Down Goes Frazier! Down Goes Frazier!

In This little E-Mail Box Of Mine .........

Michael:
Insuring lenders won't help if they don't have the capital to make loans!
Keep in mind, the assets that are currently hurting us so badly have been mostly written down to levels that are blind to any fundamentals. I'm seeing AAA-rated mortgage backed bonds (Alt A) trading at 40-50 cents on the dollar. For one particular issue I looked at today, 5% of the underlying loans are delinquent and there are no option-ARMs in the portfolio.
You can buy this today and not lose a penny of your investment, even if over 80% of the loans eventually default and you only collect 50% on the defaulted loans. On top of that, you get a 15%+ yield. (the numbers are all approximate because there is no real market for these assets, regardless of their intrinsic value)
These are the kinds of assets that the government would be purchasing. Unless you see the end of the world coming, the taxpayer would make money on credits like these, especially if the government is not permitted to buy these at a premium to their current marks (which I believe the bill would have required)
This just highlights the extreme levels of fear in the market. No one is buying. If the government doesn't intervene, this only gets worse.
Panic isn't stopped by panicked investors. Panic is stopped by an entity with a long time horizon and a big balance sheet. Right now, the government is the only player who fits that profile.

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I have been in the camp that believed that the government had not sufficiently made the case for such a massive bailout. The events of the last several days have changed my mind. I read today that banks across Europe are collapsing.
That said, the original bailout plan was conceived too quickly, was too favorable to the finance companies and gave too much power to one person. The revised plan was an improvement but was still insufficient.
There is no doubt that a bailout/rescue bill of some type will be passed before Congress leaves town. However, the odds have improved that we will see a plan that gives taxpayers a better shake.
As much as I hate the idea of a bailout, the alternative would likely be very painful for most of us who read this blog. Very few of us will enjoy Schadenfreude if the economy takes an excessively hard landing.
This isn't about propping-up the housing market...that's probably toast for the next 2 to 3 years at least. Home prices are going to have to reach an equilibrium level and this bailout plan is not designed to keep that from happening

--------------------------------------------------------------------------------------------------"Credit should remain available unless the Chinese change their mind about investing their huge surpluses in the US."
It's not as easy as that, unfortunately. As the world economy downshifts dramatically, much of the "surpluses" that China has been running will disappear. I think we will discover in short order that it really wasn't Chinese "savings". They are a growing economy, with a limited system of financial intermediation and tremendous poverty still, and they have been going flat out investing in their own country.
Much of the "savings" has been an illusion. They are the flip side of our trade balance. We borrow dollars against our houses and assets. We then ue those dollars to buy Vhinese goods. Chinese exporters give those dollars to their central bank. Their central bank "prints" yuan to give to the exporters, who then spend those yuan in domestic investment and consumption. This leads to price inflation in China (because the central bank is printing) and credit inflation in the US. The price inflation in China ultimately destabilizes their economy because of the pressure on profits and on the population. The credit inflation in the US leads to asset bubbles that are unsustainable in that the credit used to elevate the price cannot be repaid out of income. And around it goes.
When the lenders fear they will not be repaid (whether in the US or in China), and the producers cannot profitably run their businesses and/or the population cannot afford to eat (this is starting to be the case in China), the system collapses. All ponzi schemes end, and the fact that this one is collapsing at record low real interest rate levels should tell us volumes about what a mess the Fed has created by consistently trying to force real interest rates below their equilibrium level for so long. Those who on this blog used to argue that the Fed is so much smarter now than in the 1930s should really think about where we have arrived after all this "smart tinkering".
Any attempt to seriously "inflate" away the problem spooks the lenders and they stop lending. Deflation assures that the creditors are at least partially repaid with valuable currency, but it is extraordinarily painful to those leveraged buyers who were counting on "inflation" to bail them out, and iof course certain creditors will be out of luck anyway.
And so, we are at a macroeconomic impasse. I firmly believe that the guys who got us into this mess are not going to be able to get us out. But they sure will try!

Thoughts On The Bail Out

We're just rewarding bad behavior and punishing good. The responsible folks, who don't borrow beyond their means and make all their payments, have to bail out the irresponsible borrowers who took loans they couldn't pay back, and the unscrupulous banks that lent money to irresponsible borrowers.
People and institutions that make bad financial decisions should pay for those decisions. Where's my interest rate reduction, or my loan principal write-down? Oh, that's right, I don't get any breaks, because I pay my bills, so I get punished for my financial responsibility. I just have to pay for your bail out.

