Another reason why there is little cause for concern here is we already own virtually all of Fannie Mae and Freddie Mac.  At this point, we want to keep these loans going strong.  The mistake comes when we start rolling in Alt-A and option ARMs into the mix since most of the agency backed debt is prime.  Doesn’t mean it is good as we are now seeing massive prime defaults but it is nothing like the criminal Alt-A and option ARM toxic waste.  This program doesn’t open the door for the more toxic products.  However, the way the current modifications are being used many borrowers are essentially turning into long-term renters with a government backed option ARM product.  Not a good financial move for the owner.

Another concern was about equity in neighborhoods.  “Do I qualify for this?”  There is an easy way to search for this:

The site provides an easy way to see if your property has a Fannie Mae or Freddie Mac backed mortgage.  Keep in mind many lenders have botched the roll out of this program so badly.  This is expected since we are trusting the same banking industry that led us to the financial edge to all of a sudden have a sense of prudence and financial restraint.  The U.S. Treasury and Federal Reserve would love nothing more for every person qualified to refinance and be put into a 40-year fixed mortgage converting thousands into a new debt serfdom.  Why?  Because this would give irresponsible banks a second chance by converting many borrowers into long term renters.

There will be abuse with the program.  The first two questions are easily answered and verified.  If you want to refinance your second home then this won’t work.  If you have a $1 million mortgage, you do not qualify.  But question 3 is ambiguous.  Who will determine if a borrower is having a hard time paying their mortgage?  Are we going to give this judgment call to lenders who thought someone making $40,000 was qualified to take on a $500,000 mortgage?  Plus, questions 3 and 5 once again punish the prudent.  Let us say you are living within your means but are okay in paying your mortgage but you have a PITI below 31 percent?  Why should you not be eligible for a refinance?  Once again, those who have been prudent get slammed.  Winners are banks and those who over leveraged in loans they could not afford.

The current market volatility is reflecting the unsettling reality that this recession might last longer than many had hoped.  Housing prices continue to move lower and unemployment stays uncomfortably high.  But in the end, these kind of programs simply flush more money down the drain.  If you think about it, since we practically own Fannie Mae and Freddie Mac why should we offer any incentive to anyone for fixing these problems?  The taxpayer is now on the bill for this but we are going to give incentives to loan servicers for this?  More billions out the door to the real estate industry.

The problem with the current debate on housing is how it is framed.  The notion that everyone should remain in their home no matter what is wrong.  Some people would actually have a better financial picture if they downsized and rented.  They still have adequate shelter but maybe not their dream home.  Just because I don’t drive around in a Ferrari doesn’t mean I don’t have access to transportation.  Yet the way we are talking about housing is that everyone no matter what should stay put in their home.  Some shouldn’t.  Why do we need more taxpayer money to do the obvious?  The reason is the financial and real estate industries are being propped up by the U.S. Treasury and Federal Reserve.  They don’t care about your financial health.  Why do you think they are actually concerned about the rising savings rate right now?  Savings money is good but of course, they want to keep you on the hamster wheel spinning until you fly off due to consumption exhaustion.

I wouldn’t worry much about this program since it is the taxpayer money at stake already.  What I would keep an eagle eye on is how the government is going to deal with the Alt-A mortgages.  This is one area where they need to keep out 100 percent.  These mortgages were made in high speculative areas and were created with a structure to circumvent the checks and balances of conforming mortgages.  Therefore, they were meant to be high risk.  That risk did not pay off and taxpayers should not shoulder any burden for these products.  The government backed paper with the 125 percent cap basically means we are going to give servicers extra money for modifying loans that are already ours.  Forget the incentive fee, how about they do it free for all the money they lost during the housing bubble?

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In this same timeframe, we have added 24,000,000 people to the population.  But let us take a sobering look at the magnitude of job cuts we are seeing:

You will see that with the chart above the 2001 recession, which was modest by many standards, saw nonfarm employment peak right before the recession and did not hit a trough until January of 2004.  Given that this recession is the deepest since the Great Depression even if we follow the 2001 model, we shouldn’t expect to see a trough until 2011.  I am amazed that some people can look at a 467,000 job loss number and say it is okay.  There is nothing good about the employment report released Thursday.

If we dig deeper, we realize that the true unemployment rate measured by the U-6 data is showing a much more painful economic environment:

The U-6 number now shows a 16.8 percent unemployment and underemployment rate.  This is now in record territory.  Back in December of 2008 I posted these two charts and stated that people will start feeling this as a minor depression when the U-6 rate hit 19 percent:

Now the rate of job losses is still very high and it is very likely that we will see that 19 percent rate for the U-6 figure.  There are many out there believing that a second half recovery is imminent but what sectors are going to employ the 26,000,000 unemployed and underemployed Americans?  It is hard to imagine any industry having the slack to pick up this job loss amount.  Take a look at how widespread job losses are hitting the economy:

The only sector that added jobs was education and health services and even here, it was a modest amount of jobs.  Every other sector including government shed jobs.  There really is no place to hide.  Now assuming we go back to the peak employment days when 138 million people were employed in nonfarm jobs, that means that we will need to find 7 million jobs for currently unemployed or underemployed Americans (this of course assumes we lose no more jobs from here but the momentum is still moving forward).

