaid; banks will be forced by the government to lend more money to debtors who cannot repay what they already owe and the banks will not have to set aside loan loss reserves on the defaulted debt.  Japan’s debt moratorium is a final desperate attempt to “save the system” by preventing deeply indebted, income poor borrowers from defaulting on debts that can no longer be serviced.  It will move private bad debt onto the already over leveraged public balance sheet and will encourage debt repudiation on a massive scale.

When Debt Becomes Inconvenient

Debt that cannot be repaid won’t be repaid and the consequences of default are in many cases relatively minor compared to the burden of continued payments.   Japan now joins the U.S. in actively encouraging the repudiation of debt as discussed in How The Government Encourages Ruthless Defaulters and Loan Mods - Just A Warm Up For The Real Thing - A Mortgage Holiday.

Ironically, the biggest impediment to future bank lending is the growing trend of debt repudiation directly sponsored and encouraged by a government concurrently seeking to encourage more lending.

Consumers having trouble paying their debts can now chose from a long list of government programs for debt forgiveness, loan modifications, rate reductions, 125% loan to value mortgages and more programs on the way.  Their is no  longer any shame or embarrassment associated with defaults and bankruptcy.  Defaulting on debt has become a rational choice for many with little repercussions.

If the long shot odds of economic recovery and job growth do not materialize,  expect to see defaults worldwide increase exponentially as even those who can pay will chose not to.  Zombie banking is alive and well.

The FDIC always takes pride in noting that it is self funding and covers failed bank losses by assessments on FDIC insured member financial institutions.

Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation’s banking system. The FDIC insures deposits at the nation’s 8,195 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations.

How much longer the FDIC can continue to fund itself based on fee assessments is questionable.  For the second quarter of 2009, the banking industry as a whole lost $3.7 billion dollars and second quarter FDIC assessments totaled $9.1 billion.

FDIC Insurance Fund Nearly Depleted

The FDIC did borrow money from the Treasury during the last banking crisis in the early 1990’s and later paid the money back.  The escalating number of costly bank failures over the last two years has reduced the FDIC Deposit Insurance Fund (DIF) to only $10.4 billion which  covers potential losses on almost $5 trillion dollars in FDIC insured deposits.  In addition, the number of banks on the FDIC Problem Bank List continues to expand.

The Problem Bank List grew to to 416 institutions from 305 last quarter.  The total assets at Problem Banks increased to $299.8 billion from $220 billion last quarter.  This is the largest number of problem banks since June 30, 1994.  The number of FDIC  insured institutions declined to 8,195 from 8,247 last quarter.

Earlier this year the FDIC’s line of credit at the Treasury was increased to $100 billion and up to $500 billion with the consent of both the Federal Reserve and the Treasury.  With a nearly depleted  DIF fund and the prospect of hundreds of additional banking failures, the FDIC may have no choice but to borrow from the Treasury as noted in the Wall Street Journal.

WASHINGTON -- Federal Deposit Insurance Corp. Chairman Sheila Bair said Friday her agency may tap its $500 billion credit line with the U.S. Treasury to replenish its deposit insurance fund, though she appeared cautious about doing so.

“We are carefully considering all options” including borrowing from the Treasury, Ms. Bair said Friday after a speech in Washington.

Ms. Bair has already warned banks that they may face an assessment increase to bolster the fund. Friday, she said there are also other little-known options available to the agency, including requiring banks to prepay assessments. The FDIC board of directors will meet at the end of this month to consider how to replenish the fund, she said.

Ms. Bair appeared cautious about resorting to the Treasury credit line, saying there are different views on when it should be used. She said some believe it should be reserved for emergencies only, rather than for covering losses that are already known.

Surging loan defaults show no sign of leveling off which in turn puts more banks at risk of failing.  The FDIC will need a Treasury bailout - the only question is will $500 billion be enough?

Noncurrent Loan Growth

Banks that lost billions of dollars on speculative  investments and poor loans have routinely been awarding thousands of employees massive bonus payments.  Ironically, the only reason many of these banks are still in business and able to pay bonuses is due to the fact that they were bailed out by the taxpayers via the TARP program.