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Actually, I wouldn't say it is rewarding the bad behavior.
The owners (stock holders) of those banks already lost almost all their money.
And if there is no bailout, everyone will be punished, in term of economy and jobs. With bailout, at least we won't get into Great Depression 2.
Without bailout, the chance of anyone getting any mortgage is close to nil for the next year or so. It won't matter whether the price tanks...because it will because nobody can buy it. The renters will be locked out of the market, not by price, but by financing (or lack of).
With bailout, the price will still tank. However, buyers will hopefully get reasonable financing options, so we can actually take advantage of the situation.
I hope some people like to see others suffering.... to me, I don't care whether others suffer. I only care if I can take advantage of the situation.

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If the bailout works, it will work because it re-instills confidence in the current economic system. Economists, even today, only really can explain about half of all economic activity.The neoclassical model is particularly bad at modeling actual human behavior because humans don't tend to act like the "rational man" of their theories.
The overwhelming majority of economists agree that the New Deal lessened the effect of the Great Depression, the main problem is that the stimulus was not sufficient enough. This was proven when we entered WWII and government spending rose to 50% of the economy and full employment followed. Even during the period before the war, the economy grew at an average of 9-11%, the fastest economic growth period we have ever seen outside of wartime.

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The overwhelming majority of economists didn't think there was a housing bubble either. In truth, the overwhelming majority of economists are fools

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If we're going to have a socialized mortgage market then let's at least make sure to socialize the profits as well as the losses.

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and the band plays in......

Its getting very interesting.....

"The housing correction poses the biggest risk to our economy," Paulson said the day he announced the Fannie and Freddie seizure. "Our economy and our markets will not recover until the bulk of this housing correction is behind us."

Some experts even argue that the steps being taken to rescue firms like AIG could make a recovery in housing and the broader economy more difficult, as financial firms and investors become more reluctant to lend money.

"We are certainly taking credit and squeezing it tighter and tighter," said Kevin Giddis, managing director of investment bank Morgan Keegan. "Housing needs buyers. Buyers need credit."

1 Year price differance Aug 2007-Aug 2008

ATL -8.5%
Boston -5.5%
CLT -1%
CHI -9.5%
Cleveland -7.3
Dallas -3.2
Denver -4.7
Det -16.3
Vegas -28.6%
L.A -23.3% (Southern Cal)
Miami -28.3%
Minn -13.8%
NY -7.3%
PHX -27.9%
PTL -5.8%
San Diego -24.2%
SF -23.7%
Seattle -7.1%
Tampa -20.1%
Washington DC area -15.7%

A Little Light In This E-Mail Box Of Mine

Cycles: Seen them before, we'll see them again.
We have been through the cycles of the real estate market before , and we will go through them again. Right? We have seen the rise and the fall of the stock market many times, gold, oil ,copper, coal and any number of other markets and will see them again. Right?

When I trained traders on how to handle markets, the lesson was that nothing goes straight up, and nothing goes straight down, but we move and pull back, move and pull back. Everything is cyclical. Right? We have seen the meteoric rise of real estate, and at least in the residential markets a sizable decline. By my reckoning we are now due for a rise. Is that right?

Past Cycles and Fear

We saw it in the late 1980's and early 1990's, when the market pulled back, provided a buying opportunity, and then took off again. Lesson two that I would teach is that you would need to be a buyer when the lump in the pit of your stomach made it the hardest. When fear was the greatest and you were rushing in to buy as the sellers were running past you in the opposite direction. You need to buy when no one else is willing to buy. Is that where we are now?

The Present and The Future

There are some differences this time, primarily that it is not the asset itself that is the problem, but the financing mechanism. In the other real estate recessions we had supply and demand problems: that is to many properties and not enough buyers (although in some geographic areas like Florida and Las Vegas they have both problems). Now what we have is a crisis in the mortgage markets, that have caused even the most credit worthy borrowers to have an extremely diifcult time getting a loan.

We also now have huge institutional investors sitting on the sidelines with a ton of cash at the ready to jump in and buy, when they determine that the time is right. That is a good thing. We are in an extremely news driven environment, where at least at this point in time the news could not be darker. We have financial institutions like Washington Mutual and Lehman Brothers among what will probably be others that are trading as if they appear to be the next in line for a Federal bailout. Is this that time when the bold will jump in? Some may, while other may wait.

The smart money will be buyers, at a time when hindsight says it was the perfect time. Others will get in after they are sure it was a market bottom, while others will be last to the new party and be left holding the bag in this new cycle.

The Moral of the Story

One thing is for certain. We are in the downside of the cycle, that will ultimately bottom at some point, the news cycle will turn suddenly bright, and many "smart" and "bold" people will make a great deal of money. When that is going to be is for smarter minds than me to determine, but one lesson from the past is true.

Real estate is not only location, location, location, but now more than ever it is going to be timing, timing, timing. And "those that cannot remember the past are destined to repeat it."