The problem of course if we look at the data above again, we are losing higher paying jobs in “goods-producing” and also in manufacturing.  These sectors are getting hit the hardest.  Sectors like “leisure and hospitality” and “retail trade” are losing jobs but at a slower pace thus inflating the situation.  The real story is good paying jobs are disappearing at a faster rate.

It is amazing how quickly things are changing.  Since the start of the recession in December of 2007 we have seen 6,460,000 job losses.  And keep in mind this is the official number.  During this time, we have seen those working part-time for “economic reasons” go from 4.4 million to 9.3 million.  And how many people are working less hours, seeing no raises, and are having to cut back?  These numbers aren’t reflected here.  Already with the job losses and the part-time for economic reasons, we see that over 11 million Americans have either lost their job or are working part-time for economic reasons since December of 2007.

The employment situation is tough because many of the jobs added this past decade were based on the bubble economy.  Real estate and finance dominated many sectors.  In a sense, it is no surprise that we are now seeing no net added jobs for the entire decade.  The question not being explored by the media or those calling for a second half recovery is what industry is going to make up for all these job losses?  To try to re-inflate the bubble by giving banks and the housing industry more money is simply a bad approach yet that is for the most part what we are doing and calling it stimulus.  Is it any wonder that it hasn’t worked for the average American?

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This has also come from aggressive marketing from credit card companies but also the changing societal landscape.  Just think of online shopping.  Can you imagine someone sending in a check to purchase an item and actually needing to wait?  The instant gratification became a hit when credit cards turned into casino chips.  This boom in debt is massive:

As you can see from the chart, Americans started massively going into debt starting in the 1970s and that has continued for decades.  The blue line above shows Americans are pulling back their usage of debt at the fastest pace in half a century (actually, quicker if we had data that goes beyond the 1950s).  Now this is occurring because the U.S. Treasury and Federal Reserve although bailing out Wall Street and banks, has given banks even more power and money and banks realize that they still have years of bad debt to remedy and are only holding on to funds to fix their balance sheet.  End result?  Credit growth for the average American is halting by force.  As I had mentioned previously credit card companies yanked 8 million credit cards from the system back in February.  Now the problem is many Americans view credit cards as a form of wealth or pseudo-income so having their credit reduced was equivalent to a wage cut.

In fact, if we look at bankruptcy filings we will see that in 2005 filings surged because many people wanted to beat the new bankruptcy legislation that would make it harder for people to file:

It is interesting to note that we are now approaching those peak levels on top of having the stricter bankruptcy legislation.  Keep in mind 2005 was a supposedly good year.  The housing bubble was still going and pseudo wealth was still flowing like a waterfall.  Yet an enormous part of this decade was fueled by debt and not actual real wealth.  Much of that has been washed away with $13.8 trillion in household wealth disappearing since the recession started and now 26,000,000 Americans are unemployed or underemployed.

Yet the credit card was only the ultimate logical extension of a society fueled by debt.  Like those first cards in the 1920s which were used for auto fuel, the modern day credit card was used to fuel the economy.  Have you ever tried paying for an item over $500 in cash?  If you do or have, it will definitely make you think twice.  Psychologically the impact this has is you see what you are actually paying for in real terms.  It is very different to swipe a card and be done with it.  That is why so many Americans have gotten into massive amounts of debt and have used the credit card to the extreme.  Many card companies are now upping their minimum payments from 2% to 5% a month and this slight increase is causing hire defaults.

In fact, defaults are now at their highest point ever:

“(Reuters)  * Chargeoff rate rises over 10 percent for the first time

* Moody’s sees chargeoffs peaking at around 12 percent

* Moody’s says bad loans will peak in Q2 2010

NEW YORK, June 24 (Reuters) - The U.S. monthly credit card chargeoff rate surpassed 10 percent and hit a sixth straight record high in May, Moody’s Investors Services said on Wednesday, as unemployment grew to a 26-year high.

The chargeoff rate index — which measures credit card loans the banks do not expect to be repaid — rose to 10.62 percent in May from 9.97 percent in April.”

Now keep in mind it takes months before a credit card company will charge-off an account.  That is, some of these people have stopped paying back in 2008.  Given our rising unemployment and weak economy, you can expect the rate to rise.  The fact that credit is being sucked out of the system will make many Americans feel like they are quitting a hard narcotic cold turkey.  This is the final straw that breaks the debt based economy.

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Americans are increasingly putting more and more money on the sidelines.  For the month of May Americans put away 6.9 percent of their income into savings.  Not the stock market or real estate but bona fide savings.  This is a stark contrast from the zero rates achieved back in April of 2008.  When we discussed the new austerity for Americans, much of this is being driven by the loss of jobs and the fact that nearly 26,000,000 Americans are unemployed or underemployed.  Now why are Americans suddenly finding the need to save some money?  First, the decade long housing bubble has shattered the notion that phantom equity is the same as actual wealth.  The next major issue is the stock market is no longer seen as a safe investment.  Even if someone had his or her funds in the S&P 500 the index is still down approximately 40 percent and that is after the major rally since the March low.

Something is definitely going on here:

We have never seen such a rapid change in the savings rate.  Of course, going from zero anything would be an improvement.  The current seasonally adjusted annual rate has not been seen since 1993 but as the chart above shows, the percent of change is unmatched with 50 years of data.  What is occurring here?  I’ve seen a few articles talking about the new found frugality that Americans are now embracing.  This is something I hesitate to agree with because it presupposes that Americans are electing to save as a choice rather than being forced by external circumstances.  I do believe many Americans are becoming more frugal by choice but the vast majority are simply responding to the horrific economy that has evaporated $13.8 trillion in American household wealth.

