Thursday, December 29, 2011

Strategic Defaults Will Save the Housing Market

Walking away from a lousy, money-losing deal is lauded in the business world as a smart thing.  That is, if the walking is done by a corporation.

In the case of the drowning homeowner groaning under a mortgage that costs far more than his house will ever be worth, walking away is branded as irresponsible and un-American.

American Airlines decided to declare bankruptcy as a strategic move even though it could still afford to pay its bills.  It was losing money and didn’t want to “throw good money after bad.”  Its move was hailed as a smart business decision.

If a homeowner kept paying off debt attached to an asset that tumbled in value and would never recover, he/she would also be throwing "good money after bad."  Same situation, opposite outcome.

Candidate Barack Obama promised to set up bankruptcy courts for primary residence homeowners to restructure their mortgages when he became president.  That never happened. 

The banks’ attitude is do what I say, not what I do.  To paraphrase the business writer James Surowiecki in his article, “Living By Default” in the 12/19-12/26/11 issue of the New Yorker:

Banks] could have kept people in their homes by writing down mortgages, just as American’s restructured debt will reduce payment to its lenders.   
 Read “restructuring” as “reduce to manageable size".

There are ideas floating around that can ease the plight of underwater homeowners without involving taxpayer subsidies or rewarding irresponsible borrowers.  Eric Posner and Luigi Zingales of the University of Chicago suggest that banks:

[I]n exchange for writing down mortgages [reducing principal] in hard-hit areas [like Detroit, where 1 out of every 4 homes is a foreclosure], lenders would take an ownership stake in a house, getting a percentage of the capital gains when the house is eventually sold.
The “walk away” double standard burns homeowners’ dwindling cash reserves.  Banks count on social pressure to keep their borrowers from doing the smart thing.

To their delight, they keep collecting monthly mortgage payments from faithful underwater borrowers.  Therefore, they have no incentive to modify mortgages, whether allowing them to be refinanced at a lower fixed rate or reducing principal.   

Why should they, when they can take it all?  The status quo bleeds the homeowner dry at a quicker pace and gives the banks more money to leverage and loan.

All homeowners and sympathetic citizens [we’re in this together] have got to realize that it’s them or us, and do the smart, effective thing.  Strategic default as policy!

Saturday, December 24, 2011

Bank of America's $335 Million Settlement Is the Cost of Doing Business

Bank of America agreed to pay the largest award in history for violations of fair housing laws.  Even so, the amount doesn’t come close to the injuries suffered.  I can only hope that the agreement spurs Eric Holder and the Department of Justice onward as opposed to resting on their laurels.

After an investigation of Countrywide Financial that focused on the years 2004-2008, the DoJ found a widespread pattern of blatant discrimination.

Bank of America, which absorbed Countrywide in 2008, agreed to pay $335 million to settle claims that it discriminated against minority borrowers by making them pay higher fees and placing them into costly subprime mortgages when they had the same credit histories as non-Hispanic whites who received prime mortgages.

Because subprime mortgages offered a higher yield, investment banks snapped them up to bundle, tranche and resell them to eager investors.  Countrywide brokers received a higher commission for signing borrowers to subprime contracts and independent brokers contracting with Countrywide were paid even higher commissions than that.

This settlement wasn’t a matter of ideological bias.  It was based on statistics; in other words, counting heads.  The Department of Justice compared the number of minority borrowers with non-Hispanic white borrowers who shared the same proximate credit background:
The odds of a minority applicant being steered into such a loan were more than twice as high as those for a non-Hispanic white borrower with a similar credit rating, the department said.  About 2/3s of the victims were Hispanic and one-third were black, the department said.

If a judge approves the settlement, victims will receive between several hundred and several thousand dollars, with larger amounts going to those who were steered into subprime mortgages despite qualifying for regular loans.
Even though this was by far the largest amount paid by a violator of fair housing laws, the monies paid to aggrieved parties will barely dent their injuries.  Most of the victims were placed in ARMs (adjustable rate mortgages).  As opposed to a fixed-rate mortgage where a borrower paid the same amount of interest over the life of the loan, an ARM started with a low “teaser” rate.   