The shoe has fell.....

After weeks of anticipation and speculation, Treasury Secretary Henry Paulson announced that the federal government had taken over Freddie Mac and Fannie Mae.
Most of the day both before and after the seizure was announced television and Internet news sites were filled with comments and reactions from business writers, financial analysts, and presidential and vice presidential candidates. The general theme was that the takeover had to be done; that the two corporations were in critical condition and would probably continue to decline thus increasing the ultimate rescue costs; and that they were "too big to fail." There were, however, a lot of experts who questioned the method and scope of the action.
No one is really sure what the takeover will cost - estimates range as high as $200 billion - but it is clear that taxpayers and some stockholders are going to take a bath. It is also questionable just how much the drastic federal move will impact the housing slump, foreclosures, interest rates, or lots of other things that were given as reasons for the action.


Here is what we do know.


The two mortgage giants are now operating in a government conservatorship that will be administered by the new Federal Housing Finance Agency (created under the same Congressional authority that authorized the Treasury Department to shore up Freddie and Fannie. James Lockhart, former director of the Office of Federal Housing Enterprise Oversight which had responsibility for the two government sponsored entities (GSEs) is the new director of the Finance Agency.
The Conservator will control and direct the operation of the Company and will have all the powers formerly held by the shareholders, directors, and the officers of the Company and conduct all business, collect all money due to the company, preserve the assets and property of the company, and contract for any assistance necessary.
In return for providing funds to guarantee their debt the Treasury Department will immediately receive $2 billion in preferred stock that will pay a 10 percent dividend. $1 billion of the stock will come from each of the two companies and the Conservatorship will purchase additional stock, perhaps as much as $100 billion worth, if the GSE's capital reserves fall below an agreed upon level. This preferred stock will take president over any claims by holders of common or the existing preferred stock.
According to Secretary Paulson, the GSEs will modestly increase their mortgage backed securities portfolios through the end of next year "through prudent mortgage purchases" and will then reduce those holdings by 10 percent per year after 2009. The portfolios shall not exceed $850 billion for each company. An Associated Press article quoted Mark Zandi, chief economist for Moody's Economy.com, as saying this will effectively make the federal government the nation's mortgage lender.
It appears that Treasury is primarily interested in protecting holders of GSE debt. This class of creditors includes many large investment companies and a number of foreign governments.
The Treasury Department is establishing a new secured lending credit facility which will be available to the two GSEs and to Federal Home Loan banks.
Both CEOs - Fannie's Daniel Mudd and Freddie's Richard Syron - have lost their executive positions and mammoth salaries although it appears that each has agreed to stay on to assist in an orderly transition.
The conservatorship is open-ended in terms of time. The conservator alone will make the determination that the companies have returned to a safe and solvent condition.
There is much about the effects of Sunday's actions that is not known at this time and some who commented on television and print on Sunday seemed shell-shocked by the extent of the action. Several financial reporters commented that Treasury had acted far more broadly than anyone had expected.

Among the current imponderables:


What is this whole thing going to cost? As stated above, the number $200 billion is being bandied about as a direct cost, but it is impossible to measure the losses that will spread throughout the economy. The common and preferred stock is widely held by individuals, entities such as pension funds, and other financial institutions of all sizes. While these stockholders have already watched their investments plummet in value over the last 18 months, will they lose everything? Several of Paulson's statements on Sunday seem to indicate that possible losses to stockholders in the financial sector may determine the treatment of all stockholders. Pardon the cynicism, but this apparently means that big business interests will be protected.
How great will be the impact on the housing market? There seems to be a consensus that there will be little impact on the numbers of houses for sale and that home prices will continue to fall; less conviction than hope that mortgage rates will come down. Optimists say the takeover will increase the stability of and confidence in the credit market and could result in a reduction of as much as one quarter to one percent in rates.
Have lending standards already been tightened sufficiently since the subprime crisis began or are borrowers and lenders in for another round of rules that will make it tougher to obtain or grant financing?
It appears likely if not certain that fees charged banks for loan securitization services may be reduced which could lower the costs of obtaining loans.
What will happen to homeowners who are already in trouble with their mortgages? In the case of the recent closing of IndyMac Bank the FDIC almost immediately announced a program to assist these borrowers and it is clear that the government has no desire to own hundreds of thousands of foreclosed homes. Some commentators mentioned an expansion of the Hope Now program, but the sheer magnitude of the problem could be overwhelming.
Immediate reactions to Paulson's announcement on Sunday were mixed although most reactors seemed to feel it was appropriate and inevitable. Some questions were raised as to whether the takeover was too radical or did not go far enough. The presidential candidates expressed a range of support for the Conservatorship. Barack Obama commented on ABC's This Week that he felt no class of investors or debtors should carry more of the burden than others. The Republican candidates both applauded the action.
The impact on the stock market cannot yet be determined although the Asian markets were reacting favorably as was the futures market. It will be an interesting day on Wall Street.
The Conservatorship will obviously be big news for many months. We will periodically update the reactions and the effects as they become known.