But who are the big winners here?  Banks.  The Fed shows that deposits at many banks now stands at $7.5 trillion showing the largest increase for the year.  These banks are getting insanely cheap deposits from the government and now you to help mend their broken balance sheets.  Call it double dipping.  Look at how much money is being put into savings:

We have never seen so much money move to the sidelines.  We are now approaching an $800 billion SAAR which means, nearly $1 trillion in money is being put on the sidelines.  This is good right?  Unfortunately the way our economy is set up this means more and more money isn’t out there chasing consumer goods.  With massive market volatility this is actually viewed as bad.  That is the irony here.  Savings should be a good thing yet 70 percent of our economy depends on consumption.  Taking out $800 billion from commission will do damage since banks are not lending this money:

So all that is happening is banks are building up their reserves for the second round of hits that will occur with commercial real estate, credit cards, and higher unemployment coming down the pipeline.  It is fascinating to note that during the last month more insiders were selling stock than buying.  These are the folks smiling on TV one minute telling you everything is okay while quietly dumping their holdings now that the market is artificially propped up.

Let us go on a quick test shall we?  Many banks are being bailed out with golden parachutes with diamond pull strings so let us see what kind of savings rates they are offering Americans:

Don’t adjust your glasses or monitor.  You are reading the above right.  Bank of America is offering a stunning 0.10 percent for your regular savings account.  You might as well stuff the money in a mattress!  Let us see what Wells Fargo is offering:

If you thought Bank of America was low Wells Fargo is offering a 0.05% rate!  You know how much money you would get if you left $10,000 with them for one year?  Five stinking dollars!  Just for the sake of it, let us look at Chase since they now own WaMu as well:

Say what?  At these rates people are saving out of fear and not a new sense of frugality.  People figure that it is better to get the service of an ATM card than putting their money into the Wall Street casino or the housing bubble.  Oh, but it gets better.  The U.S. government through the U.S. Treasury and Federal Reserve do not want Americans to save any money.  In fact, they are offering even lower rates:

That is correct.  A 0 percent savings rate.  And this is all designed by purpose.  The Federal Reserve is intentionally keeping the Fed funds rate low so banks can fix their balance sheets and the U.S. can inflate itself out of debt.  Yet this is bad news for prudent savers.  The attempt is to make every option so unattractive that people have to pump their money back in the stock market that is now operating like a game of blackjack in Vegas.  Yet even though we hear about historical low rates, banks are making a ton on the margin of money they are borrowing from the government (aka taxpayers).  That is, they are taking in money paying 0.05 percent or whatever it is, and getting 5 or 6 percent on mortgages and taking in 15 to 20 percent on credit cards.  Give me access to those kind of terms and I’d make money too.

The bottom line is the government and Wall Street do not want Americans to save.  This is reflected in these absurdly low rates.  It is easy to encourage savings.  Increase the yield on savings accounts through hiking the Fed Funds rate.  Yet the U.S. Treasury and Federal Reserve know that their Wall Street friends and our government debt is so large, that we are going to have to deflate our currency and destroy the dollar.  Enough with the “strong dollar” policy talk since all actions point to a weak dollar policy.

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California has drastically changed in the past century.  Before 1912 California would pull 70 percent of its revenue from property taxes.  In most cases property taxes are a better and steadier revenue stream because they tend to fluctuate the least in challenging economic times (assuming we don’t have mega once in a century national real estate bubbles like we just did).  Even with recessions, property taxes are a good revenue stream because people for the most part will cut back on virtually every other line item before losing a home.  Yet that is now not the case.  Now, the primary sources of income for the state are personal income taxes, sales and use taxes, bank and corporation taxes, and a variety of excise taxes.  This is how it breaks down:

It is rather apparent how a recession this deep will plunge the state to near economic collapse.  First, personal income taxes take major hits during a crisis like this.  If the state is drawing nearly half of its revenue from a volatile stream, you will get volatile tax collections.  Plus, with an 11.5 percent unemployment rate meaning over 2,100,000 people are “officially” unemployed there is no income tax being paid in the first place by a large contingent.  Sales and use taxes make up nearly 35 percent.  Well of course during a crisis, people are going to pull back and not buy items like cars, big televisions, and therefore sales taxes will be hit as well.  The California revenue system is a boom and bust system.  Take a look at revenue streams for the past few years:

Capital gains income highlights this boom and bust cycle perfectly.  In 2000 with the technology bubble California residents took in $117.56 billion in capital gains which the state received a nice chunk of $10.6 billion.  Yet after the bust, in 2001 only $50.7 billion was made and only $35.5 billion in 2002.  So of course, this revenue stream was chopped each year.  Then with the real estate bubble, we see that 2005, 2006, and 2007 actually brought in more money than the tech bubble.  The state of course collected nice sums of money from this bubble.  Yet now, this has busted and capital gains income has fallen off a cliff.  Interestingly enough, property taxes actually increased from 2000 to 2001 at a modest rate even while cap gains split in half.