It is difficult to understand the lack of sensitivity exhibited by the bank’s compensation committees considering the populist outrage and criticism by politicians from both parties.  Consider Bankers Reaped Lavish Bonuses During Bailouts:

Nine of the financial firms that were among the largest recipients of federal bailout money paid about 5,000 of their traders and bankers bonuses of more than $1 million apiece for 2008, according to a report released Thursday by Andrew M. Cuomo, the New York attorney general.

All told, the bonus pools at the nine banks that received bailout money was $32.6 billion, while those banks lost $81 billion.

Some compensation experts questioned whether the bonuses should have been paid at all while the banks were receiving government aid.

“There are some real ethical questions given the bailouts and the precariousness of so many of these financial institutions,” said Jesse M. Brill, an outspoken pay critic who is the chairman of CompensationStandards.com, a research firm in California. “It’s troublesome that the old ways are so ingrained that it is very hard for them to shed them.”

Private firms that risk private capital on high risk leveraged investments should be free to compensate themselves as they see fit.  Banks, on the other hand, have been playing a “heads I win, tails you lose” game, risking depositor money (guaranteed against loss by the FDIC), suffering no consequences for bad decisions and collecting lavish bonuses for horrendous results.  The issue of why banks are allowed to risk taxpayer money on speculative activities was recently raised by former Federal Reserve Chairman Paul Volcker - Volcker Seeks Bank Limits.

In his speech, Volcker urged limits on the activities of banks that are considered “too big to fail,” going beyond what other officials in the Obama administration have advocated.

“I do not think it reasonable that public money –taxpayer money — be indirectly available to support risk-prone capital market activities simply because they are housed within a commercial banking organization,” Volcker said.

“Extensive participation in the impersonal, transaction- oriented capital market does not seem to me an intrinsic part of commercial banking,” Volcker said. “Substantial involvement in heavily leveraged finance and heavy proprietary trading almost inevitably entails risks.”

“I want to question any presumption that the federal safety net, and financial support, will be extended beyond the traditional commercial banking community,” he said.

Paul Volcker was probably not the only one wondering why banks are operating outside traditional banking areas and risking taxpayer funds.  Volcker’s speech seemed to hint that regulators were belatedly preparing to restrict both bonus payments and unwarranted risk taking by the banking industry.  Following up on Volcker’s comments, the Federal Reserve today  proposed dramatic restrictions on both bonuses and risky investment activity by financial institutions.

Wall Street Journal - Policies that set the pay for tens of thousands of bank employees nationwide would require approval from the Federal Reserve as part of a far-reaching proposal to rein in risk-taking at financial institutions.

Under the proposal, the Fed could reject any compensation policies it believes encourage bank employees — from chief executives, to traders, to loan officers — to take too much risk.

The U.S.’s largest banks, about 25 in number, would get especially close scrutiny. The central bank intends to compare these banks as a group to see if any practices stand out as unusually dangerous to their firms.

The Fed itself believes it has the legal authority to take such action through its existing supervisory powers, which are designed to oversee a bank’s soundness.

Pay is now seen as a factor that could make a firm, and more broadly the financial system as a whole, vulnerable to collapse. The financial crisis turned up many examples of how pay can give employees incentives to take risks. One example: loan officers who churned out thousands of low-quality loans in order to claim annual bonuses for themselves.

In a Wednesday speech, Former Fed Chairman Paul A. Volcker noted that one of the causes of the financial crisis “was the ultimately explosive combination of compensation practices that provided enormous incentives to take risks” just as new financial innovations “seemed to offer assurance — falsely, as it has turned out — that those risks had been diffused.”

The policies would apply to banks regulated by the Fed, not savings-and-loans or state banks that are overseen by the Federal Deposit Insurance Corp.

Will Fed Proposals Prevent The Next Banking Crisis?

If the Fed believed it had the legal authority to restrict undue risky activity at financial institutions, the obvious questions is why were these rules not implemented before the banking system imploded?  Regulators constantly reacting to disasters after they occur does not instill a strong sense of confidence that new regulations will prevent the next crisis.