If it was a 2/28 ARM (a very popular form of subprime mortgage) after two years the interest rate could ratchet up 3-4 times higher.  To give an example, a 30-year 4% fixed-rate mortgage on a $500,000 loan averages out to about $2,400 monthly.  If the ARM jacks up to 10% after two years, the monthly payment becomes $4,220.

Conservatively speaking, using the figures supplied by the Justice Department investigation, 10,000 homeowners were put into subprime mortgages under false pretenses.  According to the above calculations, each borrower paid an excess of $21,840 annually (the difference between 4220 and 2400 [1820] x 12). 

$21,840 x 10,000 homeowners is an eye-popping $218,400,000, 65% of the total settlement.  In other words, the settlement for Countrywide’s malfeasance (now Bank of America’s liability) would barely make the injured homeowners whole for one year.

Countrywide’s criminal practices allowed it to accumulate $200 billion in assets until it collapsed and was taken over by Bank of America for $2.8 billion.  Don’t mean to compare apples with oranges, but while Bernie Madoff’s victims howl to be made whole, management at these mortgage lending criminal enterprises skimmed hundreds of millions off the top and walked away, possibly suffering small fines (the cost of doing business), while their bleeding victims fight desperately to forestall homelessness.

Saturday, December 10, 2011

Cassandra's Predictions: Financial Tips to Pick Off Spoils from 1%

If you believe in psychic powers and/or future forecasting, you ignore Cassandra at your peril.

1) Mario Draghi, head of the ECB, will never allow "Club Med", etc. debt to be monetized.  If you haven't already, buy credit default swaps on eurozone sovereign bonds.  Even Merkel wouldn't dare prevent all holders from qualifying and collecting.

2) Facebook pre-IPO stock at artificially bargain-basement prices has already been allocated in the secondary market (or through some other opaque mechanism).  Short it for a month after the IPO.

Thursday, December 8, 2011

$7.7 Trillion to Banks Minus $7.4 Trillion from Homeowners = Debt Slavery




An unelected group accompanied by bankers as their board of directors, The Federal Reserve secretly lent $7.7 trillion to financial institutions during the economic collapse, according to Bloomberg News, which has been trying to get Fed records since 2009.  The Fed and the banks have fought disclosure all the way to the Supreme Court, which turned down the case.  Congress didn’t know about the money, even when it was debating TARP, the controversial $700 billion bank bailout pushed by then-Treasury Secretary Hank Paulson.  Many Treasury employees under Hank Paulson didn’t know about the secret lending program.  Even some Fed governors didn’t know about it:

The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.”

$7.7 trillion is more than half the U.S. annual GDP.  One can only conclude:

a)      The too-big-to-fail banks were in much worse shape than they told their shareholders, depositors and the world;
b)      If the extent of their insolvency was known, Congress might have pushed for greater restrictions, such as breaking up the banks.
c)   We should have shut them down and started new banks like the North Dakota State Bank.

During one day (12/5/2008) banks required a $1.2 trillion infusion.

The six “too-big-to-fail” banks (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley received $160 billion from TARP but borrowed as much as $460 billion from various Fed lending facilities, including the Term Auction Facility (TAF).   

In a letter to shareholders, Jamie Dimon, the CEO of JPMorgan Chase, said the only reason it borrowed any money from the Fed was to encourage other banks to borrow to lessen the “stigma”:

He didn’t say that the New York-based bank’s total TAF borrowings were almost twice its cash holdings or that its peak borrowing of $48 billion on 2/26/2009 came more than a year after the program’s creation.

The Fed justified its actions by claiming that its programs prevented a collapse of the financial system and “[kept] credit flowing to American families and businesses.”  This was not true.  Most businesses had trouble borrowing even with good credit.  Despite their easy access to funds, banks became extremely risk-averse.  The credit lines of small businesses and individuals were cut.  The Fed also said, “all loans were backed by appropriate collateral.”  If the collateral was “appropriate”, why would the banks need so much money?

At the same time that they were accepting so much money and lying to their shareholders and the world, the big banks fought fiercely against regulation, particularly the idea that they should be broken up.  The epithet “too-big-to-fail” meant that a collapse in one sector would cause a chain reaction leading to systemic financial meltdown.