Now we are seeing drops in property tax collections given the epic California housing bubble that was built over the decade.  Property taxes for the most part are viewed as local revenue streams and impact cities, counties, and schools more directly.  The breakdown for example is roughly 17 percent counties, 11 for cities, 53 percent to schools, and 19 percent to special districts.  Here is the breakdown:

Now keep in mind, this is for 2006-07 which was a banner year.   During the 2006-07 fiscal year property tax revenues came in at $43.16 billion.  According to data provided by the Board of Equalization property assessed values during this time reached $4.28 trillion in the state.  Now this was at the peak.  By most estimates, the bubble has popped and California as whole has seen the median price drop by 50 percent.  So it is safe to say that the values are now at $2.1 trillion.  No wonder why revenue is drying up from every possible angle.

A big shift in revenue streams came on June 6, 1978 when voters overwhelmingly approved Proposition 13.  The reason this was passed is dramatic rises in property taxes during that time and also, a growing state surplus of $5 billion.  Proposition 13 rolled most local property taxes back to 1975 assessments and limited property tax rate increases to 1 percent plus the rate of local voter approved bond measures.  It was a limit to future property taxes.

After this measure passed, property taxes collapsed from $10.8 billion in 1977-78 to $5.4 billion in 1978-79.  So people tend to forget that once this happened local governments went into fiscal haywire.  For the first two years after Proposition 13 passed the legislature had to bailout local governments.  The first year a stop-gap measure costing $4.17 billion was used from the state surplus.  A second year bailout cost the state $4.85 billion.

But many properties have traded hands in recent years given the California housing bubble.  With this, many properties are now sitting on overpriced assessments.  Proposition 13 allows for reassessment when properties exchange hands.  So now after the drastic collapse in prices, you can rest assured that taxes may be too high on some properties ironically.  It is pure insanity how California does its taxes.  How so?  Well if you assessed property at bubble level prices on a yearly basis, the overall cost of owning a home would be more accurately reflected.  We now have people who bought at the peak with overpriced homes and over assessed properties.  It just doesn’t give an accurate reflection of true cost.  Also, you have corporations who use Proposition 13 as a shell to keep paying commercial rates dating back to the 1970s since they don’t need to exchange property as often as say a residential homeowner.

Yet that is one side of the story.  The bigger drain is the personal income tax stream plus the sales tax.  Let us see how this plays out for someone making $100,000 a year:

Let us assume you are a young working professional making $100,000 a year.  The above chart shows you how much money you are left with once all taxes are taken.  After all is said and done, nearly 40 percent of your income is gone (most of it going to the federal government).  So after that, you can feel good right?  No.  Because the state will then tax you like crazy with sales tax.  Here in California many counties now have 9 to 10 percent sales tax rates!  So after your $8,333 a month gross goes to $5,267 net, you now have to go out and buy things.  But when you buy an item, you are going to pay an additional tax.  The true tax burden for Californians is near 50 percent when all is said and done.  It would be one thing to pay for effective government but can you call what we have effective?

What many people don’t realize is that 15 percent of California taxpayers, those that make over $100,000 pay 84 percent of all the personal income tax revenue.  And those that make over $480,940 which are the top 1 percent pay 48 percent of all state personal income taxes:

The problem with this system especially when you had many in the technology industry making tons of bubble money during the bubble is once it bursts, you will lose your primary source of income.  More recently, you had a double revenue bubble since property taxes soared because of the massive housing bubble but you also had tons of people working in the finance, real estate, and other related industries making these high incomes which are now gone.  So you lose the income and the property tax streams.  Systemically our system is broken.  Proposition 13 is only one piece of the puzzle.  The problem is we depend on revenue sources that are not stable.  Unfortunately a better source of revenue is property taxes just like many other states have.  Yet to raise property taxes without adjusting state personal income taxes is insanity.

Also, going back to the $100,000 worker, housing prices are still much too high.  For example, let us now assume this person wants to buy a modest home in a decent area.  Let us look at some L.A. areas for an example.  Let us assume this person wants to buy a starter home in Eagle Rock.  The median price for Eagle Rock is $475,000 and that is with the current reality that L.A. County as a region has seen the median price drop by 50 percent (of course much of this is because of the lower end distress market making up over half of sales).  So this person decides to buy this home with 10 percent down:

Down payment:                               $47,500

Mortgage:                           $427,500 (30 year fixed at 5.5 percent)

PITI:                                       $2,921

Net Income:                       $5,267

Disposable income after house payment:            $2,346

Now many would say big deal here.  But you need to remember we have done no contribution to a 401k or we haven’t even factored in healthcare costs.  Food?  Car?  You can see that a $100,000 in California does not go a long way and only 15 percent of taxpayers fall in this bracket.  Just imagine for the median income earner which is approximately $50,000.  So you say what about 2 income households?  That puts us up to 26 percent of the population that makes over $100,000 but this is from 2007 data.  With unemployment skyrocketing since then that figure is surely lower.  It’ll be fascinating to see the data figures once we have our next big census in 2010.  We may see a lost decade of income for many Californians.

If it isn’t obvious to you already, we need a massive overhaul of the system.  The current solutions of pure cuts or pure tax hikes are piecemeal solutions because as you can see, we’ll be back at this again next year.  We need to reform the system to include more stable revenue streams and link up state government to these streams so they don’t go into feast and famine mode every few years.  For the past 20 years, we jumped from one bubble to the next.  Unfortunately, there is no other bubble in the short-term and the reality of the mess is being exposed.  Because if $100,000 a year is not enough for someone to live on here in the state and have a middle class lifestyle, then we have some serious issues.