Alan Greenspan, former Federal Reserve Chairman, today expressed his concern about the level of the US national debt.

Sept. 16 (Bloomberg) – Former Federal Reserve Chairman Alan Greenspan said he’s worried that lawmakers will hamper U.S. central bank efforts to rein in its monetary stimulus, and that inflation might “swamp” the bond market.

The former Fed chief, who counts Deutsche Bank among his clients, also warned that the U.S. must rein in its “very dangerous” level of debt, citing the threat of increased issuance of Treasuries undermining the dollar.

Greenspan said one threat to Treasuries is the “very dangerous” level of U.S. national debt. “We’ve got to confront that issue immediately,” he said.

Mr Greenspan’s sudden concern about the buildup of the US national debt seem to imply that this situation occurred after his long tenure (1987 - 2006) as Federal Reserve Chairman.  The facts speak otherwise.  During the Greenspan era of easy money and easy credit, the US national debt had already spiraled out of control, increasing from approximately $1 trillion to $9 trillion.

Did Mr Greenspan not notice what was happening during his two decade reign at the Federal Reserve?  Mr Greenspan’s  current concerns about the explosion of US debt seem to be a disingenuous attempt at historical revisionism to obfuscate his central role in the creation of the greatest debt bubble in history.   For Mr Greenspan to suggest that he had nothing to do with fostering the current “very dangerous” level of US  national debt is like trying to argue that Hitler had nothing to do with World War II.

Mr Greenspan also commented on the potential risk of inflation:

“It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said in a broadcast to Tokyo clients of Deutsche Bank Securities Inc. today. He later said that “if inflation rears its head, it will swamp long-term markets,” referring to bonds.

Greenspan, speaking via videoconference from Washington, indicated that successor Ben S. Bernanke and his fellow Fed policy makers have until next year before inflation will present a danger.

Based on Greenspan’s past poor record of not recognizing the inherent dangers of overleverage, it is highly likely that he is now missing the big picture again.  We are now experiencing a post bubble credit collapse of epic proportions.  The deleveraging process that we are now witnessing will not unwind 20 years of reckless credit expansion in one year.   If Greenspan fears inflation, it’s a good bet that the real danger is the continuation of a deepening deflation.

Commenting on the need for a systemic risk regulator, Mr Greenspan noted that “I’m not in favor of a systemic-risk regulator because I don’t think it’s feasible.  I think we have to recognize that there are limits to what we can do.”  No argument with that statement Mr Greenspan.

Based on the recent large rally in the gold stocks, it is time to sell and take profits?  The K-Ratio, a time tested method for timing the purchase and sale of gold stocks is telling us to stay long gold.

The K-Ratio is computed by dividing the value of Barron’s Gold Mining Index (GMI) by the Handy and Harmon price of gold.  The index reflects the relative value of the price of gold stocks to the price of the underlying metal.  When the ratio of the price of gold stocks to the price of gold is low, it is a bullish signal.  Conversely, if the price ratio of the gold stocks relative to the metal is excessive, it is usually a good signal to sell the gold stocks.

The K-Ratio works best at extremes.  The rule of thumb based on past history tells us that a K-Ratio at 1.20 or lower indicates that gold is cheap compared to the price of bullion.  A K-Ratio reading of 1.90 or higher is extremely bearish and indicates extreme overvaluation of the gold stocks.

Bullish On Gold Stocks

When last reviewed on April 24, 2009, the K-Ratio was at .90 and flashing a major buy signal.  Since that time, the Gold Bugs Index (^HUI)  has advanced by 39%.  What should be of extreme interest to gold stock investors at this point is that, despite the large gains in the gold stocks, the K-Ratio has increased only modestly and presently stands at 1.15,  still in solidly bullish territory.  (K-Ratio = Barron’s Gold Mining Index of 1159.20 divided by the Handy & Harmon Gold Price of $1008.25).

Since 1975, readings at or below 1.15 on the K-Ratio have resulted in gold stock gains 90% of the time over the next 12 months with the average gain a very profitable 40%.