Tid Bits For Friday

The two firms (Fannie Mae / Freddie Mac), which were set up by the government, own or back about $5 trillion worth of home debt - half the mortgage debt in the country. Since last summer, they have suffered about $12 billion in losses. Fannie and Freddie have become virtually the only source of funding for banks and other home lenders looking to make home loans. Their ability to do so is crucial to the recovery of the battered home market and the broader U.S. economy. The two firms buy loans, attach a guarantee, then sell securities backed by the loans' income stream. They have been badly hurt in the last year by the sharp decline in home prices and the rise in mortgage delinquencies and foreclosures. Shares of the two troubled mortgage giants have plummeted more than 80% this year on fears about their financial health in the wake of the housing crisis. Saving Fannie Mae and Freddie Mac could [will] cost the U.S. taxpayer. But so could letting the two mortgage giants collapse. A rescue plan that uses federal dollars would risk increasing the deficit and possibly lowering the U.S. debt rating, making it more expensive for the government to borrow in the future. A decision not to intervene could lead to deep pain in the mortgage market and the parts of the economy tied to it. Presidential Cannidates also have their own views on the housing market. Some advocate letting the free markets play themselves out with little government intervention. Ron Paul is the biggest supporter of this. Paul does not support the increase in relaxation of guidelines in such programs such as the FHA programs and Fannie Mae guidelines. As you may be aware, President Bush has been pushing for increases in FHA and Fannie Mae loan limits as well as proposing a freeze on current ARM rates for buyers who have been making their payments on time at the introductory rate, but may have difficulties once their rates reset. Barrack Obama sees a much different root problem and solution to it. His answer is for more accountability in the real estate industry itself. Obama plans to go after the lenders, banks, loan officers and realtors who may have misled buyers as far as the programs that they were getting themselves into. He proposes increased penalties and tightening of guidelines for predatory lending, and does not necessarily believe that direct government intervention other than tax breaks for middle-class homeowners is necessary. While this is a great idea in and of itself, I do not believe that Obama has gotten to the root of the problem in his solution. Those who believe in free-market economics obviously are in support of letting the markets work themselves out. I would consider myself to lean more in this direction, although I do believe that some government protection of the industry must happen as there is plenty of room for fraud and manipulation of fees and buyers as the current guidelines now stand. We are seeing some of this happen already, specifically in Nevada and other states as loan officers are becoming directly responsible for making sure that stated income or non-verified income loans are reasonable and justified. This shifts the responsibility more on to the lending institutions and less on the borrowers. High on McCain's to-do list is something almost no Democrat or Republican leader has advocated: Raising, not lowering, minimum mortgage downpayments for the rapidly-growing FHA program. Pending bipartisan legislation on Capitol Hill would CUT FHA's downpayments from the current three percent minimum to as low as zero -- favored by the House -- or to 1.5 percent -- favored by the Senate. "So many homeowners," he told a California audience, "have found themselves owing more than their home is worth because they never had much equity in the house to begin with." He said he opposes bailouts of lenders who made bad loans, which would in effect be rewarding them for their own poor underwriting decisions. But short of that sort of collapse, he thinks lenders today ought to modify borrowers' loans, reduce principal debt and interest rates -- taking the hits to the bottom line themselves -- rather than looking to the federal government. He said when there are no good measures of the true value of mortgage bonds -- when no investors want to buy them and no index tracks them -- current accounting rules may make lenders' balance sheets look far worse than they really are.

Recover in 2011

In contrast to expectations that the U.S. housing market could see a turnaround in the first half of 2009, the monthly housing price index report for June from Radar Logic suggests that recovery won't occur until 2011. According to Radar Logic's Residential Property Index (RPX), 23 of the 25 metropolitan areas surveyed saw year-over-year price declines as of June 2008.
"Not surprisingly, June 2008 year-over-year RPX values continue to show weakness," said Michael Feder, CEO of Radar Logic. Feder said a close examination shows a mix of strength as well as absorption of distressed inventory, but added that "it is too soon to call this a bottom."
The RPX is a relatively new market that enables real estate to be traded as a liquid asset, via property derivatives marketed by major financial institutions. In the June report, trading in forwards on RPX was said to be gaining momentum.
"While it is still a new market, daily contract pricing is producing a forward curve," the report said. "That curve suggests weakness through 2009, stability in 2010 and a recovery in 2011. This is in contrast to some industry economists who are calling for a bottom in 2009."