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The problem with dealing with the current foreclosure issue in California is how the issue is being framed.  Take this perspective for example:

“(SF Chronicle) The goal is to compel banks to do systematic loan modifications across California to reduce our foreclosure rate, which is the highest in the nation,” said Assemblyman Ted Lieu, D-Torrance, who wrote the bill. “Until we slow that down, the California economy cannot recover.”

I appreciate the perspective but dropping the foreclosure rate in the short-term to pad statistics is flawed for many reasons.  The way the plan is devised, it will create an army of lifelong renters with onerous mortgage terms.  This is helping no one except servicers to get a nice kick back for modifying the loan and padding foreclosure data in the short term.  Take a look at how the last moratorium turned out in California:

So what we have in q3 and q4 of 2008 is a drop in notice of defaults but then a skyrocketing catching up in q1 of 2009.  Q2 of 2009 will be high yet again but we may see a drop for the next few months.  This is simply a diversion and there is little that can be done for a 3 decade long housing bubble that simply needs to pop.

The problem with the new plan is that it tries to force borrowers into a plan that coincides with the current administration modification bill even if it means going with gigantic LTV ratios, artificially low teaser rates, 40-year amortization, and making the loan a balloon payment.  This is essentially creating lifelong renters and servicers have every bit of incentive to avoid chopping principal down.  Here is what we are told in the CFPA FAQ:

“While a sustainable loan modification may be different for different borrowers, the potential ways a loan may be modified include any of the following:

-An interest rate reduction, as needed, for a fixed term of at least 5 years.

-An extension of amortization period for the loan term, for up to 40 years from the original date of the loan.

-Deferral of some portion of the principal amount of the unpaid principal balance until maturity of the loan.

-Reduction of principal.”
The last option is not going to happen in a large number because we already know that the banking industry has lobbied hard against cram-downs which are basically principal reduction.  If you look at this closely, a rate reduction for 5 years is basically the same thing that is going on with the toxic option ARMs and Alt-A mortgages!  These are artificially low teaser rates.  The fact that they are talking about extending the loan amortization to 40-years and including deferral of principal (i.e., negative amortization) is basically making these government sponsored option ARM loans!  This is total insanity and any borrowers need to think twice about locking themselves into such bad loan products.

As if this isn’t enough, many lenders in California have already received exemptions from the program:

So you have essentially the three behemoths of Bank of America, JP Morgan, and Wells Fargo exempt.  Keep in mind these 3 have swallowed up Wachovia, Countrywide Financial, and WaMu who were the ultimate toxic mortgage pushers.  Oh, and this is for loans that fall under conventional limits which means most of those toxic pay Option ARMs and Alt-A largely are unaddressed by this.

The problem also is that first lien holders are going to get a more exotic product after these modifications.  Think of someone with a conventional 30 year fixed mortgage of $300,000 suddenly having it modified to a 40 year mortgage with a 5 year teaser rate.  How does this help?  If anything, it assures us a longer and more prolonged housing slump since at some point, the rate will go up again.

Most of these modifications will fail within a year.  As recent data indicates, over 70 percent of modified loans have already failed.  Why would this be any different?  Except, we are going to be wasting $1,000 of taxpayer money per modified loan by kicking down the servicer.  Why not just amortize loans over 100 years if the main goal is to chop the monthly nut?

All this program does is turn negative equity home owners into long time renters.  After all, if people had equity all they would need to do is sell the home.  The crazy thing about the modification is also the debt-to-income ratios allowed:

“The program targets a ratio of the borrower’s housing related debt to gross income of 38% or less, on an aggregate basis in the program.”

This is problematic.  First, California homeowners are leveraged to the max.  So we aren’t going to factor in other debt like credit cards, student loans, auto loans, etc?  So say for example someone makes $5,000 a month (gross), they can have a home payment of $1,900.  Sounds good right?  Well after taxes we start seeing issues especially if we are only lowering the teaser rate and turning the loan into a 40 year product.  Let us run a scenario here:

Now here we are running a quick and dirty example.  As you can see, for extending the term of the loan for 40 years the borrower will save $246 per month.  However, for this quick fix they will be paying approximately $60,000 more in interest over the long term.  This again is a problem with our massive debt system.  Short sighted thinking got us into this problem so why would short sighted thinking get us out?  The U.S. Treasury and Federal Reserve are doing everything to devalue the dollar to create consumer price inflation but that isn’t happening.
The CFPA basically rewards servicers for creating a new class of pay Option ARM with government support and the borrower basically gets to live in a home with negative equity as a renter.  Actually, it is worse than renting.  We may be living through a lost decade of housing appreciation so if this borrower wanted to move in the next 5 to 7 years, they would actually have to cover the negative equity portion of the balance to leave the house.  They obviously can’t sell and the principal is still at the inflated bubble price.  Renters, can just pick up and leave.  So it is more like servitude.  How many people will jump into this is something we will look at closely.  The fact that they would allow negative amortization and teaser rates is astounding.  This is simply kicking the can down the road.  Negative equity is a major reason why people default.  Why would you want to pay on an underwater asset?  Plus, California now has an 11.5 percent unemployment rate which isn’t exactly helping.

A better solution is what is occurring with foreclosures.  A market bottom will be found.  Many people will become renters but that is okay.  Instead, policies like this simply prolong the inevitable decline while providing taxpayer money to the housing industry which lived it up during this mess.  You can rest assured that the CFPA is going to be a failure and will only serve to pad the resume of certain politicians while prolonging the housing mess in California.