By keeping the true nature of their insolvency secret, the Fed and the banks conspired to maintain and enhance their monolithic power.  This is moral hazard on a global scale.  The market perceives that the government won’t let these banks fail because of their size.  Therefore, the big banks borrow money at lower rates than other businesses that don’t jeopardize the world financial system.  The bankers speculate wildly because they know the losses will be borne by the taxpayers, thus ensuring a future collapse.

The Federal Reserve, an unelected body, basically decided which businesses would live or die.

Here are two figures:

The Fed acting in secrecy plugged a $7.7 trillion hole in the rapidly collapsing banks.  At the same time,
$7.4 trillion was lost in housing wealth by the middle class when bubble burst.

That’s the amount of wealth that’s been lost from the bursting of the housing bubble according to the Federal Reserve’s comprehensive Flow of Funds report.  It’s how much homeowners lost when housing prices plunged 30% nationwide.

Nobody stood by to bail out the homeowner.  The middle class, the engine of prosperity, was being destroyed.  Wage gains over the past few decades were negligible or declining.  Households kept up with spending with two working adults instead of one.  Then housing came into play as a tradeable asset and asset prices rose.  Values soared far beyond objective touchstones.  You couldn’t get a raise or make money in the stock market, but you could refinance your house in order to spend.  That bubble spending spawned auxillary businesses and jobs, all of which are now gone with the wind.

 “[O]n average, American homeowners lost 55% of the wealth in their home.” :

For the 22 million families right in the middle of the income distribution (those making between $39,000 and $62,000 before taxes) about 90% of their assets was in the house.  Now half of their wealth is gone and it will never come back as long as they live.

The engine has sputtered to a stop.  The middle class is mired in debt.  28% of all U.S. mortgages are underwater.  People are faithfully making their mortgage payments with no hope they will get out from under their enormous overhang of debt, praying that they don’t get sick or fired.  There is no extra money to spend.  The American consumer, responsible for 70% of GDP, is tapped out.

Our leaders aren’t acting or even talking seriously about this crisis.  But why should they?

With the upper classes prospering and global markets booming, they don’t need the U.S. middle class anymore.  The market is up, profits are soaring and the corporate jet is fueled and ready for takeoff.

And the middle class can’t buy bread?  Let them eat cake.

When the bubble burst for the homeowner, the value of his house went down.  His mortgage, however, stayed the same.  Commercial real estate debt could be restructured in the courts; not so for residential mortgages.  Ordinary market rules don’t apply.  William C. Dudley, the president of the Federal Reserve Bank of New York (Tim Geithner’s old haunt) contrasted the separate systems of working out troubled debts:

”In contrast to the efficient mechanisms in place in the commercial property market…the infrastructure of the residential mortgage market is wholly inadequate to deal with a systemic shock to the housing market.  Left alone, this flawed structure will destroy much more value in housing than is necessary.”

Many homeowners resent any sort of substantial mortgage modification or heaven forbid, principal reduction because they perceive themselves as responsible and the others irresponsible.  They did not borrow more than they could afford.  Others lied about their income, bought McMansions on a janitor’s salary and were otherwise profligate.  This is the same moralizing that cuts off your nose to spite your face. 

The housing story is a tawdry one, starting with poorly explained and badly underwritten subprime mortgages given to unqualified borrowers sometimes financing 100% of the cost.  Wince while following the chain of private-label securitizations which enriched every link with fat fees starting with the mortgage broker who was paid for every loan he made however rotten, the investment banks pooling the toxic mortgages together and slicing the sausage slapped with a phony triple-A rating and sold to investors who didn’t do their due diligence.  The securitization machine was so fast and sloppy that proper recordkeeping wasn’t done and papers proving ownership were lost or forged.  However, if you focus on the tree, you can’t see the forest.  Take another case: Germany’s self-righteousness may lead it into poor bond auctions and credit rating downgrades:

[F]ocusing on such outrages can obscure what needs to be done.  By now we should understand that the problems went far beyond the subprime market.  There are many prime loans, made to responsible borrowers with good credit, that are in deep trouble.  Property values did not collapse only in the neighborhoods where dubious loans were being made.