There are no absolutes in investing and gold stocks are likely to fluctuate, but based on the time tested K-Ratio, it is way too early to be taking profits in the gold stocks.

Disclosures: Long GOLD, KGC, GG

The FDIC announced a new initiative to reduce foreclosures on home mortgage loans held by failed banks that were acquired by another institution.   This new FDIC program goes far beyond previous government mortgage assistance programs such as the Home Affordable Refinance Program (HARP) and the Home Affordable Modification Program (HAMP).

Whereas the HARP and HAMP programs require income verification and attempt to lower a monthly mortgage payment to a level that is reasonable in relationship to a homeowner’s income, the new FDIC forbearance plan will attempt to help homeowners who are currently unemployed.

FDIC Encourages Forbearance To Unemployed

As part of its loss-share agreement with acquirers of failed FDIC-insured institutions, the FDIC is encouraging its loss-share partner institutions to consider temporarily reducing mortgage payments for borrowers who are unemployed or underemployed. This program will provide additional foreclosure prevention alternatives to these borrowers through forbearance agreements that will give them an opportunity to regain full employment and avoid an unnecessary foreclosure.

“With more Americans suffering through unemployment or cuts in their paychecks, we believe it is crucial to offer a helping hand to avoid unnecessary and costly foreclosures. This is simply good business since foreclosure rarely benefits lenders and would cost the FDIC more money, not less,” said FDIC Chairman Sheila C. Bair. “This is a win-win for the borrower, who can remain in his or her home while looking for a new job, and the acquiring institution, which continues to receive payments on the loan. Ultimately, by reducing losses under our loss-share agreements, this approach helps reduce losses to the FDIC as well.”

The recommendation to loss-share partners applies where unemployment, or underemployment, is the primary cause for default on a home mortgage. In such cases, the FDIC is urging its loss-share partners to consider the borrower for a temporary forbearance plan, reducing the loan payment to an affordable level for at least six months. The monthly payment during this period should be established based on an affordable payment – given the borrower’s circumstances – and it should allow for reasonable living expenses after payment of mortgage-related expenses.

FDIC Plan Likely To Help Few Homeowners

The objectives of the FDIC’s forbearance plan are well intentioned.  Allowing an out of work homeowner time to find a new job may prevent an unnecessary foreclosure and eliminate the need for a costly foreclosure by the bank.  From a practical standpoint, the FDIC plan may ultimately benefit very few homeowners for the following reasons:

• The program is only available to those homeowners who have mortgages with failed banks that were acquired by another institution under a loss-share agreement with the FDIC.

• Under the forbearance agreement, the bank will accept only a portion of the regular mortgage payment.  The FDIC is asking for only a 6 month forbearance.  Given the prospects of a “jobless economic recovery” and the difficulty in finding new employment, the FDIC appears wildly optimistic about a quick change in fortune for an unemployed homeowner.   Banks do not want to foreclose, but very few banks now offer a forbearance plan to the unemployed since they do not expect them to quickly find a new job.

• The mortgage foreclosure prevention plans currently in effect have had dismal success rates and these programs are limited to candidates who have income.  The HARP program, expected to help millions of homeowners had at the end of July approved only 60,000 refinances.   The government loan modification program (for those not qualified under HARP) has been plagued by very high re default rates ranging from 17% to 45%.

• The FDIC recommends that the lender establish an “affordable payment” for six months, allowing for reasonable living expenses.  Many homeowners with jobs are struggling to make their mortgage payments.  Many states pay only a fraction of previous earnings in unemployment benefits.   Unless the homeowner has put aside some savings, unemployment compensation will usually cover only basic needs, leaving nothing for a mortgage payment.  It is likely that any payment (other than zero) will be too high for unemployed homeowners.

• Recent statistics on the “cure rate” for delinquent mortgages show a stunning decline.  The cure rate is the percentage of borrowers who are able to catch up and bring a delinquent mortgage current again.  As of July, the cure rate for prime mortgage loans plummeted to 6.6% from an average of 45% during  2000 to 2006.  Some of the delinquent borrowers had lost their jobs but many were still employed.  This is a sea change in attitudes towards home ownership.   Many of those financially able to catch up apparently saw no benefit in doing so; either the burden of home ownership outweighed the benefits or there was no perceived benefit in continuing to make payments on a home with large negative equity.   Many homeowners may view foreclosure as the best “program” for getting back on their feet since they could potentially enjoy years of “rent free” housing before the bank ultimately forecloses.