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On June 15, 2009 the Office of the Inspector General issued their audit report regarding the failure of California’s Downey Savings and Loan Association (Downey).  Now the story of DSL is important because it highlights the entire process of how we came to this financial crisis that now threatens the economic stability of the world.  The market volatility that we are seeing is merely a reflection of what institutions like Downey dabbled in with their love affair with toxic mortgage assets.  And California now has an 11.5 percent unemployment rate which is the highest in record keeping history.  If we look at alternative measures, the state is probably closer to a 20 percent unemployment rate.  Yet the 71 page report issued by the OIG is probably only being read by a few people.  This report tells us much and gives us solutions as how to approach this problem.

Downey was taken over on November 21, 2008 by the FDIC at a staggering cost of $1.4 billion.  This puts it into the top ten most expensive institutions taken over by the FDIC during this crisis.  It is fascinating to note that in the report, we are told that the primary cause of Downey’s collapse was its high concentration of option adjustable rate (ARM) loans and its lack of documentation in loans:

“The primary causes of Downey’s failure were the thrift’s high concentrations in single-family residential loans which included concentrations in option adjustable rate mortgage (ARM) loans, reduced documentation loans, subprime loans, and loans with layered risk; inadequate risk-monitoring systems; the thrift’s unresponsiveness to OTS recommendations; and high turnover in the thrift’s management. These conditions were exacerbated by the drop in real estate values in Downey’s markets.”

This shouldn’t be a surprise to many.  Yet the policy implications should be clear as day.  There is no reason for these toxic mortgage products to exist.  And the way we are currently handling the problem will only ensure a deeper and more prolonged battle.  First, banks will get the message fast if the government stops buying or subsidizing any of these toxic assets.  Banks will learn quickly never to make these loans again if we allow those institutions like Downey to fail completely because of their own decision to jump into this segment of the market.  Instead, we are developing a public-private investment program designed to buy up these toxic products.  What does this teach banks?  It teaches them that making toxic products available is a worthy risk to take because if things get bad like they are in this current recession, then the government will bailout their risky behavior.  The major losers here of course are average American taxpayers.

When Downey failed it had $12.8 billion in assets.  I question the worth of the assets but that was the book value.  Downey was a big player in the California housing market and was a player in the toxic mortgage waste that pushed the median price of a California home to the near $600,000 median price during the peak.  Now, the median price is in the low $200,000s.  They of course shifted from making more traditional loans to ever more toxic products that simply imploded the bank for short-term gains.

As we read the report, we are told that the OTS made constant recommendations to the bank but of course, the OTS was stripped to the very minimum because of bank lobbying over the past decade.  The policy implication here becomes radically clear that if we are to have a legitimate oversight board, it must have the power to enact regulations on the books.  That is probably one thing many people fail to understand right now.  Many of the regulations necessary are already on the books.  Yet the bodies governing these policies are so weak and pathetic, that banks were able to ramrod legislation that essentially made them shells with no ability to enforce the laws.

Downey by the end of 2005 at the height of the bubble had 91 percent of its single family home loan portfolio in option ARMs.  They basically went 100 percent with this toxic product.  73 percent of Downey’s option ARMs had negative amortization potential which of course did occur and imploded the bank.  Just take a look at this stunning chart:

And as the chart shows, Downey was in the game early on.  Thus, their recast of 5 years on their typical option ARM started imploding much earlier and led to their demise in 2008 even before the major wave of option ARMs will swarm the market in 2010 through 2012.  The disturbing facts also come out regarding teaser introductory rates which artificially allowed people to buy more home than they could afford.  With the availability of “no-doc” loans anyone with a desire to get a loan got one.  The fact that 91 percent of their SFR loan portfolio is option ARMs is appalling.  Institutions here in California basically created a casino with housing even though agencies knew of the longer term implications.  In regards to policy, this gives us clear implications:

1.  Do not bailout any mortgage product that is an option ARM.

2.  Government agencies overseeing these institutions must have teeth to act and stop companies before things get out of hand.  Imagine the police with no power to enforce the laws on the book.

3.  Clearly these products had no life outside of the bubble.  They should be labeled as

such and any institutions engaging in these products goes forward at their own risk.  No bailouts ever.

And of course, the method of accounting allowed the bank to book capitalized interest as income even though borrowers were electing to pay the very minimum which in reality, meant the institution was getting closer and closer to the end:

The policy implication is clear.  This was never income.  How in the world banks could be allowed to do accounting this way is insanity.  Yet much of the first quarter of 2009 profits booked by banks were because of the suspension of mark to market and this kind of accounting shenanigans.  We have learned nothing.  The policy implication is clear.  Banks should not be allowed to book these items as income.
The chart below shows the insanity reached by institutions like Downey:

Even as problems started rising with Downey, up into 2008 over 90 percent of loans made were with reduced documentation!  That is, the vast majority of their business was liar loans.  Now, these are the potential loans that we will be buying through the PPIP.  These are the loans made to speculators and people delusional in California thinking that $600,000 home prices were justified.  These loans should fail and through foreclosure, the market will find a price for them.  The PPIP by all means should have a clause banning any purchase of options ARMs or Alt-A products.  End of story.