Housing prices are still falling.  Banks are still making fees servicing mortgages, delinquencies and foreclosures.  Over the last two quarters the percentage of underwater homeowners has increased by 25%.  As housing equity declines, the homeowner groans under more and more debt until it becomes “unsustainable”; that is, all his excess income is going to pay the mortgage.  He has no job mobility because he can’t sell his house.  Federal, state and local governments are slashing their budgets, laying off millions of workers.  The private sector has moved its operations overseas to emerging markets, local labor and consumers with discretionary income.  They’re hiring over there, and cutting jobs here.

Moral superiority and righteousness can drag us down the road of austerity just as it’s doing in the Eurozone.  Just as the Fed made its choice with its unlimited secret trillion-dollar lending program, so too do unelected banking representatives put in place in the Troika, Greece and Italy make their decisions based on austerity for the underclass.  As an economic growth engine, austerity is genocide for the people.  For the banksters seeking to wring every dime from a pauper, it’s manna from heaven.  For the self-righteous like Jens Weidmann, head of the Bundesbank, it’s tough love and just desserts for the wastrel “Club Med” countries. 

It’s as though The Merchant of Venice had a new ending: Shylock gets his pound of flesh on a platter.  In exchange for a neat billion-dollar package, the dutiful country will slash salaries and hike taxes on the working and middle class.

You can see an example of the two sides of the coin within Ireland:

The German chancellor, Angela Merkel, recently praised the Irish prime minister, Enda Kenny, for setting an “outstanding example” while the French president, Nicolas Sarkozy, declared that Ireland was already “almost out of the crisis.”

The Troika and other financial powerhouses (I’m sure Geithner and the president are there, too) are happy.  But the Irish people are suffering:

Salaries of nurses, professors and other public sector workers have been cut around 20% [that’s in 1 year].  A range of taxes, including on housing and water, have increased.  Investment in public works is virtually moribund.

On Monday and Tuesday, Mr. Kenny’s government is announcing an additional 3.8 billion euros in tax increases and spending cuts for 2012 that will affect health care, social protections and child benefits.

There are glimmers of statistical recovery which are belied by the lack of demand and unemployment ticking up to 14.5%.  The rate would be even higher if it weren’t for so many natives leaving for other countries and the hope for more opportunities.  Highly trained professionals such as accountants, engineers and dentists are moving with their families for Australia and Canada and they’re not looking back.

The Economic and Social Research Institute, based in Dublin, “cited an expected recession in the wider euro zone, in part because the austerity being pressed on much of Europe by German and the ECB is seen as worsening the prospect for recovery rather than improving them.”:

”The present situation contains elements reminiscent of policy during the Great Depression, when a mounting crisis was confronted by an orthodoxy that resulted in great poverty that could have been avoided,” the institute wrote in a report.

The only thing the powerful care about in the developed world, the U.S., the UK and Europe, is reverse Robin Hood.  Take from ordinary folk, the taxpayer, to pay off the creditor.  Everything else has no importance.  Only money and debt have value.  In this cruel, cold, pitiless and deadly world, only the vulnerable are attacked because in essence the power structure is craven and cowardly.  It goes after the easy marks, the powerless and gladly bends on its knees to those who can shower it with gold.  Simon Johnson, the professor at MIT’s Sloan School of Management and a former economist at the IMF, predicted the global takeover of predatory finance in his essay The Quiet Coup, comparing the capture by financial oligarchs to emerging market behavior and emerging market-crises:

”The euro zone is entering a very serious slump…Why Ireland would want to send its time being a model student in the context of the broader European mishandling of the situation, I don’t know.”

In the meantime, the Irish are shining their lights on the Occupy movement:

On a recent frosty night in Dublin, David Johnson, 38, an IT consultant, stepped outside a makeshift camp set up by the Occupy Dame Street movement in front of the Irish Central Bank.

“This is all new to Ireland,” he said, pointing to tarpaulins and protest signs that urged the government to boot out the IMF and require bondholders to share Irish banks’ losses that have largely been assumed by taxpayers.  “The feeling is that the people who can least afford it are the ones shouldering the burden of this crisis.”

Here ye, here ye!  An I.T. consultant sympathetic to the Occupy movement!  How can that be, when we are all told that we are ignorant and must be reborn as software engineers or else we cannot stay?  Well, what kind of system is this?