Trapped Homeowners Want Out

Heavy Load

Courtesy: laprogressive

Many Americans are apparently rethinking the “dream” of home ownership and acting accordingly by relieving themselves of the costly burden of mortgage payments, taxes and maintenance on what has become a depreciating asset.

While the government says “yes we can”, impoverished homeowners are saying “no we can’t”.  Perhaps this is why the massive government initiatives to prevent foreclosures are failing.   Trapped homeowners are doing what’s best for them and walking away, while the government vainly attempts to impose home ownership on those who now reject it.

The latest report from the Census Bureau on income, poverty and health insurance coverage portrays a darkening economic picture for millions of Americans.  Incomes and living standards fell without regard to geography, race or work profession.  For many, the Census report only confirms the destruction of the “American Dream” of economic advancement.

• For 2008 real median household income declined 3.6% to $50,303.

• The official poverty rate in 2008 increased to 13.2% from 12.5% the previous year and is the highest since 1997.   There are now 39.8  million people in poverty.  The government definition of poverty for a family of four is an income below $22,025.

• The number of people without health insurance increased from 45.7 million to 46.3 million.  The number of people with private health insurance decreased slightly to 201 million.

• Incomes declined across all racial groups.

• Incomes declined in every geographic region except the Northeast where incomes remained unchanged.

• Income inequality was unchanged in 2008 from the prior year, indicating that no income class was spared from a decline in income.

While the government is rolling out the press releases congratulating itself on an economic recovery, many Americans remain in an economic nightmare of unemployment, poverty and hopelessness.   The latest stats from the Census Bureau provide little reason for optimism since without income growth there will be no economic recovery. The latest report on the number of homeowners in foreclosure signals no recovery to date in incomes or jobs.

U.S. Foreclosure Filings Top 300,000 for Sixth Straight Month

Sept. 10 (Bloomberg) — Foreclosure filings in the U.S. exceeded 300,000 for the sixth straight month as job losses that boosted the unemployment rate to a 26-year high left many homeowners unable to keep up with their mortgage payments.

A total of 358,471 properties received a default or auction notice or were seized last month, according to data provider RealtyTrac Inc. That’s up 18 percent from a year earlier…. One in 357 households received a filing.

Foreclosures rose from a year earlier as companies cut payrolls by 216,000 workers last month…

“The foreclosure numbers are largely unemployment related,” Davis, a former Federal Reserve Board economist, said in an interview. “As long as 15 million Americans are unemployed, record foreclosures will continue.”

With the real world unemployment rate approaching 20%, the government’s loan modification schemes merely delay inevitable foreclosure for many homeowners - without income any monthly payment is too high.  Nor is unemployment the only cause of foreclosures.  For those who still have jobs but are barely getting by, a decrease in income can easily lead to mortgage default.

We Need Income - Not More Debt

While the divorced from reality politicians in Washington decide on what new deficit financed spending program they should enact next, they are missing the big picture.  Our future long term national prosperity will be based on promoting free enterprise job creation - something that does not appear to be on the agenda in Washington.

Mortgage rates continue their downward trend with the perfect borrower now able to obtain a rate of 4.75% with a two point buy-down on a 30 year fixed rate mortgage.  As expected, with mortgage rates now back in the 4% range, mortgage applications have increased.   The latest stats from the The Mortgage Bankers Association show large increases in mortgage activity, with refinances accounting for almost 60% of total mortgage applications.

The Market Composite Index, a measure of mortgage loan application volume, increased 17.0 percent on a seasonally adjusted basis from one week earlier.  On an unadjusted basis, the Index increased 15.8 percent compared with the previous week and 64.5 percent compared with the same week one year earlier.