The report tells us that by the end of 2007 the option ARM portfolio started facing major stress.  Yet Downey as the chart shows above kept making those loans.  Why?  The system was built on casino like rules.  Mortgage brokers kept selling products that yielded the most for them while putting the most risk on the borrower.  Management was chasing profits so they didn’t care.  In the end, it became an ultimate moral hazard.  If banks are required to hold these loans, this will not happen.  Just use common sense.  Would you lend your money out like this?  Of course not.  But this was the “other people’s money” delusion pumped out by late night real estate snake oil salesman that became mainstream for the decade.

The fact that the report tells us that Downey was unresponsive is a joke.  This is like a person speeding down the highway going 100 miles per hour not “responding” to a cop and his siren.  Do you think the cop would just let him go and say, “oh well, I’m sure he’ll slow down later.”  It is this kind of nonsense that has made the banking industry the ultimate oligarchy in our country since they are not only guiding policy, but writing it.  The case of Downey Savings and Loan gives us clear policy implications yet we are not following what is in front of us.  If we keep letting the banks loot this country with the aid from the U.S. Treasury and Federal Reserve, there will be a repeat of this kind of bubble in a few years in some other industry.

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The headline number of 9.4 percent unemployment doesn’t do any justice to the 26,000,000 unemployed or underemployed Americans.  Last month, we saw the unemployment situation improve when only 345,000 job losses came online.  This sure beats the 500,000+ months we had for six consecutive months.  Yet the actual unemployment rate jumped from 8.9 percent to 9.4 percent.  This was the highest percentage jump in the recession tying another 0.5 percent monthly jump.  So what gives?  In a nutshell, companies are not hiring.  So yes, job losses may have dropped but there are no new jobs to pick up the currently unemployed so the actual rate increases.  This is one of those nuances of the two surveys used by the BLS.

So what can we look at for a better indicator?  We should be looking at actual hours being worked.  The decline in aggregate hours is the steepest since 1975.  Take a look at this chart:

Now this may be the best leading indicator of when the employment situation will really turn around.  Given the current market volatility using the stock market as a leading indicator is completely flawed since this is the steepest recession since the Great Depression.  Old measures may not work.  We also have unique “saved” employment with many places going with furloughs or cutting back on overtime work.  Take a look at what happened in January in California with tens of thousands of state workers being furloughed:

“(SacBee)  Some were furious. Others were sad, even tearful. Many more accepted the news with graceful resignation, trying to hide their worries.

At the end of a week that brought nothing but more grim economic news, that’s how dozens of state workers greeted the state personnel department’s announcement that thousands of California public servants will be furloughed two Fridays a month and lose 10 percent in pay, starting Feb. 6.”

Now how this plays into the employment situation is when things do start picking up, the aggregate amount of hours work will be a first signal of any turnaround.  Why?  Well think about the furloughs for example.  When work does pick up and the economy begins to turn around companies will first go to their currently hired full-time workers and give them more hours. 

Companies will also offer more overtime when work starts picking up but this will benefit their current employees.  So this may not show up in the current employment data since it measures full-time employment and hires and this will only show up initially in aggregate hours.  Yet as you can clearly see on the aggregate hours chart above, we are still heading lower.  What is fascinating if you look at the gray recession bars above, almost every time once aggregate hours start moving up it nearly indicates the end of the recession for statistical purposes. 

The amount of people working part-time jobs for economic reasons is off the charts:

With 9.1 million people falling into this category, our nation is quickly buffering this current recession with part-time work.  The official number of unemployed is 14.5 million so the part-time number is inching closer to the actual number of unemployed.  However, last month the part-time number stalled while the actual unemployment rate jumped.  So what this tells us is even at the part-time level, some companies are pulling back. 

It is hard to project where things will go from here.  With so many stimulus programs at work, it is hard to say how this will translate but the bottom line is when it comes to employment, there are no green shoots.  The aggregate hours worked figure is probably one of those indicators that you want to follow closely because it will be a more accurate leading indicator of when the employment situation will change for those on main street.

The U-6 rate is now up to 16.4 percent.  Back in December I made the assessment that we will feel a mini-depression once the U-6 hit the 19 percent mark.  We are inching closer to that.  At the time, the U-3 rate was at 6.7% and the U-6 rate was at 12.5%.  And just to show how close these two track, this is how much they have increased since then:

6.7% then - 9.4% now =      Change of 40%

12.5% then - 16.4% now =  Change of 31%

The reason as we mentioned with part-time not hiring, is a reason why the U-6 has fallen.  But at this rate, U-6 will be at 20 percent by the end of 2009.  The U-3 rate will be in double-digits certainly by the end of the year (probably the end of the summer).    

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When we hear the deep pain of our average citizens, they are told with a round about manner that there is no more money.  We are broke.  This is true.  Yet over and over banks and Wall Street get hand out after hand out and policy that is conducive to their well being.  Not from a current savings account since there is none to be found but from future generations and the sustainability of our country.  The public was mislead to believe that Wall Street survival in its current form was the only way to assure the prosperity of America.  This has turned out to be a ruse of historical proportions.  If we even think about the two biggest purchases Americans make, that of the automobile and home they are no where near their historical peaks:

For an entire decade, auto sales averaged about 16 million per year.  At times in the debt mania, the seasonally adjusted average went up to 22 million and 20 million.  This is simply astounding.  If we are to examine the troubles of the auto industry we need to only look at the current sale count.  The current SAAR is hovering around 9.89 million.  We are at half the volume from only a few years ago.  The psychology that fueled the auto industry was partly based on the ever growing desire for more and more with deeper debt.  Marketing and advertising attempted to convince would be buyers that the thing to do was to buy the next shiny model.  This of course for many cars is utterly unnecessary.  Instead of 3 years, many cars with basic maintenance can go for 5, 7, or even 10 years.  Yet this idea propelled more and more people to buy out of want instead of need.  With our current stock, we have enough cars for many years.  This same pattern applied to the housing market.

Home building went for a once in a lifetime building spree.  It wasn’t like the United States experienced some kind of second Baby Boom but it experienced an obsession with real estate.  The home became the vector to transmit the debt bubble.  After all, what can be more secure than a home?  Yet the home became more than that.  The home transformed into a mini bank with phony valuations that allowed many Americans to drain their own wells and live a life that was fully beyond their means.  The stock market collapsing with its wild fluctuations is merely deflating after a decade long bubble.  There was no justification given population growth for the boom in homes.  Price jumps were purely based on speculation and easy access to credit.  The fact that in many of the regions in the country one can buy a home for half off is no random event.  It is a mere reversion to the mean.  We are trying to find the actual equilibrium but after a decade of high finance, how can one say that the bottom will be reached after a few months?

We have enough housing for many years and many people including Wall Street depended on the housing market perpetually going up.  What industry will fill this gaping hole?  The homeowner vacancy rate still stands near record levels:

Since 1960, the average rate hovers around 1.58.  We are at 2.7 still near the all-time high of 2.9.  What this tells us is we have plenty of housing to work through the system.  So let us look at some data:

Total Housing Units:               130,429,000

Occupied:                                111,368,000

Owner:                                                74,942,000

Renter:                                                36,426,000

Vacant:                                    19,061,000

As you would suspect, the owner occupied number has fallen by 203,000 from last quarter and the renter amount has risen by 748,000 given the current foreclosure crisis.  The bottom line is that there is still too much housing on the market.

So as we continue with the decoy bailout of Wall Street, we will still be looking at main street indicators to get a better sense of when we can expect recovery.

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How the investing world quickly forgets.  If we go back into the distant future of March 2009, you would remember that on a panic filled day, the S&P 500 flirted with the 666 low.  Since that day, the S&P 500 has rallied an astonishing 41 percent in only a 3-month period.  Yet as astonishing as this is, the stock market is still down 40 percent from the peak reached in October of 2007.  We are now 2 years into this economic downturn yet the sentiment for many investors has shifted from apocalyptic to outright giddy.  Somehow 26,000,000 unemployed and underemployed Americans does not conjure up visions of a healthy economy.

If we are to carefully look at actual indicators of commerce and fix our gaze away from the banks, we realize that we are nowhere out of the woods just yet.  Take a look at world industrial output:

*Source: Voxeu

Now this chart in itself should put a damper on any notion that we are fully in recovery.  Let us forget about the underemployment measure now being at 16.4 percent and growing.  If we think back to early 2008 part of the idea that this economic recession would not be so deep stemmed from the idea of decoupling.  That is, the world would keep chugging along while the U.S. and other industrialized powers drifted into a recession silo.  This of course has been utterly off base.  This is a global recession:

Many have never witnessed a 40 percent rise in overall stock markets that occurred over  a few weeks.  We have now achieved that accolade.  Yet this is not a sign of a healthy market.  Massive volatility like this especially rapid jumps are signs of a market unsure of itself.  The fact that global stock markets are actually deeper in the red than during the Great Depression tells us that we are still very much in a precarious state.  The bet is that we will have a second half recovery.  This is the second half.

Recent data has pointed to things getting worse more slowly but that is not reason enough to celebrate.  There are deep and structural problems in the system.  Let us look at industrial production at home:

Industrial production is contracting on its fastest pace since the 1950s and the trend is still heading lower.  Unemployment is increasing at a rapid pace as well.  As we have discussed, even the slight gains in employment are occurring in large part by replacing $20 per hour jobs with $10 per hour jobs.  On the surface the decrease in unemployment is good but is it really when we examine which jobs are replacing the old?  If anything, the middle class is being squeezed further and further.  Disposable income has collapsed since the recession hit:

This of course sends ripples through the global system.  Many countries depend on the United States purchasing goods and with less disposable income, many Americans are pulling back and spending less.  This is also occurring in more affluent countries dealing with their own aftermath of the recession.  It is only logical to see contractions in global trade.

Some people are wondering why all the bailouts and quantitative easing have failed to stimulate the economy?  First of all, the multiplier is below 1.0:

This is the first time it has gone below zero since the data series started in the early 1980s.  What this means is that the government printing money has less and less of an impact in the real economy.  How else would you explain that nearly $14 trillion in bailouts and commitments, one year of U.S. GDP mind you, can have so little real world impact on the real economy?  First, much of the money has gone into the repair of the banking syndicate.  That is, money was pumped into the banks and has remained their even though the purpose was for it to be lent to the public.  If you have any doubt, I give you exhibit a:

The contraction in consumer credit is the first one in nearly 20 years.  Something tells me we didn’t make $14 trillion in commitments and bailouts in the early 1990s.  So as the real world tracks the Great Depression in many key aspects, the investing world keeps on believing in the green shoot argument.  The second half is here and the clock is now ticking.

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