While fluctuations in mortgage rates are historically based on many factors, the biggest factor affecting mortgage rates today are the manipulations by the Federal Reserve.   With the mortgage market dominated by the government, it is difficult to determine where rates would be in a free market but indications are that rates would be much higher.  For example, non agency lenders who do not sell mortgage loans to the government agencies but portfolio them instead, are currently quoting 30 year fixed rates at around 6 to 6.5% depending on credit and loan to value (obviously, the non agency lenders are not doing much conforming loan business).

Fed Price Fixing Efforts With Mortgages Will Fail

So what’s the problem with having low mortgage rates?  The  government manipulations in the mortgage market allow homeowners to refinance and buy at low rates.   If mortgage rates drop low enough, perhaps the government will succeed in its objective of re-inflating housing prices.  There just might be a few problems with the government’s manic quest to keep mortgage rates low.

• How long will investors continue to buy securities backed by mortgages on which payments are guaranteed by the government?  Perhaps forever, but perceptions of the value of a “government guarantee” may diminish as the financial condition of the US Government continues to erode.  At some point, rational buyers will give little credence to the guarantee of a government that needs to borrow 40% of its year outlays while running multi trillion dollar yearly deficits.
  

• How long can the Federal Reserve continue to purchase mortgage backed securities and treasury debt with printed money?  It may not seem to be causing a problem in this country (yet) but some of the USA’s largest foreign creditors are getting very nervous - See China Alarmed By US Money Printing.

Banks Load Up On Mortgages

Theoretically, the Federal Reserve can buy every mortgage backed security in existence but at what point does the bond market react with higher rates based on the risk that the Fed is going to monetize debt on a colossal scale?  Fed purchases of mortgage backed securities are fast approaching the announced goal of $1.25 trillion.

Courtesy wsj

As it turns out, the Fed has a willing and able partner in the purchase of mortgage backed securities.  With the banking industry facing massive losses on defaulting mortgages, how is this for irony? - Banks Load Up On Mortgages.

As of June 30, the roughly 8,500 federally insured banks and thrifts were holding $113.5 billion of Ginnie securities, compared with just $41 billion a year earlier, according to a Wall Street Journal analysis of bank financial disclosures. It is the largest amount that banks have reported holding since at least 1994.

Banks, sometimes with the blessing of federal regulators, have been loading up on Ginnie securities for one main reason: They make their balance sheets look healthier. Since the securities are guaranteed by the government, federal banking regulators have deemed them risk-free, meaning that adding them to a bank’s investment portfolio, or replacing assets deemed riskier, lowers the overall risk of the portfolio in the eyes of regulators.

Some banks have used government cash infusions under the Troubled Asset Relief Program to buy Ginnie Mae bonds.

Holding Ginnie bonds help banks look better because federal bank-capital guidelines give the Ginnie securities a “risk weighting” of 0%. That means banks don’t have to hold any cash in reserve to protect against losses.

At the same time that the banks are choking on defaulted mortgages and reluctant to lend, they are purchasing vast quantities of government guaranteed mortgages to shore up their capital ratios, sometimes using TARP funds.

The Great Unwind

The Fed fostered the bubble in the housing market with easy money, leaving us with collapsed housing prices and oceans of defaulted mortgage debt.  The Fed is now inviting a similar disaster in the mortgage market, again with super easy monetary policies.

The massive purchases by the Fed and the banks of mortgage backed securities is artificially inflating the prices of mortgage backed securities, consequently curtailing purchases by private investors.  This leaves the Fed and the banks as the only (irrational) buyers.

At some point mortgage rates will rise regardless of the Fed’s manipulations.  The taxpayers will be stuck with massive losses on the Fed’s mortgage backed securities as yields climb and prices plunge.  Banks, as always, will be heavily invested in the wrong asset at the wrong time.  Due to the magic of FASB accounting rules, the banks won’t have to take losses if they do not sell their mortgage backed securities; but neither will they be able to increase lending with capital frozen in underwater mortgages.

The government’s obsession with housing has resulted in the misallocation of untold trillions of dollars.   Meanwhile, urgent human and infrastructure needs of the country are left unfunded.   With the mortgage markets now completely dominated by the government, we can look forward to a continuation of the same failed policies.